Loading the player...

What is 'Too Big To Fail'?

"Too big to fail" describes the concept whereby a business has become so large that a government will provide assistance to prevent its failure because not doing so would have a disastrous ripple effect throughout the economy. If a large company fails, companies that rely on it for portions of their income might also be extinguished along with the employment they provide. Therefore, if the cost of a bailout is less than the cost of the failure to the economy, a government may decide a bailout is the most cost-effective solution.


“Too big to fail” is the idea that specific businesses, such as the biggest banks, are so vital to the U.S. economy that it would be disastrous if they went bankrupt. To avoid a crisis, the government might provide bailouts to protect creditors against losses and enable managers to retain their high wages and bonuses. This concept was integral to the financial crisis of the late 2000s when the U.S. government disbursed $700 billion to save companies, such as AIG, that were on the verge of financial failure.

Background on Bank Reform

Because of bank failures during the Great Depression, deposit insurance and regulators, such as the Federal Deposit Insurance Corporation (FDIC), were created to take over and efficiently liquidate failing banks. In 2007 and 2008, deeply indebted investment banks without FDIC protection faced failure as creditors and shareholders doubted their solvency. When Lehman Brothers collapsed, regulators discovered the biggest firms were so interconnected that only large bailouts would prevent half the financial sector from failing.

Dodd-Frank Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was created to avoid future bailouts. Part of the Act requires financial institutions to create living wills outlining how they will liquidate assets quickly if filing for bankruptcy. In November 2015, an international board of financial regulators published rules requiring big banks to raise up to $1.2 trillion in new debt funding that can be written off or converted to equity in case of losses.

Debate over Solvency Solutions

According to a 2014 study by the International Monetary Fund (IMF), many lenders who believe governments will not let big banks go under produce annual savings up to $300 billion. The savings suggest that an implicit subsidy could be at least as big as the big banks’ profits, and governments should charge accordingly for the subsidy. In emerging markets such as China, the government owns the biggest banks, which means it enjoys the upside in good times and shoulders the burden when banks need bailouts. However, a July 2014 study by the Government Accountability Office (GAO) showed that any borrowing advantage has dramatically shrunk, making such a solution infeasible for the United States.

In December 2015, Standard and Poor’s downgraded U.S. big banks’ debt rating stating that new capital requirements could make bailouts less likely. Ultimately, global banks operate across borders, and no agreement exists among national authorities regarding response to a financial crisis. Countries have different laws, asset protection procedures and court systems. Immediate prospects for an international treaty are nonexistent.

  1. Assisted Merger

    The merger of two or more financial institutions undertaken with ...
  2. Bank

    A bank is a financial institution licensed as a receiver of deposits. ...
  3. Dodd-Frank Wall Street Reform and ...

    A series of federal regulations, affecting financial institutions ...
  4. Assistance Agreement

    An agreement between a lending government, financial institution, ...
  5. Asset Valuation Review (AVR)

    A process that establishes an estimate of the value of a failed ...
  6. Bailout Bond

    A debt security issued by the Resolution Funding Corporation ...
Related Articles
  1. Insurance

    From Booms To Bailouts: The Banking Crisis Of The 1980s

    The economic environment of the late 1970s and early 1980s created the perfect storm for a banking crisis.
  2. Investing

    Fed Announces New Rules for Banks "Too Big To Fail" (BAC, C)

    On Monday, the Fed announced new regulations to better align its policy with the requirements of the 2010 Dodd-Frank Act.
  3. Insights

    Top 6 U.S. Government Financial Bailouts

    U.S. bailouts date all the way back to 1792. Learn how the biggest ones affected the economy.
  4. Investing

    Will the Next Financial Crisis Come From Europe? (DB, CS)

    Discover why the European financial system might be in trouble, why the European Central Bank may turn to bailouts, and why that is probably a mistake.
  5. Investing

    Trump Vows to 'Dismantle' Dodd-Frank (MET, VFH)

    According to Trump's transition site, his administration will put an end to the law that includes restrictions on institutions that are "too big to fail."
  6. Insights

    Is a Banking Crisis Looming in Europe?

    Could this be another Lehman?
  7. Managing Wealth

    Liquidity And Toxicity: Will TARP Fix The Financial System?

    TARP is the government's attempt to forestall a deep, extended recession. Will it work?
  8. Insights

    War Over "Too Big to Fail" Continues (RIF, CIT)

    Under new legislation, banks will no longer be designated as "too big to fail" just because they control assets of $50 billion or more.
  9. Personal Finance

    Does Deutsche Bank Have Similarities to Lehman? (DB)

    Learn why Deutsche Bank's mounting debt and need to raise capital lead some analysts to believe it may be the next Lehman Brothers.
  1. How do government bailouts increase moral hazard?

    Learn how government bailouts increase moral hazard by shifting the responsibility of bad behavior from guilty executives ... Read Answer >>
  2. What is the banking sector?

    Why the banking sector is a vital industry, what it does to drive economic growth and examples of companies in this sector. Read Answer >>
  3. Why should an investor consider the financial services sector?

    Learn why every investor should consider putting money into the financial services sector despite a tumultuous history and ... Read Answer >>
  4. How are investment banks regulated in the United States?

    Read about the extensive regulations placed on investment banks in the United States, beginning with the Glass-Steagall Act ... Read Answer >>
Hot Definitions
  1. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  2. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  3. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  4. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  5. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
  6. Restricted Stock Unit - RSU

    A restricted stock unit is a compensation issued by an employer to an employee in the form of company stock.
Trading Center