What Is Too Big to Fail?
“Too big to fail” describes a business or business sector so ingrained in a financial system or economy that its failure would be disastrous. The government will considerbailing outa corporate entity or a market sector, such as Wall Street banks or U.S. carmakers, to prevent economic disaster.
Key Takeaways
- “Too big to fail” describes a business or sector whose collapse would cause catastrophic economic damage.
- The U.S. government has intervened with rescue measures where failure poses a risk to the economy.
- The Emergency Economic Stabilization Act of 2008, following the failure of banks during the financial crisis of 2007-2008, included the $700 billion Troubled Asset Relief Program (TARP).
Financial Institutions
A bailout of Wall Street banks and other financial institutions deemed "too big to fail" occurred during the global financial crisis of 2007-2008. Following the collapse of Lehman Brothers, Congress passed the Emergency Economic Stabilization Act (EESA) in October 2008.
The rescue measures included the $700 billion Troubled Asset Relief Program (TARP), which authorized the U.S. government to purchase distressed assets to stabilize the financial system. Following the assistance, regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 were imposed on financial institutions.
“Too big to fail” became a common phrase during the 2007–2008 financial crisis, which led to financial sector reform in the United States and globally.
Bank Reform
Following bank failures in the 1920s and early 1930s, theFederal Deposit Insurance Corp. (FDIC) was created to monitor banks, insure customer deposits, and provide Americans with confidence that their savings would be safe. The FDIC insures individual accounts in member banks for up to $250,000 per depositor.
The 21st century saw new challenges for banks, which had developed financial products and risk models that were inconceivable in the 1930s. The 2007–2008 financial crisis exposed unknown consumer and economic risks.
Dodd-Frank Act
Passed in 2010, Dodd-Frank was created to help prevent future bailouts of the financial system. It included new regulations regarding capital requirements, proprietary trading, and consumer lending. Dodd-Frank also imposed higher requirements for banks collectively labeled systemically important financial institutions (SIFIs).
Global Banking Reform
The 2007–2008 financial crisis affected banks around the world. Global regulators also implemented reforms, with the majority of new regulations focused on “too big to fail” banks. Examples of global SIFIs include Mizuho, the Bank of China, BNP Paribas, Deutsche Bank, and Credit Suisse. Global bank regulations are led by the Basel Committee on Banking Supervision, the Bank for International Settlements, and the Financial Stability Board.
Companies Considered Too Big to Fail
Banks that the U.S. Federal Reserve (Fed) has said could threaten the stability of the U.S. financial system include:
- Bank of America Corp.
- The Bank of New York Mellon Corp.
- Citigroup Inc.
- The Goldman Sachs Group Inc.
- JPMorgan Chase & Co.
- Morgan Stanley
- State Street Corp.
- Wells Fargo & Co.
Other entities that were deemed as “too big to fail” during the financial crisis of 2007-2008 and required government intervention were:
- General Motors (auto company)
- AIG (insurance company)
- Chrysler (auto company)
- Fannie Mae (government-sponsored enterprise (GSE))
- Freddie Mac (GSE)
- GMAC—now Ally Financial (financial services company)
15 years following the banking crisis of 2008, the big banks are bigger than ever. In early 2023, JPMorgan Chase took over the deposits and substantial assets from the failure of First Republic Bank.
Critique of the Too Big to Fail Theory
Numerous policies and regulations were imposed to prevent future financial disasters and curtail government intervention. The Dodd-Frank Act passed in July 2010 requires banks to limit their risk-taking by holding larger financial reserves. Banks must keep a ratio of higher-quality assets or capital requirements, in the event of distress within the bank or the wider financial system.
The Consumer Financial Protection Bureau (CFPB) addressed the subprime mortgage crisis and implemented mortgage lending practices that make it easier for consumers to understand the terms of a mortgage agreement.
Critics have argued that regulations harm the competitiveness of U.S. firms and contend that regulatory compliance requirements unduly burden community banks and smaller financial institutions that did not play a role in the financial crisis.
In 2018, some provisions of Dodd-Frank were loosened under President Trump with the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act.
Is 'Too Big to Fail’ a New Concept?
This term was publicized by U.S. Rep. Stewart McKinney (R-Conn.) in a 1984 congressional hearing, discussing the intervention of the Federal Deposit Insurance Corp. (FDIC) with the Continental Illinois bank. Although the term was previously used, it became more widely known during the global financial crisis of 2007–2008 when Wall Street received a government bailout.
What Protections Mitigate "Too Big To Fail"?
Regulations have been put in place to require systemically important financial institutions to maintain adequate capital and submit to enhanced supervision and resolution regimes.
After the 2008 collapse of large financial institutions, policies were enacted, including the Emergency Economic Stabilization Act of 2008 (EESA) and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
How Did the Troubled Assets Relief Program Assist Banks That Were Too Big To Fail?
The EESA established theTroubledAssets Relief Program(TARP) authorizing the Treasury secretaryto "purchase, and to make and fund commitments to purchase, troubled assets fromany financial institution, on such terms and conditions as are determined by the secretary." Proponents believed vital to minimize the economic damage created by the sub-prime mortgage meltdown.
The Bottom Line
To protect the U.S. economy from a disastrous financial failure that might have global repercussions, the government may step in to financially bail out a systemically critical business or an economic sector, such as transportation or the auto industry. During the 2007-2008 global financial crisis, policymakers and regulators in the U.S. deemed some banks and corporations "too big to fail" and provided rescue measures through the Emergency Economic Stabilization Act of 2008.
As an expert on financial systems and economic policies, I can provide a comprehensive analysis of the concepts used in the article about "Too Big to Fail." My depth of knowledge extends to historical perspectives, legislative actions, global implications, and critiques of the "Too Big to Fail" theory.
1. Too Big to Fail Concept:
- Definition: "Too big to fail" refers to a business or business sector deeply embedded in a financial system or economy, whose failure could lead to catastrophic economic consequences.
- Historical Context: The term gained prominence during the 2007–2008 global financial crisis, emphasizing the need for government intervention to prevent economic disaster.
2. Emergency Economic Stabilization Act of 2008 (EESA):
- Purpose: Enacted in response to the 2007-2008 financial crisis, the EESA aimed to stabilize the financial system.
- Key Measure: Included the Troubled Asset Relief Program (TARP), a $700 billion initiative allowing the government to purchase distressed assets to prevent further financial instability.
3. Financial Institutions and Bailouts:
- Example: Wall Street banks received bailouts during the 2007-2008 crisis, with measures such as TARP to prevent their collapse.
- Regulatory Response: Dodd-Frank Act of 2010 imposed regulations on financial institutions, focusing on capital requirements, proprietary trading, and consumer lending.
4. Bank Reform and FDIC:
- Historical Context: The FDIC was created in the 1930s following bank failures to monitor banks, insure deposits, and instill confidence in the safety of savings.
- 21st Century Challenges: New challenges arose in the 2007-2008 crisis due to complex financial products and risk models, leading to the need for additional reforms.
5. Dodd-Frank Act:
- Purpose: Enacted in 2010 to prevent future financial crises and bailouts.
- Regulations: Introduced new regulations on capital requirements, proprietary trading, and consumer lending. Applied higher standards to systemically important financial institutions (SIFIs).
6. Global Banking Reform:
- Impact of 2007-2008 Crisis: Global banking reforms were implemented, with a focus on addressing the risks posed by "too big to fail" banks.
- Regulatory Bodies: Basel Committee on Banking Supervision, Bank for International Settlements, and Financial Stability Board led global efforts in banking regulations.
7. Companies Considered Too Big to Fail:
- Examples: Banks like JPMorgan Chase, Bank of America, and corporations like General Motors, AIG, and Fannie Mae were deemed "too big to fail."
- Government Intervention: These entities required government intervention during the 2007-2008 crisis to prevent systemic collapse.
8. Critique of the Too Big to Fail Theory:
- Regulatory Measures: Policies and regulations, such as those in the Dodd-Frank Act, were implemented to prevent future financial disasters and limit government intervention.
- Criticisms: Some argue that regulations harm U.S. firms' competitiveness, burdening smaller institutions. Loosening of Dodd-Frank provisions in 2018 aimed at addressing such concerns.
9. Troubled Assets Relief Program (TARP):
- Purpose: Established under EESA, TARP aimed to assist banks by allowing the Treasury Secretary to purchase troubled assets and make commitments to stabilize financial institutions.
- Justification: Supporters believed TARP was vital to minimize economic damage resulting from the sub-prime mortgage meltdown.
10. Evolution of the Concept:
- Origin: The term "too big to fail" was publicized by U.S. Rep. Stewart McKinney in 1984 during a congressional hearing regarding the FDIC's intervention with the Continental Illinois bank.
- Widening Recognition: The concept gained wider recognition during the 2007-2008 crisis, especially with the government bailout of Wall Street.
In conclusion, the article provides a thorough overview of the "Too Big to Fail" concept, its historical context, regulatory responses, and the ongoing debate surrounding the effectiveness of measures taken to prevent future financial crises.
