by Sheldon Bloom
“Too big to fail” is now a common phrase you might hear in the modern world, especially when discussing fiscal politics. The phrase, which emerged in popularity during the 2007-2008 Global Financial Crisis, refers to financial institutions that have become so interconnected that their failure could be detrimental to the overall health of the economy.
These institutions, which range from insurance companies to investment banks, have been deemed too important to be allowed to fail by their respective governments. Due to their perceived importance, authorities across the world have often provided emergency funding to effectively bailout these institutions when facing potential failure. This continues to be true even today, as proven by the Federal Reserve System of the United States of America electing on March 12 to once again invoke emergency funding, most notably to the rapidly failing Silicon Valley Bank.
In light of the Federal Reserve System’s recent decision to provide emergency funding, I was prompted to revisit the topic in search of understanding as to why the decision was made. What I concluded however, was that no institution, financial or otherwise, should ever grow to the point of being too big to fail.
When providing bailout money, the government is communicating that there is no risk involved for financial institutions that have passed a certain threshold. The creditors and investors of these institutions need not worry about the riskiness of their potential investments, as the government repeatedly shows that they will always be there to lend a helping hand if things turn sour. By providing this emergency money, the government is essentially handing a security blanket to the largest institutions in the country, which is not fair to smaller institutions that are not afforded the same luxury.
Additionally, you may also be surprised to learn that the government bailouts following the Global Financial Crisis were funded using tax dollars. This is particularly unfair to the average American taxpayer as they are being required to cover the losses for an institution from which they will never receive anything. In other words, the government’s decision to bailout these banks with taxpayer money socializes the losses but privatizes the profit.
If the average American is required to cover the losses of an institution’s bad investments, then they should reap the rewards of that same institution’s good investments as well.
In recent years, many economists, government regulators, and even central bankers have all weighed in with their solutions to this problem. One popular solution is to divide these large, important banks into smaller institutions. This way, when one of the smaller institutions fail, it can be allowed to fail without detrimental effects to the economy.
Another popular solution is to dramatically increase regulation surrounding the banks, preventing them from ever being able to grow to such proportions in the first place.
Regardless of the potential solutions, one thing is for certain: any bank that is too big to fail has already overstepped its welcome in the American economy, and something must be done to cut it down to size.
