Too Big to Fail: Definition, History, and Reforms (2024)

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).

Too Big to Fail: Definition, History, and Reforms (1)

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.

Too Big to Fail: Definition, History, and Reforms (2024)

FAQs

Too Big to Fail: Definition, History, and Reforms? ›

"Too big to fail" (TBTF) is a theory in banking and finance that asserts that certain corporations, particularly financial institutions, are so large and so interconnected that their failure would be disastrous to the greater economic system, and therefore should be supported by government when they face potential ...

How would you explain what the too big to fail doctrine means? ›

“Too big to fail” refers to an entity so important to a financial system that a government would not allow it to go bankrupt due to the seriousness of the economic repercussions.

What is the history of too big to fail? ›

The Bank of the Commonwealth bailout in 1972 was the first too-big-to-fail bailout of the modern era. It was then followed by a sequence of too-big-to-fail bailouts by the FDIC and the Federal Reserve that led to the Continental bailout of 1984 and, ultimately, those of the recent financial crisis.

What are the benefits of a too big to fail policy? ›

- It is valuable to big banks rather than little banks. - Too-big-to-fail policy assists with overseeing risk efficiently. - Policy would offer security to depositors as well as creditors. The Too-big-to-fail policy upholds huge monetary foundations and offers advantages to depositors and creditors.

What was too big to fail in the financial crisis of 2008? ›

In September 2008, one of the world's largest investment banks filed for Chapter 11 bankruptcy, sparked by a credit crisis, and falling real estate prices.

What is moral hazard too big to fail? ›

In crafting policies to address too-big-to-fail banks, policymakers must also consider moral hazard—that is, whether by rescuing troubled, systemically important banks they encourage their growth and remove some of the consequences of risky behavior (see box).

Is every bank too big to fail? ›

In short, for the RBI, irrespective of the size, every bank is reckoned as 'too big to fail', and this is the approach adopted every time the country faced a crisis.

How can the problem of too big to fail be avoided? ›

Reducing the probability of failure of G-SIBs is the cornerstone of the regulatory response to the too-big-to-fail problem. Raising the amount of going-concern capital for these institutions through the application of a capital surcharge will lower their probability of failure.

Who said we are too big to fail? ›

During that hearing, Congressman Stewart McKinney, a Republican from Connecticut, uttered the now well-known phrase: “We have a new kind of bank,” he said. “It is called too big to fail. TBTF, and it is a wonderful bank.”

Is too big to fail based on a true story? ›

The movie, based on a book by New York Times columnist Andrew Ross Sorkin, captures the frustration of government officials as each hole they patched was followed by an even bigger leak. “Too Big to Fail,” which premieres Monday, hews closely to actual events.

What is the evaluation of the effects of too big to fail reforms final report? ›

The evaluation finds that TBTF reforms have made banks more resilient and resolvable, and that reforms have produced net benefits to society. Indicators of systemic risk and moral hazard moved in the right direction, suggesting that market participants view these reforms as credible.

Who went to jail for the 2008 financial crisis? ›

Did Anyone Go to Jail for the 2008 Financial Crisis? Kareem Serageldin was the only banker in the United States who was sentenced to jail time for his role in the 2008 financial crisis. He was convicted of hiding losses by mismarking bond prices.

Who should be blamed for the Great Recession? ›

Financial institutions were to blame for the Great Recession, because they created trillions of dollars in risky mortgages and they packaged, repackaged, and sold those loans to investors around the world.

What banks are too big to fail in the US? ›

As the following chart shows, JPMorgan along with Bank of America, Wells Fargo and Citibank tower above the competition in terms of deposits. With combined domestic deposits of $6.1 trillion at the end of 2022, these big four exceeded the combined deposits of their 33 closest competitors at the time.

What were the negative effects of the 2008 financial crisis? ›

The 2008 global financial crisis affected economies around the world. It led to the deepest UK recession since World War II, with rises in unemployment, debt and home repossessions. Young people experienced particularly high levels of job losses and unemployment.

How did the 2008 financial crisis affect the poor? ›

The Census Bureau showed the overall poverty rate rose to 14.3% in 2009 from 13.2% in 2008, an increase that added 3.7 million people to the ranks of the poor. One-third of those people were children. Among working-age people, the poverty rate reached an all-time high of 12.9%.

What is too big to fail systemic risk? ›

“Too big to fail” describes a situation in which a business is so deeply ingrained in an economy that its failure would be disastrous to that economy. A systemically important financial institution (SIFI) is a firm that regulators feel would pose a serious risk to the economy if it were to collapse.

Is Charles Schwab too big to fail? ›

If there is an institution too big to fail, it is Schwab, which has over $7 trillion in assets.

Is Fidelity too big to fail? ›

Whether this makes Fidelity “too big to fail” or not is up for debate, as that term usually applies to banks instead of brokerage firms. However, it seems very unlikely that the US government would allow such a large and systemically important firm to fail in a worst-case scenario.

Was Bear Stearns too big to fail? ›

In other words, Bear Stearns received a lifeline because it was “too big to fail.” Its fallout would have been a systemic risk to the financial system.

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