The Too-big-to-fail Debate

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"Too Big To Fail": Solution or Problem?

The notion behind the 'too big to fail' perspective and approach of the government behind massive institutions had its roots in the Great Depression of the 30's - massive banks failing without government intervention as a 'lender of last resort' made recovery and confidence protracted and difficult. The Government then has put in place, after the lessons of the 30's a federal insurance for clients of small and big banks as a kind of 'safety net'. The lessons of the 30's made banks and the financial institutions much more risk averse. According to Financial Historians Stern and Feldman however, by the 1970's when competitive pressures (2004) pushed banks to new territory in foreign investments and unregulated risks (speculative real estate & oil for example), massive debt build up led to the demise of Continental Illinois Bank, then one of the largest lending institutions in the US. It was a systemic institution - its clients being small and big businesses across the country side by side with individual depositor-clients. It was important an institution that a complete failure would have affected a huge part of the market with grim socio-economic implications. The Federal Reserve had to step in - recapitalizing the bank, the first of the 'too big to fail' government interventions; from then on the Federal Insurance Corporation and the Federal Savings and Loan Insurance Corporation (now merged as the Federal Deposit Insurance Corp. or FDIC) ensured all deposits and in the case of massive banks judged as one of systemic importance where failure risks the stability of the entire financial system, the 'too big to fail' approach has been made a government option when all else fails (i.e. the efforts of the bank to save themselves from eminent disaster).

This was the case of many financial institutions across the United States in the recent recession which came to manifestation from 2007, leading to a world-wide financial meltdown. Unregulated speculation into subprime-mortgages and unrestricted and unregulated lending and bad loans led to massive build up of debt among home owners and their lending banks which soon affected the entire economy as well as investor-capitalists around the world. In the US, Goldman-Sachs, Citibank & Bank of America were close to failure yet the latter chose to absorb Merrill Lynch & all the risks it had. In 2009 the FDIC reported 105 bank failures across ...