Monday, June 22, 2009

Too big to farm?...

One persistent argument arising from the financial crisis has been the issue of firms labeled "too big to fail".  It is easy to look at investment firms and banks and count the zeroes in their financial statements and come to the conclusion they are so big their failure could trigger catastrophic "knock on" failures.

Although these explanations can help account for how individual banks, insurers, and so on got themselves into trouble, they gloss over a larger question: how these institutions collectively managed to put trillions of dollars at risk without being detected. Ultimately, therefore, they fail to address the all-important issue of what can be done to avoid a repeat disaster.
Answering these questions properly requires us to grapple with what is called "systemic risk." Much like the power grid, the financial system is a series of complex, interlocking contingencies. And in such a system, the biggest risk of all - that the system as a whole might fail - is not related in any simple way to the risk profiles of its individual parts. Like a downed tree, the failure of one part of the system can trigger an unpredictable cascade that can propagate throughout the entire system.
It may be true, in fact, that complex networks such as financial systems face an inescapable trade-off - between size and efficiency on one hand, and global stability on the other. Once they have been assembled, in other words, globally interconnected and integrated financial networks just may be too complex to prevent crises like the current one from reoccurring.
Rather than waiting until the next cascade is imminent, and then following the usual modus operandi of propping up the handful of firms that seem to pose the greatest threat, it may be time for a new approach: preventing the system from becoming overly complex in the first place. [More]

While complexity is not the same thing as size, it certainly seems as size increases for any business, the complexity of their connections and risk management rises as well.  Noting the last sentence (which the author goes on to cogently flesh out), it is interesting to speculate whether agriculture has its own "TBTF" entities.

I would suggest we do, and we also have our own systemic risks.  Consider the failure of ADM or Cargill, for example. The huge dairy or supply coops. Or Deere. If you can't quite picture such a thing, that is one hint as to how their sizes make them seem invulnerable, but if nothing else, we have learned that very large businesses can almost inadvertently expose themselves to more risk than they think they really are facing.  Also recall, not long ago most Americans would have felt the same way about GM.

Consequently, as regulators begin bandying about solutions the the complexity/size risk problems, we might be surprised how that could suddenly change our commercial landscape.


Anonymous said...

Riddle me this, John. Isn't it the ability of farmers & companies to manage their risk that allows them to profit in bad times and good times? There are plenty of large successful companies that are prudent with risk mgmt and should be rewarded with sustained growth and profits. Now, I'll accept that argument that there are implications with your examples of Cargill/ADM because of the foodstuffs that they handle, but as we saw with VeraSun (too big too fail in ethanol, no?)...somebody can fill the spot vacated by poor risk takers. I trust that we would have seen the same in the banking industry had the Gov't kept clear.

John Phipps said...


I see I wandered around my point. I was thinking that while I watch curiously as TBTF institutions fall under more regulation, the metrics used (market share, for example) could suddenly affect firms we would not normally think of as TBTF candidates.

I have no idea what if any regulation is coming. I was just surprised when I tried to imagine how they would choose who to regulate.

Again, I think there is a possibility a regulation written for seemingly different sectors could show up with startling consequences in our own corner of the world.

EPA GHG permits spring to mind as an example.

John Phipps said...

Anon (II):

One more point occurs. Imagine Cargill "going Verasun". At what point would you think farmers would be more in favor of bailouts?

We haven't had a dog in the bailout fight - at least directly. Should an entity as big as ADM leave farmers without a market, I'm betting suddenly waiting for the market to eat the dead and make room for replacement could strike many as pretty harsh.

Anonymous said...

I sense that we are entering a trust busting era. It is no accident that Dupont is counter suing Monsanto based upon antitrust issues. The courts are taking notice of this. It should also be noted that several key appointments to the USDA and Dept of Justice are looking at Ag antitrust issues. The legal profession after 25 years is finally turning a corner in terms of antitrust and monopoly practices. I think it is about time this is coming to the business of farming too. Farmers operate at a great disadvantage to input suppliers and output processors. These "middle men" have captured much of the margin in ag production through market manipulation and antitrust behavior. This have left less and less margin for the actual ag producers. Trust busters for Ag, I say bring them on!

Oh and on an ending note Vera Sun was not TBTF by agribusiness standards it was small potatoes.


Anonymous said...

TBTF is a problem. When the worst run company that needs to be dismantled is TBTF(i.e. Citi, GM), this does not allow growth and innovation by their competitors to actually improve service, product, etc. The problem is the size of these firms distorting the market while simultaneously these companies prove to be too large/complex to manage well. The best analogy I can think of is a tree in a forest. No one or two tree(s) should ever be so big as to overshadow the whole forest. Sooner or later it will rot or get to big to support itself, and no amount of propping it up will keep it up permanently. The dead make way for the living or the living die too.
There were good reasons for all the financial and anti-trust regs. that were in place and have been run roughshod over for the past 30 years. When we finally admit our failure in deregulation/financial mismanagement, then we can move ahead. BTW, none of the ag firms you mention are TBTF. Their competitors (foreign and domestic) would gobble up the pieces faster than you could believe, with little more market disruption than we currently experience with the smaller scale business failures we all run into now.

Tim said...

John,International Harvester was an example of how GM should have been allowed to fail. If you look at what followed there was some pain for uaw employees who lost jobs but a more efficient buisness energed without government help.

John Phipps said...


Thanks for the great input. One final note.

Letting firms of any size fail can seem like a good idea in abstract, but I'll still wager, a failure like Cargill that would shut down elevators, hog contractors and processing plants would elicit a different response from those who depend economically on them.

This is where the "too-big" part takes effect, and where immediate personal concerns override even valid economic theory. If the number of folks affected reaches a certain critical mass, this seems to be the pattern.

I agree replacement businesses will fill in the gaps left by fallen behemoths, but not quickly and not completely. And certainly not without major dislocations among those in their value chain.