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What is ‘Too Big to Fail’?
‘Too big to fail‘’ refers to a business or financial sector deemed so consequential to a financial system that its collapse would ruin the economy. In the event a company or sector that’s too big to fail actually starts failing, there’s a high chance the government will step in and bail them out.
The phrase entered into popular discourse after a 1984 Congressional hearing when Congressman Stewart McKinney discussed the Federal Deposit Insurance Corporation’s (FDIC) bailout of Continental Illinois (a bank that had $1.2 billion in assets). The concept of “too big to fail” re-emerged as a major talking point as the government scrambled to find a way to mitigate the disastrous effects of the 2008 subprime mortgage crisis. Many massive corporations that had arguably contributed to the crisis infamously received billions in order to stay afloat (more on this later).
We at the Zero Theft Movement are working to eliminate the rigged parts of the U.S. economy in order to let the ethical and healthy parts thrive. Because government-led bailouts of ‘too big to fail’ companies are funded by taxpayer money, they often incite public outrage. The question is: should they?
The government deemed the failing hedge fund Long-Term Capital Management (LTCM) too big to fail. The Federal Reserve created a $3.65 billion loan fund to bail the company out. This allowed LTCM to survive the market volatility and liquidate in early 2000. But did the Federal Reserve really have to bail out LTCM with taxpayer money? Or could global financial markets have fared well enough without the intervention?
Too Big to Fail Before ‘Too Big to Fail’
In reality, the first examples of too-big-to-fail companies date back to the 1920s and 30s, before the phrase actually came into existence. Relatively illiquid banks, due to fractional reserve banking, could not handle the widespread panic and consequent bank runs. As you probably know, the collapse of the financial system resulted in the dark decade (1929-1939) known as the Great Depression.
The government, hoping to prevent future systemic failures, formed the Federal Deposit Insurance Corporation (FDIC). To this day, the agency monitors financial institutions and insures customers’ deposits, which deters bank runs and helps maintain the confidence of the American public.
To supplement the FDIC, the government also passed the Glass-Steagall Act of 1933. The legislation prohibited financial institutions from working in both investment and retail banking. Glass-Steagall eventually got neutered in 1999, with the passing of the Gramm-Leach-Bliley Act.
The Emergence and Popularization of ‘Too Big to Fail’
Fast forward a few decades to 1972, and another string of bank failures and bailouts began with the Bank of the Commonwealth’s collapse. Failure after failure, the sorry state of the financial system led to the banking crisis of the 1980s.
According to the FDIC, 1,617 commercial and savings banks failed between 1980 and 1994. These failed institutions held roughly $206.2 billion in assets.
News outlets had been using the phrase ‘too big to fail,’ but it didn’t catch on until Congressman McKinney used it in 1984.
The bailouts throughout the 70s and 80s compelled the government to establish better regulations and legislation. Among all the reforms, the FDIC Improvement Act of 1991 proves particularly pertinent to our discussion of bailouts and ‘too big to fail.’ It limited bailouts to failures that would cause systemic risk (as determined by regulators).
The 1989 Savings and Loan crisis resulted in a government bailout of $500 billion (in 1990 money). Furthermore, the Congressional Budget Office published a study, claiming “The cumulative loss in GNP in 1990 dollars for the years 1981 through 1990 could be as large as a whopping $200 billion. An additional loss approaching $300 billion of forgone GNP [was] likely to occur during the years 1991 through 200 as a consequence of the S&L breakdown.”
See what the ZT community has uncovered on the S&L crisis…
When Too-Big-to-Fail Actually Fail
A quiet financial period followed after the failures in the 80s, and it seemed like the economy would remain stable and healthy for the foreseeable future. It took about two decades until the next financial disaster came, but this time it was bigger than ever before.
In early 2008, global banking firm Bear Stearns failed. The government did not bail out the company, rather the ruins were purchased at fire-sale prices by JPMorgan Chase. In September of the same year, another storied financial institution in Lehman Brothers filed Chapter 11 bankruptcy. Again, the government did not intervene as a lender of last resort.
A month after Lehman Brothers collapse, the government passed the Emergency Economic Stabilization Act (EESA). The EESA included the $700 billion Troubled Asset Relief Program (TARP), which authorized the government to bail out Wall Street, the automotive industry, and other corporate giants by purchasing their unwanted, ruined assets.
The government believed these industries and companies were simply too big to fail.
As of February 16, 2021, the TARP has been paid back and then some. The actual outflows came out to be $634.1 billion, the inflows $743.8 billion. The government realized a $110 billion profit.
That being said, significant, irreparable damage had already been done. To many people’s livelihoods, retirement funds, the next generation’s prospects, and so on. $20 trillion in estimated losses. $20 trillion. That’s not to mention the extensive mental and emotional damages the crisis caused.
AIG wrote $78 billion in just real estate credit default swaps—i.e. insurance for the high-risk securities called collateralized debt obligations, which many of the failing financial institutions bought up. Research shows that corporations’ reckless investments into CDOs played a considerable role in tanking the economy.
Should AIG have been bailed out? See what the ZT community discovered…
The Risks of Too-Big-To-Fail Companies
“If they’re too big to fail, they’re too big.”
After the 2008 financial crisis, Ben Bernanke, the 14th Chair of the Fed, testified in front of the Financial Crisis Inquiry Commission. He discussed the risks of too-big-to-fail corporations, which we have presented below.
In his testimony, Bernanke claimed that companies deemed too big to fail to face moral hazards that they shouldn’t. Because the health of the economy as a whole (somewhat) hinges on these colossal companies and industries performing well, the government has a strong incentive to save them when things go wrong.
The problem is, too-big-to-fail companies and industries can view these safety nets as incentives to take excessive risks, knowing they will likely get bailed out with taxpayer money.
The rich get richer
Bernanke also argued in his testimony that the status of ‘too large to fail’ creates an unfair playing field between big and small companies. Big companies can continue to take huge risks and expand because of the aforementioned protections provided by the government. Small businesses, on the other hand, likely won’t be able to reap the same rewards (relatively speaking) as they would have to actually shoulder the consequences of their risk-taking.
The larger they are, the bigger the ripple effect
Finally, Bernanke claimed that too-big-to-fail corporations always present a major risk to the stability of the financial system. If the crisis had involved smaller financial institutions, the damage obviously would not have been so catastrophic.
Instead, the collapsing companies disrupted financial markets, impeded credit flows, tanked stock prices, and damaged public confidence.
Financial Reform and the Future of Too Big to Fail
Out of the economic ruins, the government had to find a way forward. It went ahead and enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
The legislation brought sweeping reform to deter future crises and bailouts, especially ones that should be avoided. Capital requirements, proprietary trading, consumer lending, all came under new regulations.
The Volcker Rule, for example, helps prevent financial institutions from growing too big to fail. The rule prohibits them from trading stocks, commodities, or derivatives for their own profit. They can only engage in those activities for their customers, or to offset business risk.
As we continue to distance ourselves from the 2008 financial crisis, regulators, legislators, and the public must remain vigilant. We will have to collectively suffer tremendous financial setbacks. Don’t think you can’t contribute to protecting the economy, because you can…
We at the Zero Theft Movement, along with our growing community, strive to eradicate the rigged parts of the U.S. economy and protect the ethical parts.
On our voting app, citizens author theft proposals, and the community decides whether that investigation has convincingly proven (1) theft is or isn’t occurring in a specific area of the economy, and (2) how much is being stolen or possibly saved. Through direct democracy, we can collectively decide where the problem areas are and start working on addressing them systematically.
The ZTM community knows that many businesses, including some corporations, act ethically. We are trying to hold the bad actors accountable. The corrupt corporations, lobbyists, and government officials. That way, good people and businesses can properly thrive and enjoy the piece of the pie they’re all due.
The Zero Theft Movement does not have any interest in partisan politics/competition or attacking/defending one side. We seek to eradicate theft from the U.S economy. In other words, how the wealthy and powerful rig the system to steal money from us, the everyday citizen. We need to collectively fight against crony capitalism in order for us to all profit from an ethical economy.
Terms like ‘steal,’ ‘theft,’ and ‘crime’ will frequently appear throughout the article. Zero Theft will NOT adhere strictly to the legal definitions of these terms (since congress sells out). We have broadly and openly defined terms like ‘steal’ and ‘theft’ to refer to the rigged economy and other debated unethical acts that can cause citizens to lose out on money they deserve to keep.