Unravelling capitalism’s hidden networks of power

Jacob Aron

NEVER again? The global financial crisis of 2008 saw banks around the world bailed out to the tune of billions by governments worried that the entire financial system was in meltdown. “Too big to fail”, the thinking went, and since then, efforts have been made to increase scrutiny of large institutions. But the latest research suggests a much more sophisticated analysis is needed to prevent another crisis.

Control Hierarchy Networks

Control Hierarchy Networks

We already know that firm size isn’t the only problem in a financial crisis. In 2011, New Scientist revealed that 147 interconnected entities – not all of them large financial institutions – control the network of global capitalism. A problem with any of them could have a significant effect on the system, demonstrating the ongoing potential for vulnerability.

Shortly after the New Scientist story was published, the Financial Stability Board, an international body that monitors global finance, published a list of 29 systemically important financial institutions (SIFIs) – which could harm the global economy if they fail. SIFIs are now required to safeguard against collapse by holding significant amounts of their capital as collateral, even though this affects their profitability. The FSB has since added more firms to the list, including some that aren’t banks.

A SIFI designation is based on an institution’s size, interconnectedness and complexity – but there is no consensus on how these factors interact to determine a firm’s global importance, so the designations can be challenged. For instance, US insurance company MetLife is currently disputing its SIFI designation – although the US Department of Justice last week dismissed its lawsuit, saying the firm was “significantly interconnected”.
Most of the emphasis in SIFI designation is placed on this interconnectedness, which has been much studied by academics, along with size, which is easy to determine. To date, relatively little attention has been paid to the third part of the SIFI designation – complexity – says Robin Lumsdaine of American University in Washington DC.

Complexity has been overlooked for the same reason that it causes problems for global capitalism: it is hard to quantify. If a company has many subsidiaries in multiple countries working in a variety of different industries, it can be difficult for anyone – either inside or outside the company – to be sure of what’s going on. And when there’s uncertainty, financial markets worry. This year, for instance, HSBC shares fell in the wake of news that the firm’s executives in the UK and Hong Kong were unaware of tax evasion at a Swiss subsidiary.

Firms with a complex structure are not only a potential source of dangerous financial uncertainty – they are also more difficult to sell off if they do get into trouble. Lehman Brothers collapsed in 2008, but is still being unwound.

To better understand complexity, Lumsdaine and her colleagues used tools from network science to analyse the corporate structure of a variety of financial institutions, including Goldman Sachs, Barclays and HSBC. The researchers anonymised the firms – identifying them only by their country – and used snapshots of data from 26 May 2011 and 25 February 2013 to see if the firms’ complexity had changed.

Their method involves mapping out a firm’s subsidiaries, and then each subsidiary’s subsidiaries and so on. These “control hierarchy” networks are then labelled according to the country or industry of each subsidiary (see diagram) […]

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