How big should financial firms be?

The Baseline Scenario suggests we simplify financial services regulation by setting size limits. Then, in theory, market forces can punish the foolish -- without destroying the economy.

I'm sympathetic.

The bit of the post I liked best, however, was the reference to a classic paper on corporations ...

Big and Small The Baseline Scenario

.... this is the issue that Ronald Coase discussed in “The Nature of the Firm” (Wikipedia summary; paper). A firm’s optimal size is reached when the transaction costs of doing business in the market equal the administrative costs of managing the firm; the bigger the firm, the higher the administrative costs... To this equation, we now need to add the social costs (negative externalities) of being Too Big To Fail: moral hazard, socialized losses, and so on.

I suspect a simple interpretation of this theorem would find many corporations are far larger than the "optimum".

What the theorem may miss (I've not read the paper) is that corporations don't just compete in the marketplace. They attack each other through acquisitions, cutting off suppliers, buying up critical components, purchasing senators (typically by paying for their election and reelection) and so on. In other words, within certain boundaries, corporations go to war.

That may favor bigger corporations than simplistic models of economic efficiency.