Chart of the Month – December 2018

How Big is “Too Big to Fail”?

In 2008 we saw banks that were “too big to fail” being bailed out all around the world by central banks that in effect created fiat money to bail out the banking system. This in turn created asset bubbles. Late this year we saw the first publicly listed companies break through the $1 trillion market capitalization barrier, then the FAANG bubble burst and the market took a turn for the worse in the last quarter of the year. It is noteworthy that no bank was close to the $1 trillion mark, in fact JP Morgan Chase was the largest listed bank at slightly lower than $400 billion in market capitalization. So how big are today’s companies and does the runup in the FAANG stocks qualify as a bubble? When one looks at historic markers it turns out that they are not so big at all. So why are any of today’s companies “too big to fail”?

Over the last 500 years there have been some much larger companies, and some of these did in fact fail and cause massive disruption throughout the economic world. The largest of these was the Dutch East India Company which ruled the East Indies spice trade in the 1600’s and was also a broker for tulips. By the turn of the century in 1600 tulips were already a rage and a brisk trade developed in tulip bulbs. As with all bubbles this seemed to start for no apparent reason when prices spiked in January 1637 when prices for some bulbs rose 1100% to Fl 1500 (the equivalent of three times a skilled artisan’s annual wage). This jumped to Fl 5,000 the very next month and then the market crashed. This crash affected a comparatively small number of people and the DEIC company survived quite well and continued to dominate world commerce through the balance of the 17th century and well into the 18th century. This may have been due to the fact that they were brokers and tulips were only a modest component of their business. This is underscored by the fact that this vast company would have been worth in today’s terms the equivalent of ~$8 Trillion. Notably they did not leverage themselves by dealing in credit.

Size combined with government ownership, was not enough to save either the Mississippi Company or the South Sea Company, both of which failed. Both companies had a valuation equivalent to ~$7 trillion in current dollars and both were started as monopolies by the government. The Mississippi Company was founded in 1684 to hold monopolies on trade in the French North America and the French West Indies. It is an example of early attempts to create a credit economy, on the part of the French government whose wars had effectively bankrupted the royal treasury. The company issued uncollateralized notes, guaranteed by the Crown, which far exceeded their ability to repay. However spurious claims about wealth in Louisiana encouraged the public to ignore the risk and invest in these notes and in stock of the Mississippi Company. This created an inflationary bubble, the company was unable to carry the debt and the company failed spectacularly bringing down stock markets around the region. France was left with a massive debt on top of the depression caused by the crash in the French stock market. In fact, The Mississippi Company had been acting as a central bank, creating fiat money.

The South Sea Company was another monopolistic enterprise set up by government, in this case the English Crown, to consolidate rising war debts and offset them with fishing and trading profits from the “South Seas” of the Atlantic Ocean. The company never made any profit, but the public was fraudulently encouraged to invest in this sure thing, with the Crown behind it. In 1720 the company’s promoters started to sell their stock and triggered a run on the stock which turned out to be worthless. This happened concurrently with the impending collapse of the Mississippi Company. The outcome was that England’s economy and market went into a tailspin and it took years to recover. Here too the company was acting as a central bank, creating fiat money.

We can take several interesting points from these three massive companies, one of which survived and flourished, two of which ended in tears and economic hardship for their respective countries.

Firstly, in the case of both the Mississippi Company and the South Sea Company their respective governments were complicit in the “printing of money”. The overleveraged companies failed and took their countries’ economies down and caused years of economic pain. This is not unlike the US Government having to bail out the US mortgage banking system (Ginnie Mae & Freddie Mac), which then created a global banking crisis that forced central banks to combine and print money to help prevent the failure of a global banking system. We have yet to see the final chapter written on these corrective measures. Hopefully today’s central bankers are smarter than their predecessors and are able to return their economies to a “normal” level of liquidity.

Secondly, except for Saudi Aramco, there is no company in existence today that is close to the size of these behemoths. However, there are numerous state-owned oil companies that are vitally important assets for their respective governments. Saudi Aramco, Petro China, Rosneft (Russia), National Iranian Oil Co, Pemex (Mexico), Petroleós de Venezuela, Nigerian National Petroleum Co. and Petrobras (Brazil) are but a few. These companies are all vulnerable to manipulation by their respective governments who do use them to enhance the finances of the state. An extended oil price decline could bring large economies crashing down with it in much the same way that The Mississippi and South Sea companies ruined the French and English economies so many years ago.

Thirdly we can see that in today’s economy the mightiest companies are relatively new players, all in the tech sector. We also know that they are largely unregulated and have a massive reach in terms of their economic footprint. Could a failure of one of these giants trigger a “South Sea Bubble” of the twenty-first century?

We all know that history does not necessarily repeat itself, but it certainly does rhyme. We are well advised to be vigilant about the excessive size of individual companies (particularly state-owned companies) or interconnected companies, including technology in a single industry, especially one that affects many sectors of the economy like banks or finance companies.