Too Big to Fail: Definition, History, Examples, and Reforms

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 U.S. government to purchase distressed assets to stabilize the financial system.

This ultimately meant that the government was bailing out big banks and insurance companies because they were “too big to fail,” meaning that 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.

Key Takeaways

  • “Too big to fail” describes a business or sector whose collapse would cause catastrophic damage to the economy.
  • The U.S. government may 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 Corp. (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 2007–2008 financial crisis exposed the risks

“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.

Dodd-Frank Act

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 2007–2008 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. 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 SIFIs include:

  • Mizuho
  • Bank of China
  • BNP Paribas
  • Deutsche Bank
  • Credit Suisse

Examples of ‘Too Big to Fail’ Companies

Banks that the U.S. Federal Reserve (Fed) has said could threaten the stability of the U.S. financial system include the following:

  • 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” 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)

Support for the ‘Too Big to Fail’ Theory

On the pro-regulation side, the Dodd-Frank Act passed in July 2010 requires banks to limit their risk taking by holding larger financial reserves, and other measures. Banks must keep a ratio of higher-quality, easily sold assets in the event of any difficulty in either their bank or the wider financial system. These are known as capital requirements.

The Consumer Financial Protection Bureau (CFPB) seeks to prevent predatory mortgage lending practices and make it easier for consumers to understand the terms of a mortgage before agreeing to them. Other features in the establishment of this agency deter bad actors from preying on potential borrowers.

Criticism of ‘Too Big to Fail’

Criticism of “too big to fail” regulations includes the discussion that although government rolled out huge capital and liquidity assistance programs for banks and large nonbank financial institutions, there was significant political backlash against government bailouts used as a policy tool.

One concern is that if any financial institution is so critical that the government can’t allow it to fail, investors will lend to it too cheaply. This is a subsidy that provides an advantage over smaller competitors and encourages borrowing over safe limits, making a collapse more likely. Customers recognize that their investments with larger banks are safer than deposits with smaller banks. Larger banks are thus able to pay lower interest rates to customers than small banks must pay to attract depositors.

In the rush to prevent any potential future government bailouts, it is possible to create new weaknesses that could worsen the next catastrophe. Regulators now force the largest financial companies to have more capital to prevent losses. This makes them less likely to fail and less profitable, thereby inhibiting growth to “too big to fail” proportions.

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—for example, in 1975, it was used to describe the government rescue of Lockheed Corp.—it became more widely known during the global financial crisis of 2007–2008 when Wall Street received a government bailout. Additional government regulations were then established to lessen the probability of these occurrences, including the Emergency Economic Stabilization Act of 2008 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

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.

Many economists, financial experts, and even banks themselves have called for breaking up large banks into smaller institutions.

More government regulations were established after the 2008 collapse of large financial institutions to lessen the probability of these occurrences. They include the Emergency Economic Stabilization Act of 2008 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The Bottom Line

To protect the U.S. economy from a disastrous financial failure that also might have global repercussions, the government may step in to financially bail out a systemically critical business when it is failing—or even an entire economic sector, such as transportation or the auto industry.

Article Sources
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  1. U.S. House of Representatives, Committee on Oversight and Government Reform, via “The Causes and Effects of the Lehman Brothers Bankruptcy.” Accessed Jan. 20, 2022.

  2. U.S. Congress. “Public Law 110-343, Emergency Economic Stabilization Act of 2008,” 122 Stat. 3780 (Page 16). Accessed Sept. 17, 2021.

  3. Federal Deposit Insurance Corp. “About FDIC: What We Do.” Accessed Sept. 17, 2021.

  4. U.S. Department of the Treasury. “Financial Stability Oversight Council: Designations.” Accessed Sept. 17, 2021.

  5. U.S. Congress. “H.R.4173 — Dodd-Frank Wall Street Reform and Consumer Protection Act.” Accessed Jan. 26, 2022.

  6. Financial Stability Board. “2021 List of Global Systematically Important Banks (G-SIBs).” Accessed Jan. 26, 2022.

  7. Federal Reserve System. “Large Institution Supervision Coordinating Committee.” Accessed Jan. 26, 2022.

  8. ProPublica, Bailout Tracker. “Bailout Recipients.” Accessed Feb. 3, 2022.