What Is Too Big to Fail?
"Too big to fail" describes a business or business sector deemed to be so deeply ingrained in a financial system or economy that its failure would be disastrous to the economy. Therefore, the government will consider bailing out the business or even an entire sector—such as Wall Street banks or U.S. carmakers—to prevent economic disaster.
Too Big To Fail
Too Big to Fail Financial Institutions
Perhaps the most vivid recent example of "too big to fail" is the bailout of Wall Street banks and other financial institutions during the global financial crisis. Following the collapse of Lehman Brothers, Congress passed the Emergency Economic Stabilization Act (EESA) in October 2008. It included the $700 billion Troubled Asset Relief Program (TARP), which authorized the government to purchase distressed assets to stabilize the financial system.
This ultimately meant the government was bailing out big banks and insurance companies because they were "too big to fail," meaning their failure could lead to a collapse of the financial system and the economy. They later faced additional regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
- "Too big to fail" describes a business or sector whose collapse would cause catastrophic damage to the economy.
- The government will often intervene in situations where failure poses a grave risk to the economy.
- One example of such intervention was the Emergency Economic Stabilization Act of 2008, which included the $700 billion Troubled Asset Relief Program (TARP).
Background on Bank Reform
Following thousands of bank failures in the 1920s and early 1930s, the Federal Deposit Insurance Corporation (FDIC) was created to monitor banks and insure customers' deposits, giving Americans confidence that their money would be safe in the bank. The FDIC now insures individual accounts in member banks for up to $250,000 per depositor.
The dawn of the 21st century presented new challenges in regulating banks, which had developed financial products and risk models that were inconceivable in the 1930s. The 2007-08 financial crisis exposed the risks.
"Too big to fail" became a common phrase during the 2007-08 financial crisis, which led to financial sector reform in the U.S. and globally.
Passed in 2010, Dodd-Frank was created to help avoid the need for any future bailouts of the financial system. Among its many provisions were 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 2007-08 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. Global bank regulations are primarily carried out by the Basel Committee on Banking Supervision, the Bank for International Settlements and the Financial Stability Board.
Examples of global systemically important financial institutions include:
- Bank of China
- BNP Paribas
- Deutsche Bank
- Credit Suisse
Banks that the U.S. Federal Reserve has said could threaten the stability of the U.S. financial system include the following:
- Bank of America Corporation
- The Bank of New York Mellon Corporation
- Citigroup Inc.
- The Goldman Sachs Group, Inc.
- JP Morgan Chase & Co.
- Morgan Stanley
- State Street Corporation
- Wells Fargo & Company