![AIG_Headquarters](https://upload.wikimedia.org/wikipedia/commons/7/7f/AIG_Headquarters.jpg)
"Too big to fail" (TBTF) and "too big to jail" is a
theory
A theory is a rational type of abstract thinking about a phenomenon, or the results of such thinking. The process of contemplative and rational thinking is often associated with such processes as observational study or research. Theories may be s ...
in
banking
A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets.
Because ...
and
finance
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...
that asserts that certain
corporation
A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal context) and r ...
s, particularly
financial institution
Financial institutions, sometimes called banking institutions, are business entities that provide services as intermediaries for different types of financial monetary transactions. Broadly speaking, there are three major types of financial insti ...
s, are so large and so interconnected that their failure would be disastrous to the greater
economic system
An economic system, or economic order, is a system of Production (economics), production, resource allocation and Distribution (economics), distribution of goods and services within a society or a given geographic area. It includes the combinati ...
, and that they therefore must be
supported by governments when they face potential failure. The colloquial term "too big to fail" was popularized by
U.S. Congress
The United States Congress is the legislature of the federal government of the United States. It is Bicameralism, bicameral, composed of a lower body, the United States House of Representatives, House of Representatives, and an upper body, ...
man
Stewart McKinney in a 1984 Congressional hearing, discussing the
Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation (FDIC) is one of two agencies that supply deposit insurance to depositors in American depository institutions, the other being the National Credit Union Administration, which regulates and insures cred ...
's intervention with
Continental Illinois
The Continental Illinois National Bank and Trust Company was at one time the seventh-largest commercial bank in the United States as measured by deposits, with approximately $40 billion in assets. In 1984, Continental Illinois became the largest ...
. The term had previously been used occasionally in the press, and similar thinking had motivated earlier bank bailouts.
The term emerged as prominent in public discourse following the global
financial crisis of 2007–2008
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fi ...
. Critics see the policy as counterproductive and that large banks or other institutions should be left to fail if their
risk management is not effective. Some critics, such as economist
Alan Greenspan
Alan Greenspan (born March 6, 1926) is an American economist who served as the 13th chairman of the Federal Reserve from 1987 to 2006. He works as a private adviser and provides consulting for firms through his company, Greenspan Associates LLC. ...
, believe that such large organisations should be deliberately broken up: "If they're too big to fail, they're too big."
Some economists such as
Paul Krugman
Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was th ...
hold that
financial crises
A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and man ...
arise principally from banks being under-regulated rather than their size, using the widespread collapse of small banks in the
Great Depression
The Great Depression (19291939) was an economic shock that impacted most countries across the world. It was a period of economic depression that became evident after a major fall in stock prices in the United States. The economic contagio ...
to illustrate this argument.
[Paul Krugma]
"Financial Reform 101"
April 1, 2010[Paul Krugma]
"Stop 'Stop Too Big To Fail'."
''New York Times'', April 21, 2010[Paul Krugma]
"Too big to fail FAIL"
''New York Times'', June 18, 2009[Paul Krugma]
"A bit more on too big to fail and related"
''New York Times'', June 19, 2009
In 2014, the
International Monetary Fund
The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution, headquartered in Washington, D.C., consisting of 190 countries. Its stated mission is "working to foster globa ...
and others said the problem still had not been dealt with.
While the individual components of the new regulation for systemically important banks (additional
capital requirement
A capital requirement (also known as regulatory capital, capital adequacy or capital base) is the amount of capital a bank or other financial institution has to have as required by its financial regulator. This is usually expressed as a capital ad ...
s, enhanced supervision and resolution regimes) likely reduced the prevalence of TBTF, the fact that there is a definite
list of systemically important banks
Certain large banks are tracked and labelled by several authorities as Systemically Important Financial Institutions (SIFIs), depending on the scale and the degree of influence they hold in global and domestic financial markets.
Since 2011, the ...
considered TBTF has a partly offsetting impact.
Definition
Federal Reserve Chair
Ben Bernanke
Ben Shalom Bernanke ( ; born December 13, 1953) is an American economist who served as the 14th chairman of the Federal Reserve from 2006 to 2014. After leaving the Fed, he was appointed a distinguished fellow at the Brookings Institution. Durin ...
also defined the term in 2010: "A too-big-to-fail firm is one whose size, complexity, interconnectedness, and critical functions are such that, should the firm go unexpectedly into liquidation, the rest of the financial system and the economy would face severe adverse consequences." He continued that: "Governments provide support to too-big-to-fail firms in a crisis not out of favoritism or particular concern for the management, owners, or creditors of the firm, but because they recognize that the consequences for the broader economy of allowing a disorderly failure greatly outweigh the costs of avoiding the failure in some way. Common means of avoiding failure include facilitating a merger, providing credit, or injecting government capital, all of which protect at least some creditors who otherwise would have suffered losses. ... If the has a single lesson, it is that the too-big-to-fail problem must be solved."
Bernanke cited several risks with too-big-to-fail institutions:
# These firms generate severe
moral hazard
In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk ...
: "If creditors believe that an institution will not be allowed to fail, they will not demand as much compensation for risks as they otherwise would, thus weakening market discipline; nor will they invest as many resources in monitoring the firm's risk-taking. As a result, too-big-to-fail firms will tend to take more risk than desirable, in the expectation that they will receive assistance if their bets go bad."
# It creates an uneven playing field between big and small firms. "This unfair competition, together with the incentive to grow that too-big-to-fail provides, increases risk and artificially raises the market share of too-big-to-fail firms, to the detriment of economic efficiency as well as financial stability."
# The firms themselves become major risks to overall financial stability, particularly in the absence of adequate resolution tools. Bernanke wrote: "The failure of
Lehman Brothers
Lehman Brothers Holdings Inc. ( ) was an American global financial services firm founded in 1847. Before Bankruptcy of Lehman Brothers, filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Gol ...
and the near-failure of several other large, complex firms significantly worsened the crisis and the recession by disrupting financial markets, impeding credit flows, inducing sharp declines in asset prices, and hurting confidence. The failures of smaller, less interconnected firms, though certainly of significant concern, have not had substantial effects on the stability of the financial system as a whole."
Background on banking regulation
Depository banks
Prior to the
Great Depression
The Great Depression (19291939) was an economic shock that impacted most countries across the world. It was a period of economic depression that became evident after a major fall in stock prices in the United States. The economic contagio ...
, U.S. consumer bank deposits were not guaranteed by the government, increasing the risk of a
bank run
A bank run or run on the bank occurs when many clients withdraw their money from a bank, because they believe the bank may cease to function in the near future. In other words, it is when, in a fractional-reserve banking system (where banks no ...
, in which a large number of depositors withdraw their deposits at the same time. Since banks lend most of the deposits and only retain a fraction in the proverbial vault, a bank run can render the bank insolvent. During the Depression, hundreds of banks became insolvent and depositors lost their money. As a result, the U.S. enacted the
1933 Banking Act
The Banking Act of 1933 () was a statute enacted by the United States Congress that established the Federal Deposit Insurance Corporation (FDIC) and imposed various other banking reforms. The entire law is often referred to as the Glass–Stea ...
, sometimes called the
Glass–Steagall Act, which created the
Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation (FDIC) is one of two agencies that supply deposit insurance to depositors in American depository institutions, the other being the National Credit Union Administration, which regulates and insures cred ...
(FDIC) to insure deposits up to a limit of $2,500, with successive increases to the current $250,000. In exchange for the deposit insurance provided by the federal government, depository banks are highly regulated and expected to invest excess customer deposits in lower-risk assets.
After the Great Depression, it has become a problem for financial companies that they are too big to fail, because there is a close connection between financial institutions involved in financial market transactions. It brings liquidity in the markets of various financial instruments. The crisis in 2008 originated when the liquidity and value of financial instruments held and issued by banks and financial institutions decreased sharply.
Investment banks and the shadow banking system
In contrast to depository banks, investment banks generally obtain funds from sophisticated investors and often make complex, risky investments with the funds, speculating either for their own account or on behalf of their investors. They also are "market makers" in that they serve as intermediaries between two investors that wish to take opposite sides of a financial transaction. The Glass–Steagall Act separated investment and depository banking until its repeal in 1999. Prior to 2008, the government did not explicitly guarantee the investor funds, so investment banks were not subject to the same regulations as depository banks and were allowed to take considerably more risk.
Investment banks, along with other innovations in banking and finance referred to as the
shadow banking system
The shadow banking system is a term for the collection of non-bank financial intermediaries (NBFIs) that provide services similar to traditional commercial banks but outside normal banking regulations. Examples of NBFIs include hedge funds, ins ...
, grew to rival the depository system by 2007. They became subject to the equivalent of a bank run in 2007 and 2008, in which investors (rather than depositors) withdrew sources of financing from the shadow system. This run became known as the
subprime mortgage crisis
The United States subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010 that contributed to the Financial crisis of 2007–2008, 2007–2008 global financial crisis. It was triggered by a large decline ...
. During 2008, the five largest U.S. investment banks either failed (Lehman Brothers), were bought out by other banks at fire-sale prices (Bear Stearns and Merrill Lynch) or were at risk of failure and obtained depository banking charters to obtain additional Federal Reserve support (Goldman Sachs and Morgan Stanley). In addition, the government provided bailout funds via the
Troubled Asset Relief Program
The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase toxic assets and equity from financial institutions to strengthen its financial sector that was passed by Congress and signed into law by President G ...
in 2008.
Fed Chair
Ben Bernanke
Ben Shalom Bernanke ( ; born December 13, 1953) is an American economist who served as the 14th chairman of the Federal Reserve from 2006 to 2014. After leaving the Fed, he was appointed a distinguished fellow at the Brookings Institution. Durin ...
described in November 2013 how the
Panic of 1907
The Panic of 1907, also known as the 1907 Bankers' Panic or Knickerbocker Crisis, was a financial crisis that took place in the United States over a three-week period starting in mid-October, when the New York Stock Exchange fell almost 50% from ...
was essentially a run on the non-depository financial system, with many parallels to the crisis of 2008. One of the results of the Panic of 1907 was the creation of the
Federal Reserve
The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
in 1913.
Resolution authority
Before 1950, U.S. federal bank regulators had essentially two options for resolving an
insolvent
In accounting, insolvency is the state of being unable to pay the debts, by a person or company (debtor), at maturity; those in a state of insolvency are said to be ''insolvent''. There are two forms: cash-flow insolvency and balance-sheet inso ...
institution: 1) closure, with
liquidation of assets and payouts for
insured depositors; or 2) purchase and assumption, encouraging the acquisition of assets and assumption of
liabilities by another firm. A third option was made available by the
Federal Deposit Insurance Act of 1950
The Federal Deposit Insurance Corporation (FDIC) is one of two agencies that supply deposit insurance to depositors in American depository institutions, the other being the National Credit Union Administration, which regulates and insures credi ...
: providing assistance, the power to support an institution through loans or direct federal acquisition of assets, until it could recover from its distress.
The statute limited the "assistance" option to cases where "continued operation of the bank is essential to provide adequate banking service". Regulators shunned this third option for many years, fearing that if regionally or nationally important banks were thought generally immune to liquidation, markets in their shares would be distorted. Thus, the assistance option was never employed during the period 1950–1969, and very seldom thereafter.
Research into historical banking trends suggests that the consumption loss associated with National Banking Era bank runs was far more costly than the consumption loss from stock market crashes.
The
Federal Deposit Insurance Corporation Improvement Act was passed in 1991, giving the FDIC the responsibility to rescue an insolvent bank by the least costly method. The Act had the implicit goal of eliminating the widespread belief among depositors that a loss of depositors and bondholders will be prevented for large banks. However, the Act included an exception in cases of systemic risk, subject to the approval of two-thirds of the FDIC Board of Directors, the Federal Reserve Board of Governors, and the Treasury Secretary.
Analysis
Bank size and concentration
![5-Bank Asset Concentration in U](https://upload.wikimedia.org/wikipedia/commons/9/90/5-Bank_Asset_Concentration_in_U.S._1997-2012.png)
Bank size, complexity, and interconnectedness with other banks may inhibit the ability of the government to resolve (wind-down) the bank without significant disruption to the financial system or economy, as occurred with the Lehman Brothers bankruptcy in September 2008. This risk of "too big to fail" entities increases the likelihood of a government bailout using taxpayer dollars.
The largest U.S. banks continue to grow larger while the concentration of bank assets increases. The largest six U.S. banks had assets of $9,576 billion as of year-end 2012, per their 2012 annual reports (SEC Form 10K). The top 5 U.S. banks had approximately 30% of the U.S. banking assets in 1998; this rose to 45% by 2008 and to 48% by 2010, before falling to 47% in 2011.
This concentration continued despite the
subprime mortgage crisis
The United States subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010 that contributed to the Financial crisis of 2007–2008, 2007–2008 global financial crisis. It was triggered by a large decline ...
and its aftermath. During March 2008, JP Morgan Chase acquired investment bank Bear Stearns. Bank of America acquired investment bank Merrill Lynch in September 2008. Wells Fargo acquired Wachovia in January 2009. Investment banks Goldman Sachs and Morgan Stanley obtained depository bank holding company charters, which gave them access to additional Federal Reserve credit lines.
Bank deposits for all U.S. banks ranged between approximately 60–70% of GDP from 1960 to 2006, then jumped during the crisis to a peak of nearly 84% in 2009 before falling to 77% by 2011.
The number of U.S. commercial and savings bank institutions reached a peak of 14,495 in 1984; this fell to 6,532 by the end of 2010. The ten largest U.S. banks held nearly 50% of U.S. deposits as of 2011.
Implicit guarantee subsidy
Since the full amount of the deposits and debts of "too big to fail" banks are effectively guaranteed by the government, large depositors and investors view investments with these banks as a safer investment than deposits with smaller banks. Therefore, large banks are able to pay lower interest rates to depositors and investors than small banks are obliged to pay.
In October 2009,
Sheila Bair
Sheila Colleen Bair (born April 3, 1954) is an American civil servant who was the 19th Chair of the U.S. Federal Deposit Insurance Corporation (FDIC), during which time she assumed a prominent role in the government's response to the 2008 financi ...
, at that time the Chairperson of the FDIC, commented:
A study conducted by the
Center for Economic and Policy Research
The Center for Economic and Policy Research (CEPR) is a progressive American think tank that specializes in economic policy. Based in Washington, D.C. CEPR was co-founded by economists Dean Baker and Mark Weisbrot in 1999.
Considered a left-lea ...
found that the difference between the
cost of funds for banks with more than $100 billion in assets and the cost of funds for smaller banks widened dramatically after the formalization of the "too big to fail" policy in the U.S. in the fourth quarter of 2008. This shift in the large banks' cost of funds was in effect equivalent to an indirect "too big to fail" subsidy of $34 billion per year to the 18 U.S. banks with more than $100 billion in assets.
The editors of Bloomberg View estimated there was an $83 billion annual subsidy to the 10 largest United States banks, reflecting a funding advantage of 0.8 percentage points due to implicit government support, meaning the profits of such banks are largely a taxpayer-backed illusion.
Another study by Frederic Schweikhard and Zoe Tsesmelidakis estimated the amount saved by America's biggest banks from having a perceived safety net of a government bailout was $120 billion from 2007 to 2010.
[Brendan Greeley]
"The Price of Too Big to Fail"
''BusinessWeek'', 5 July 2012 For America's biggest banks the estimated savings was $53 billion for
Citigroup
Citigroup Inc. or Citi (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services corporation headquartered in New York City. The company was formed by the merger of banking ...
, $32 billion for
Bank of America
The Bank of America Corporation (often abbreviated BofA or BoA) is an American multinational investment bank and financial services holding company headquartered at the Bank of America Corporate Center in Charlotte, North Carolina. The bank w ...
, $10 billion for
JPMorgan
JPMorgan Chase & Co. is an American multinational investment bank and financial services holding company headquartered in New York City and incorporated in Delaware. As of 2022, JPMorgan Chase is the largest bank in the United States, the w ...
, $8 billion for
Wells Fargo
Wells Fargo & Company is an American multinational financial services company with corporate headquarters in San Francisco, California; operational headquarters in Manhattan; and managerial offices throughout the United States and intern ...
, and $4 billion for
AIG
American International Group, Inc. (AIG) is an American multinational finance and insurance corporation with operations in more than 80 countries and jurisdictions. , AIG companies employed 49,600 people.https://www.aig.com/content/dam/aig/amer ...
. The study noted that passage of the
Dodd–Frank Act—which promised an end to bailouts—did nothing to raise the
price of credit (i.e., lower the implicit subsidy) for the "too-big-to-fail" institutions.
[
One 2013 study (Acharya, Anginer, and Warburton) measured the funding cost advantage provided by implicit government support to large financial institutions. Credit spreads were lower by approximately 28 basis points (0.28%) on average over the 1990–2010 period, with a peak of more than 120 basis points in 2009. In 2010, the implicit subsidy was worth nearly $100 billion to the largest banks. The authors concluded: "Passage of Dodd–Frank did not eliminate expectations of government support."]
Economist Randall S. Kroszner summarized several approaches to evaluating the funding cost differential between large and small banks. The paper discusses methodology and does not specifically answer the question of whether larger institutions have an advantage.
During November 2013, the Moody's credit rating agency reported that it would no longer assume the eight largest U.S. banks would receive government support in the event they faced bankruptcy. However, the GAO reported that politicians and regulators would still face significant pressure to bail out large banks and their creditors in the event of a financial crisis.
Moral hazard
Some critics have argued that "The way things are now banks reap profits if their trades pan out, but taxpayers can be stuck picking up the tab if their big bets sink the company." Additionally, as discussed by Senator Bernie Sanders
Bernard Sanders (born September8, 1941) is an American politician who has served as the junior United States senator from Vermont since 2007. He was the U.S. representative for the state's at-large congressional district from 1991 to 2007 ...
, if taxpayers are contributing to rescue these companies from bankruptcy, they "should be rewarded for assuming the risk by sharing in the gains that result from this government bailout".
In this sense, Alan Greenspan
Alan Greenspan (born March 6, 1926) is an American economist who served as the 13th chairman of the Federal Reserve from 1987 to 2006. He works as a private adviser and provides consulting for firms through his company, Greenspan Associates LLC. ...
affirms that, "Failure is an integral part, a necessary part of a market system." Thereby, although the financial institutions that were bailed out were indeed important to the financial system, the fact that they took risk beyond what they would otherwise, should be enough for the Government to let them face the consequences of their actions. It would have been a lesson to motivate institutions to proceed differently next time.
Inability to prosecute
The political power of large banks and risks of economic impact from major prosecutions has led to use of the term "too big to jail" regarding the leaders of large financial institutions.
On March 6, 2013, then United States Attorney General
The United States attorney general (AG) is the head of the United States Department of Justice, and is the chief law enforcement officer of the federal government of the United States. The attorney general serves as the principal advisor to the p ...
Eric Holder
Eric Himpton Holder Jr. (born January 21, 1951) is an American lawyer who served as the 82nd Attorney General of the United States from 2009 to 2015. Holder, serving in the administration of President Barack Obama, was the first African America ...
testified to the Senate Judiciary Committee
The United States Senate Committee on the Judiciary, informally the Senate Judiciary Committee, is a standing committee of 22 U.S. senators whose role is to oversee the Department of Justice (DOJ), consider executive and judicial nominations, a ...
that the size of large financial institutions has made it difficult for the Justice Department
A justice ministry, ministry of justice, or department of justice is a ministry or other government agency in charge of the administration of justice. The ministry or department is often headed by a minister of justice (minister for justice in a ...
to bring criminal charges when they are suspected of crimes, because such charges can threaten the existence of a bank and therefore their interconnectedness may endanger the national or global economy. "Some of these institutions have become too large," Holder told the Committee. "It has an inhibiting impact on our ability to bring resolutions that I think would be more appropriate." In this he contradicted earlier written testimony from a deputy assistant attorney general, who defended the Justice Department's "vigorous enforcement against wrongdoing". Holder has financial ties to at least one law firm benefiting from ''de facto'' immunity to prosecution, and prosecution rates against crimes by large financial institutions are at 20-year lows.
Four days later, Federal Reserve Bank of Dallas
The Federal Reserve Bank of Dallas covers the Eleventh Federal Reserve District, which includes Texas, northern Louisiana and southern New Mexico, a district sometimes referred to as the Oil Patch.
The Federal Reserve Bank of Dallas is one of 12 ...
President Richard W. Fisher and Vice-President Harvey Rosenblum co-authored a ''Wall Street Journal'' op-ed about the failure of the Dodd–Frank Wall Street Reform and Consumer Protection Act
The Dodd–Frank Wall Street Reform and Consumer Protection Act, commonly referred to as Dodd–Frank, is a United States federal law that was enacted on July 21, 2010. The law overhauled financial regulation in the aftermath of the Great Recessi ...
to provide for adequate regulation of large financial institutions. In advance of his March 8 speech to the Conservative Political Action Conference
The Conservative Political Action Conference (CPAC; ) is an annual political conference attended by conservative activists and elected officials from across the United States and beyond. CPAC is hosted by the American Conservative Union (ACU). ...
, Fisher proposed requiring breaking up large banks into smaller banks so that they are "too small to save", advocating the withholding from mega-banks access to both Federal Deposit Insurance and Federal Reserve
The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
discount window
The discount window is an instrument of monetary policy (usually controlled by central banks) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by ...
, and requiring disclosure of this lack of federal insurance and financial solvency support to their customers. This was the first time such a proposal had been made by a high-ranking U.S. banking official or a prominent conservative. Other conservatives including Thomas Hoenig
Thomas Michael Hoenig (born September 6, 1946) is a Distinguished Senior Fellow at the Mercatus Center. He became a director of the Federal Deposit Insurance Corporation on April 16, 2012, and served as vice chairman from November 30, 2012 to Apr ...
, Ed Prescott
Edward Christian Prescott (December 26, 1940 – November 6, 2022) was an American economist. He received the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, Nobel Memorial Prize in Economics in 2004, sharing the award with ...
, Glenn Hubbard Glenn Hubbard may refer to:
*Glenn Hubbard (baseball) (born 1957), American baseball player
*Glenn Hubbard (economist) (born 1958), American academic specializing in tax policy and health care
See also
*Hubbard (surname) Hubbard is an English sur ...
, and David Vitter
David Bruce Vitter (born May 3, 1961) is an American lobbyist, lawyer, and politician who served as United States Senator for Louisiana from 2005 to 2017.
A Republican, Vitter served in the Louisiana House of Representatives from 1992 to 1999. ...
also advocated breaking up the largest banks, but liberal commentator Matthew Yglesias
Matthew Yglesias (; born May 18, 1981) is a liberal American blogger and journalist who writes about economics and politics. Yglesias has written columns and articles for publications such as ''The American Prospect'', ''The Atlantic'', and ''Sla ...
questioned their motives and the existence of a true bipartisan consensus.
In a January 29, 2013, letter to Holder, Senators Sherrod Brown
Sherrod Campbell Brown (; born November 9, 1952) is an American politician serving as the senior United States senator from Ohio, a seat which he has held since 2007. A member of the Democratic Party, he was the U.S. representative for Ohio's ...
( D-Ohio
Ohio () is a state in the Midwestern region of the United States. Of the fifty U.S. states, it is the 34th-largest by area, and with a population of nearly 11.8 million, is the seventh-most populous and tenth-most densely populated. The sta ...
) and Charles Grassley
Charles Ernest Grassley (born September 17, 1933) is an American politician serving as the president pro tempore emeritus of the United States Senate, and the senior United States senator from Iowa, having held the seat since 1981. In 2022, he ...
( R-Iowa
Iowa () is a state in the Midwestern region of the United States, bordered by the Mississippi River to the east and the Missouri River and Big Sioux River to the west. It is bordered by six states: Wisconsin to the northeast, Illinois to the ...
) had criticized this Justice Department policy citing "important questions about the Justice Department's prosecutorial philosophy". After receipt of a DoJ response letter, Brown and Grassley issued a statement saying, "The Justice Department's response is aggressively evasive. It does not answer our questions. We want to know how and why the Justice Department has determined that certain financial institutions are 'too big to jail' and that prosecuting those institutions would damage the financial system."
Kareem Serageldin pleaded guilty on November 22, 2013, for his role in inflating the value of mortgage bonds as the housing market collapsed, and was sentenced to two and a half years in prison. As of April 30, 2014, Serageldin remains the "only Wall Street
Wall Street is an eight-block-long street in the Financial District of Lower Manhattan in New York City. It runs between Broadway in the west to South Street and the East River in the east. The term "Wall Street" has become a metonym for t ...
executive prosecuted as a result of the financial crisis
A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and man ...
" that triggered the Great Recession
The Great Recession was a period of marked general decline, i.e. a recession, observed in national economies globally that occurred from late 2007 into 2009. The scale and timing of the recession varied from country to country (see map). At ...
. The much smaller Abacus Federal Savings Bank
Abacus Federal Savings Bank () is an American bank founded in December 1984 by a group of business leaders from the Chinese American community in New York City.
Abacus was the only U.S. bank prosecuted in relation to the 2008 financial crisis; i ...
was prosecuted (but exonerated after a jury trial) for selling fraudulent mortgages to Fannie Mae
The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, is a United States government-sponsored enterprise (GSE) and, since 1968, a publicly traded company. Founded in 1938 during the Great Depression as part of the N ...
.
Solutions
The proposed solutions to the "too big to fail" issue are controversial. Some options include breaking up the banks, introducing regulations to reduce risk, adding higher bank taxes for larger institutions, and increasing monitoring through oversight committees.
Breaking up the largest banks
More than fifty economists, financial experts, bankers, finance industry groups, and banks themselves have called for breaking up large banks into smaller institutions. This is advocated both to limit risk to the financial system posed by the largest banks as well as to limit their political influence.
For example, economist Joseph Stiglitz
Joseph Eugene Stiglitz (; born February 9, 1943) is an American New Keynesian economist, a public policy analyst, and a full professor at Columbia University. He is a recipient of the Nobel Memorial Prize in Economic Sciences (2001) and the Joh ...
wrote in 2009 that: "In the United States, the United Kingdom, and elsewhere, large banks have been responsible for the bulk of the ailoutcost to taxpayers. America has let 106 smaller banks go bankrupt this year alone. It's the mega-banks that present the mega-costs ... banks that are too big to fail are too big to exist. If they continue to exist, they must exist in what is sometimes called a 'utility' model, meaning that they are heavily regulated." He also wrote about several causes of the crisis
A crisis ( : crises; : critical) is either any event or period that will (or might) lead to an unstable and dangerous situation affecting an individual, group, or all of society. Crises are negative changes in the human or environmental affair ...
related to the size, incentives, and interconnection of the mega-banks.
Reducing risk-taking through regulation
The United States passed the Dodd–Frank Act in July 2010 to help strengthen regulation of the financial system in the wake of the subprime mortgage crisis
The United States subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010 that contributed to the Financial crisis of 2007–2008, 2007–2008 global financial crisis. It was triggered by a large decline ...
that began in 2007. Dodd–Frank requires banks to reduce their risk taking, by requiring greater financial cushions (i.e., lower leverage ratios or higher capital ratios), among other steps.
Banks are required to maintain a ratio of high-quality, easily sold assets, in the event of financial difficulty either at the bank or in the financial system. These are liquidity requirements.
Since the 2008 crisis, regulators have worked with banks to reduce leverage ratios. For example, the leverage ratio for investment bank Goldman Sachs declined from a peak of 25.2 during 2007 to 11.4 in 2012, indicating a much-reduced risk profile.
The Dodd–Frank Act includes a form of the Volcker Rule
The Volcker Rule iof the Dodd–Frank Wall Street Reform and Consumer Protection Act (). The rule was originally proposed by American economist and former United States Federal Reserve Chairman Paul Volcker to restrict United States banks from ma ...
, a proposal to ban proprietary trading by commercial banks. Proprietary trading refers to using customer deposits to speculate in risky assets for the benefit of the bank rather than customers. The Dodd–Frank Act as enacted into law includes several loopholes to the ban, allowing proprietary trading in certain circumstances. However, the regulations required to enforce these elements of the law were not implemented during 2013 and were under attack by bank lobbying efforts.
Another major banking regulation, the Glass–Steagall Act from 1933, was effectively repealed in 1999. The repeal allowed depository banks to enter into additional lines of business. Senators John McCain and Elizabeth Warren proposed bringing back Glass–Steagall during 2013.
Too big to fail tax
Economist Willem Buiter
Willem Hendrik Buiter CBE (born 26 September 1949) is an American-British economist. He spent most of his career as an academic, teaching at various universities. More recently, he was Chief Economist at Citigroup.
Early life and education
Buit ...
proposes a tax to internalize the massive costs inflicted by "too big to fail" institution. "When size creates externalities, do what you would do with any negative externality: tax it. The other way to limit size is to tax size. This can be done through capital requirements that are progressive in the size of the business (as measured by value added, the size of the balance sheet or some other metric). Such measures for preventing the New Darwinism of the survival of the fittest and the politically best connected should be distinguished from regulatory interventions based on the narrow leverage ratio aimed at regulating risk (regardless of size, except for a de minimis lower limit)."
Monitoring
On November 16, 2021, a policy research and development entity, called the Financial Stability Board
The Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system. It was established after the G20 London summit in April 2009 as a successor to the Financial Stability Forum ...
, released a list of 32 banks worldwide that they considered "systemically important financial institutions"—financial organisations whose size ''and role'' meant that any failure could cause serious systemic problems.
* Agricultural Bank of China
Agricultural Bank of China (ABC), also known as AgBank, is one of the " Big Four" banks in China. It was founded on 10 July 1951, and has its headquarters in Dongcheng District, Beijing. It has branches throughout mainland China, Hong Kong, Lond ...
* Banco Bilbao Vizcaya Argentaria, S.A.
* Banco Santander, S.A.
* Bank of America
The Bank of America Corporation (often abbreviated BofA or BoA) is an American multinational investment bank and financial services holding company headquartered at the Bank of America Corporate Center in Charlotte, North Carolina. The bank w ...
* Bank of China
The Bank of China (BOC; ) is a Chinese majority state-owned commercial bank headquartered in Beijing and the fourth largest bank in the world.
The Bank of China was founded in 1912 by the Republican government as China's central bank, repl ...
* Bank of New York Mellon
The Bank of New York Mellon Corporation, commonly known as BNY Mellon, is an American investment banking services holding company headquartered in New York City. BNY Mellon was formed from the merger of The Bank of New York and the Mellon Financ ...
* Barclays
Barclays () is a British multinational universal bank, headquartered in London, England. Barclays operates as two divisions, Barclays UK and Barclays International, supported by a service company, Barclays Execution Services.
Barclays traces ...
* BNP Paribas
BNP Paribas is a French international banking group, founded in 2000 from the merger between Banque Nationale de Paris (BNP, "National Bank of Paris") and Paribas, formerly known as the Banque de Paris et des Pays-Bas. The full name of the grou ...
* China Construction Bank
China Construction Bank Corporation (CCB) is one of the " big four" banks in China. In 2015, CCB was the 2nd largest bank in the world by market capitalization and 6th largest company in the world. The bank has approximately 13,629 domestic bra ...
* Citigroup
Citigroup Inc. or Citi (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services corporation headquartered in New York City. The company was formed by the merger of banking ...
* Crédit Agricole Group
* Credit Suisse Group AG
Credit Suisse Group AG is a global Investment banking, investment bank and financial services firm founded and based in Switzerland. Headquartered in Zürich, it maintains offices in all Financial centre, major financial centers around the w ...
* Deutsche Bank AG
Deutsche Bank AG (), sometimes referred to simply as Deutsche, is a German multinational investment bank and financial services company headquartered in Frankfurt, Germany, and dual-listed on the Frankfurt Stock Exchange and the New York Stoc ...
* Goldman Sachs
Goldman Sachs () is an American multinational investment bank and financial services company. Founded in 1869, Goldman Sachs is headquartered at 200 West Street in Lower Manhattan, with regional headquarters in London, Warsaw, Bangalore, H ...
* Groupe BPCE
Groupe BPCE (for Banque Populaire Caisse d'Epargne) is a major French banking group formed by the 2009 merger of two major retail banking groups, Groupe Caisse d'Épargne and Groupe Banque Populaire. As of 2021, it was France's fourth largest ba ...
* HSBC Holdings plc
HSBC Holdings plc is a British multinational universal bank and financial services holding company. It is the largest bank in Europe by total assets ahead of BNP Paribas, with US$2.953 trillion as of December 2021. In 2021, HSBC had $10.8 tril ...
* Industrial and Commercial Bank of China Limited
Industrial and Commercial Bank of China Limited (ICBC; ) is a Chinese multinational bank.
Founded as a limited company on 1 January 1984, ICBC is a state-owned commercial bank. With capital provided by the Ministry of Finance of China, the ...
* ING Group
The ING Group ( nl, ING Groep) is a Dutch multinational banking and financial services corporation headquartered in Amsterdam. Its primary businesses are retail banking, direct banking, commercial banking, investment banking, wholesale bankin ...
* JPMorgan Chase
JPMorgan Chase & Co. is an American multinational investment bank and financial services holding company headquartered in New York City and incorporated in Delaware. As of 2022, JPMorgan Chase is the largest bank in the United States, the ...
* Mitsubishi UFJ Financial Group, Inc
* Mizuho Financial Group, Inc.
* Morgan Stanley
Morgan Stanley is an American multinational investment management and financial services company headquartered at 1585 Broadway in Midtown Manhattan, New York City. With offices in more than 41 countries and more than 75,000 employees, the fir ...
* Nordea Bank Abp
Nordea Bank Abp, commonly referred to as Nordea, is a European financial services group operating in northern Europe and based in Helsinki, Finland. The name is a blend of the words "Nordic" and "idea". The bank is the result of the successive m ...
* Royal Bank of Canada
Royal Bank of Canada (RBC; french: Banque royale du Canada) is a Canadian multinational financial services company and the largest bank in Canada by market capitalization. The bank serves over 17 million clients and has more than 89,000& ...
* Royal Bank of Scotland plc
* Société Générale S.A.
* Standard Chartered plc
Standard Chartered plc is a multinational bank with operations in consumer, corporate and institutional banking, and treasury services. Despite being headquartered in the United Kingdom, it does not conduct retail banking in the UK, and around 9 ...
* State Street Corporation
State Street Corporation is an American financial services and bank holding company headquartered at One Lincoln Street in Boston with operations worldwide. It is the second-oldest continually operating United States bank; its predecessor, Un ...
* Sumitomo Mitsui Banking Corporation Group
* UBS Group AG
UBS Group AG is a multinational Investment banking, investment bank and financial services company founded and based in Switzerland. Co-headquartered in the cities of Zürich and Basel, it maintains a presence in all major financial centres ...
* UniCredit S.p.A.
* Wells Fargo
Wells Fargo & Company is an American multinational financial services company with corporate headquarters in San Francisco, California; operational headquarters in Manhattan; and managerial offices throughout the United States and intern ...
Notable views on the issue
Economists
More than fifty notable economists, financial experts, bankers, finance industry groups, and banks themselves have called for breaking up large banks into smaller institutions. (See also Divestment
In finance and economics, divestment or divestiture is the reduction of some kind of asset for financial, ethical, or political objectives or sale of an existing business by a firm. A divestment is the opposite of an investment. Divestiture is a ...
.)
Some economists such as Paul Krugman
Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was th ...
hold that bank crises arise from banks being under regulated rather than their size in itself. Krugman wrote in January 2010 that it was more important to reduce bank risk taking (leverage) than to break them up.
Economist Simon Johnson has advocated both increased regulation as well as breaking up the larger banks, not only to protect the financial system but to reduce the political power of the largest banks.
Politicians
One of the most vocal opponents in the United States government of the "too big to fail" status of large American financial institutions in recent years has been Elizabeth Warren
Elizabeth Ann Warren ( née Herring; born June 22, 1949) is an American politician and former law professor who is the senior United States senator from Massachusetts, serving since 2013. A member of the Democratic Party and regarded as a ...
. At her first U.S. Senate Banking Committee hearing on February 14, 2013, Senator Warren pressed several banking regulators to answer when they had last taken a Wall Street bank to trial and stated, "I'm really concerned that 'too big to fail' has become 'too big for trial'." Videos of Warren's questioning, centering on "too big to fail", became popular on the internet, amassing more than 1 million views in a matter of days.
On March 6, 2013, United States Attorney General
The United States attorney general (AG) is the head of the United States Department of Justice, and is the chief law enforcement officer of the federal government of the United States. The attorney general serves as the principal advisor to the p ...
Eric Holder
Eric Himpton Holder Jr. (born January 21, 1951) is an American lawyer who served as the 82nd Attorney General of the United States from 2009 to 2015. Holder, serving in the administration of President Barack Obama, was the first African America ...
told the Senate Judiciary Committee
The United States Senate Committee on the Judiciary, informally the Senate Judiciary Committee, is a standing committee of 22 U.S. senators whose role is to oversee the Department of Justice (DOJ), consider executive and judicial nominations, a ...
that the Justice Department
A justice ministry, ministry of justice, or department of justice is a ministry or other government agency in charge of the administration of justice. The ministry or department is often headed by a minister of justice (minister for justice in a ...
faces difficulty charging large banks with crimes because of the risk to the economy. Four days later, Federal Reserve Bank of Dallas
The Federal Reserve Bank of Dallas covers the Eleventh Federal Reserve District, which includes Texas, northern Louisiana and southern New Mexico, a district sometimes referred to as the Oil Patch.
The Federal Reserve Bank of Dallas is one of 12 ...
President Richard W. Fisher wrote in advance of a speech to the Conservative Political Action Conference
The Conservative Political Action Conference (CPAC; ) is an annual political conference attended by conservative activists and elected officials from across the United States and beyond. CPAC is hosted by the American Conservative Union (ACU). ...
that large banks should be broken up
Ship-breaking (also known as ship recycling, ship demolition, ship dismantling, or ship cracking) is a type of ship disposal involving the breaking up of ships for either a source of Interchangeable parts, parts, which can be sold for re-use, ...
into smaller banks, and both Federal Deposit Insurance and Federal Reserve
The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
discount window
The discount window is an instrument of monetary policy (usually controlled by central banks) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by ...
access should end for large banks. Other conservatives including Thomas Hoenig
Thomas Michael Hoenig (born September 6, 1946) is a Distinguished Senior Fellow at the Mercatus Center. He became a director of the Federal Deposit Insurance Corporation on April 16, 2012, and served as vice chairman from November 30, 2012 to Apr ...
, Ed Prescott
Edward Christian Prescott (December 26, 1940 – November 6, 2022) was an American economist. He received the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, Nobel Memorial Prize in Economics in 2004, sharing the award with ...
, Glenn Hubbard Glenn Hubbard may refer to:
*Glenn Hubbard (baseball) (born 1957), American baseball player
*Glenn Hubbard (economist) (born 1958), American academic specializing in tax policy and health care
See also
*Hubbard (surname) Hubbard is an English sur ...
, and David Vitter
David Bruce Vitter (born May 3, 1961) is an American lobbyist, lawyer, and politician who served as United States Senator for Louisiana from 2005 to 2017.
A Republican, Vitter served in the Louisiana House of Representatives from 1992 to 1999. ...
also advocated breaking up the largest banks.
International organizations
On April 10, 2013, International Monetary Fund
The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution, headquartered in Washington, D.C., consisting of 190 countries. Its stated mission is "working to foster globa ...
Managing Director Christine Lagarde
Christine Madeleine Odette Lagarde (; née Lallouette, ; born 1 January 1956) is a French politician and lawyer who has been serving as President of the European Central Bank since 2019. She previously served as the 11th managing director of the ...
told the Economic Club of New York
The Economic Club of New York is a U.S. nonprofit and non-partisan membership organization dedicated to promoting the study and discussion of social, economic and political questions.
History
Founded in 1907, the Economic Club of New York is t ...
"too big to fail" banks had become "more dangerous than ever" and had to be controlled with "comprehensive and clear regulation ndmore intensive and intrusive supervision".[United Press Internationa]
(UPI), "Lagarde: 'Too big to fail' banks 'dangerous'"
Retrieved April 13, 2013
Other commentators
Ron Suskind
Ronald Steven "Ron" Suskind (born November 20, 1959) is an American journalist, author, and filmmaker. He was the senior national affairs writer for ''The Wall Street Journal'' from 1993 to 2000, where he won the 1995 Pulitzer Prize for Feature ...
claimed in his book ''Confidence Men
''Confidence Men: Wall Street, Washington and the Education of a President'' is a book by journalist Ron Suskind, published by HarperCollins on September 20, 2011.
Having obtained an advance copy of the book, ''The New York Times'' published a re ...
'' that the administration of Barack Obama
Barack Hussein Obama II ( ; born August 4, 1961) is an American politician who served as the 44th president of the United States from 2009 to 2017. A member of the Democratic Party, Obama was the first African-American president of the U ...
considered breaking up Citibank
Citibank, N. A. (N. A. stands for " National Association") is the primary U.S. banking subsidiary of financial services multinational Citigroup. Citibank was founded in 1812 as the City Bank of New York, and later became First National City ...
and other large banks that had been involved in the financial crisis of 2008. He said that Obama's staff, such as Timothy Geithner
Timothy Franz Geithner (; born August 18, 1961) is a former American central banker who served as the 75th United States Secretary of the Treasury under President Barack Obama from 2009 to 2013. He was the President of the Federal Reserve Bank o ...
, refused to do so. The administration and Geithner have denied this version of events.
Mervyn King, the governor of the Bank of England
The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the English Government's banker, and still one of the bankers for the Government of ...
during 2003–2013, called for cutting "too big to fail" banks down to size, as a solution to the problem of banks having taxpayer-funded guarantees for their speculative investment banking activities. "If some banks are thought to be too big to fail, then, in the words of a distinguished American economist, they are too big. It is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee against failure."
Former Chancellor of the Exchequer Alistair Darling
Alistair Maclean Darling, Baron Darling of Roulanish, (born 28 November 1953) is a British politician who served as Chancellor of the Exchequer under Prime Minister Gordon Brown from 2007 to 2010. A member of the Labour Party, he was a Member ...
disagreed: "Many people talk about how to deal with the big banks – banks so important to the financial system that they cannot be allowed to fail, but the solution is not as simple, as some have suggested, as restricting the size of the banks". Additionally, Alan Greenspan
Alan Greenspan (born March 6, 1926) is an American economist who served as the 13th chairman of the Federal Reserve from 1987 to 2006. He works as a private adviser and provides consulting for firms through his company, Greenspan Associates LLC. ...
said that "If they're too big to fail, they're too big", suggesting U.S. regulators to consider breaking up large financial institutions considered "too big to fail". He added, "I don't think merely raising the fees or capital on large institutions or taxing them is enough ... they'll absorb that, they'll work with that, and it's totally inefficient and they'll still be using the savings."
Public opinion polls
Gallup reported in June 2013 that: "Americans' confidence in U.S. banks increased to 26% in June, up from the record low of 21% the previous year. The percentage of Americans saying they have 'a great deal' or 'quite a lot' of confidence in U.S. banks is now at its highest point since June 2008, but remains well below its pre-recession level of 41%, measured in June 2007. Between 2007 and 2012, confidence in banks fell by half—20 percentage points." Gallup also reported that: "When Gallup first measured confidence in banks in 1979, 60% of Americans had a great deal or quite a lot of confidence in them—second only to the church. This high level of confidence, which hasn't been matched since, was likely the result of the strong U.S. banking system established after the 1930s Great Depression and the related efforts of banks and regulators to build Americans' confidence in that system."
Lobbying by banking industry
In the US, the banking industry spent over $100 million lobbying politicians and regulators between January 1 and June 30, 2011. Lobbying in the finance, insurance and real estate industries has risen annually since 1998 and was approximately $500 million in 2012.
Historical examples
Prior to the 2008 failure and bailout of multiple firms, there were "too big to fail" examples from 1763 when Leendert Pieter de Neufville
Leendert Pieter de Neufville (Amsterdam, March 8, 1729Rotterdam, July 28, 1811) was a Dutch merchant and banker trading in silk, linen, and grain. His business grew quickly during the Seven Years' War. De Neufville secretly supplied the Prussian ...
in Amsterdam and Johann Ernst Gotzkowsky
Johann Ernst Gotzkowsky (21 November 1710 – 9 August 1775) was a Prussian merchant with a successful trade in trinkets, silk, taft, porcelain, grain and bills of exchange
A negotiable instrument is a document guaranteeing the payment of a ...
in Berlin failed, and from
the 1980s and 1990s. These included Continental Illinois and Long-Term Capital Management
Long-Term Capital Management L.P. (LTCM) was a highly-leveraged hedge fund. In 1998, it received a $3.6 billion bailout from a group of 14 banks, in a deal brokered and put together by the Federal Reserve Bank of New York.
LTCM was founded in 1 ...
.
Continental Illinois case
An early example of a bank rescued because it was "too big to fail" was the Continental Illinois National Bank and Trust Company during the 1980s.
Distress
The Continental Illinois National Bank and Trust Company
The Continental Illinois National Bank and Trust Company was at one time the seventh-largest commercial bank in the United States as measured by deposits, with approximately $40 billion in assets. In 1984, Continental Illinois became the largest ...
experienced a fall in its overall asset quality during the early 1980s. Tight money, Mexico's default (1982) and plunging oil prices followed a period when the bank had aggressively pursued commercial lending business, Latin American syndicated loan
A syndicated loan is one that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial banks or investment banks known as lead arrangers.
The syndicated loan market is the dominant way for larg ...
business, and loan participation in the energy sector. Complicating matters further, the bank's funding mix was heavily dependent on large certificates of deposit
A certificate of deposit (CD) is a time deposit, a financial product commonly sold by banks, thrift institutions, and credit unions in the United States. CDs differ from savings accounts in that the CD has a specific, fixed term (often one, th ...
and foreign money market
The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less.
As short-term securities became a commodity, the money market became a compon ...
s, which meant its depositors were more risk-averse than average retail depositors in the US.
Payments crisis
The bank held significant participation in highly speculative oil and gas loans of Oklahoma's Penn Square Bank
Penn Square Bank was a small commercial bank located in Oklahoma City, Oklahoma. The bank made a large number of poorly underwritten energy-related loans that it sold to other banks. Losses on these loans led to significant financial problems in th ...
. When Penn Square failed in July 1982, the Continental's distress became acute, culminating with press rumors of failure and an investor-and-depositor run
Run(s) or RUN may refer to:
Places
* Run (island), one of the Banda Islands in Indonesia
* Run (stream), a stream in the Dutch province of North Brabant
People
* Run (rapper), Joseph Simmons, now known as "Reverend Run", from the hip-hop group ...
in early May 1984. In the first week of the run, the Fed permitted the Continental Illinois discount window
The discount window is an instrument of monetary policy (usually controlled by central banks) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by ...
credits on the order of $3.6 billion. Still in significant distress, the management obtained a further $4.5 billion in credits from a syndicate of money center banks the following week. These measures failed to stop the run, and regulators were confronted with a crisis.
Regulatory crisis
The seventh-largest bank in the nation by deposits would very shortly be unable to meet its obligations. Regulators faced a tough decision about how to resolve the matter. Of the three options available, only two were seriously considered. Even banks much smaller than the Continental were deemed unsuitable for resolution by liquidation, owing to the disruptions this would have inevitably caused. The normal course would be to seek a purchaser (and indeed press accounts that such a search was underway contributed to Continental depositors' fears in 1984). However, in the tight-money financial climate of the early 1980s, no purchaser was forthcoming.
Besides generic concerns of size, contagion of depositor panic and bank distress, regulators feared the significant disruption of national payment and settlement systems. Of special concern was the wide network of correspondent banks with high percentages of their capital invested in the Continental Illinois. Essentially, the bank was deemed "too big to fail", and the "provide assistance" option was reluctantly taken. The dilemma then became how to provide assistance without significantly unbalancing the nation's banking system.
Trying to stop the run
To prevent immediate failure
Failure is the state or condition of not meeting a desirable or intended objective (goal), objective, and may be viewed as the opposite of Success (concept), success. The criteria for failure depends on context, and may be relative to a parti ...
, the Federal Reserve announced categorically that it would meet any liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Liqui ...
needs the Continental might have, while the Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation (FDIC) is one of two agencies that supply deposit insurance to depositors in American depository institutions, the other being the National Credit Union Administration, which regulates and insures cred ...
(FDIC) gave depositors and general creditors a full guarantee (not subject to the $100,000 FDIC deposit-insurance limit) and provided direct assistance of $2 billion (including participations). Money center banks assembled an additional $5.3 billion unsecured facility pending a resolution and resumption of more-normal business. These measures slowed, but did not stop, the outflow of deposits.
Controversy
In a United States Senate
The United States Senate is the upper chamber of the United States Congress, with the House of Representatives being the lower chamber. Together they compose the national bicameral legislature of the United States.
The composition and pow ...
hearing afterwards, the then Comptroller of the Currency
The Office of the Comptroller of the Currency (OCC) is an independent bureau within the United States Department of the Treasury that was established by the National Currency Act of 1863 and serves to charter, bank regulation in the United States ...
C. T. Conover defended his position by admitting the regulators will not let the largest 11 banks fail.
Long-Term Capital Management
Long-Term Capital Management L.P. (LTCM) was a hedge fund management firm based in Greenwich, Connecticut, that utilized absolute-return trading strategies combined with high financial leverage. The firm's master hedge fund, Long-Term Capital Portfolio L.P., collapsed in the late 1990s, leading to an agreement on September 23, 1998, among 14 financial institutions for a $3.6 billion recapitalization (bailout) under the supervision of the Federal Reserve.
LTCM was founded in 1994 by John W. Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers. Members of LTCM's board of directors included Myron S. Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences for a "new method to determine the value of derivatives". Initially successful with annualized returns of over 40% (after fees) in its first years, in 1998 it lost $4.6 billion in less than four months following the Russian financial crisis requiring financial intervention by the Federal Reserve, with the fund liquidating and dissolving in early 2000.
International
Canada
In March 2013, the Office of the Superintendent of Financial Institutions
The Office of the Superintendent of Financial Institutions (OSFI; french: Bureau du surintendant des institutions financières, BSIF) is an independent agency of the Government of Canada reporting to the Minister of Finance created "to contribute ...
announced that Canada's six largest banks, the Bank of Montreal
The Bank of Montreal (BMO; french: Banque de Montréal, link=no) is a Canadian multinational investment bank and financial services company.
The bank was founded in Montreal, Quebec, in 1817 as Montreal Bank; while its head office remains in ...
, the Bank of Nova Scotia
The Bank of Nova Scotia (french: link=no, Banque de Nouvelle-Écosse), operating as Scotiabank (french: link=no, Banque Scotia), is a Canadian multinational banking and financial services company headquartered in Toronto, Ontario. One of Canada ...
, the Canadian Imperial Bank of Commerce
The Canadian Imperial Bank of Commerce (CIBC; french: Banque canadienne impériale de commerce) is a Canadian multinational banking and financial services corporation headquartered at CIBC Square in the Financial District of Toronto, Ontario. ...
, National Bank of Canada
The National Bank of Canada (french: Banque Nationale du Canada) is the sixth largest commercial bank in Canada. It is headquartered in Montreal, and has branches in most Canadian provinces and 2.4 million personal clients. National Bank is the ...
, Royal Bank of Canada
Royal Bank of Canada (RBC; french: Banque royale du Canada) is a Canadian multinational financial services company and the largest bank in Canada by market capitalization. The bank serves over 17 million clients and has more than 89,000& ...
and Toronto-Dominion Bank
Toronto-Dominion Bank (french: links=no, Banque Toronto-Dominion), doing business as TD Bank Group (french: links=no, Groupe Banque TD), is a Canadian Multinational corporation, multinational banking and financial services corporation headquarte ...
, were too big to fail. Those six banks accounted for 90% of banking assets in Canada at that time. It noted that "the differences among the largest banks are smaller if only domestic assets are considered, and relative importance declines rapidly after the top five banks and after the sixth bank (National)."
New Zealand
Despite the government's assurances, opposition parties and some media commentators in New Zealand say that the largest banks are too big to fail and have an implicit government guarantee.
United Kingdom
George Osborne
George Gideon Oliver Osborne (born Gideon Oliver Osborne; 23 May 1971) is a former British politician and newspaper editor who served as Chancellor of the Exchequer from 2010 to 2016 and as First Secretary of State from 2015 to 2016 in the ...
, Chancellor of the Exchequer under David Cameron
David William Donald Cameron (born 9 October 1966) is a British former politician who served as Prime Minister of the United Kingdom from 2010 to 2016 and Leader of the Conservative Party from 2005 to 2016. He previously served as Leader o ...
(2010–2016), threatened to break up banks which are too big to fail.
The too-big-to-fail idea has led to legislators and governments facing the challenge of limiting the scope of these hugely important organisations, and regulating activities perceived as risky or speculative—to achieve this regulation in the UK, banks are advised to follow the UK's Independent Commission on Banking Report.
See also
* Brown–Kaufman amendment
* Bulge Bracket
* Corporate welfare
Corporate welfare is a phrase used to describe a government's bestowal of money grants, tax breaks, or other special favorable treatment for corporations.
The definition of corporate welfare is sometimes restricted to direct government subsidie ...
* Crony capitalism
Crony capitalism, sometimes called cronyism, is an economic system in which businesses thrive not as a result of free enterprise, but rather as a return on money amassed through collusion between a business class and the political class. This is ...
* Dirigisme
Dirigisme or dirigism () is an economic doctrine in which the state plays a strong directive (policies) role contrary to a merely regulatory interventionist role over a market economy. As an economic doctrine, dirigisme is the opposite of ''lai ...
* Greenspan Put
The Greenspan put was a monetary policy response to financial crises that Alan Greenspan, former chair of the Federal Reserve, exercised beginning with the crash of 1987. Successful in addressing various crises, it became controversial as it le ...
* Lemon socialism
Lemon socialism is a pejorative term for a form of government intervention in which government subsidies go to weak or failing firms (''lemons''; see Lemon law), with the effective result that the government (and thus the taxpayer) absorbs part ...
* Liquidity trap
A liquidity trap is a situation, described in Keynesian economics, in which, "after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash rathe ...
* Speculative bubble
An economic bubble (also called a speculative bubble or a financial bubble) is a period when current asset prices greatly exceed their intrinsic valuation, being the valuation that the underlying long-term fundamentals justify. Bubbles can be c ...
* Too connected to fail
Banking collapse
* List of bank failures in the United States (2008–present)
The Financial crisis of 2007–2008 led to a lot of bank failures in the United States. The Federal Deposit Insurance Corporation (FDIC) closed 465 failed banks from 2008 to 2012. In contrast, in the five years prior to 2008, only 10 banks failed. ...
* List of banks acquired or bankrupted in the United States during the financial crisis of 2007–2008
* List of largest U.S. bank failures
This is a list of the largest U.S. bank failures with respect to total assets under management at the time of the bank failure (banks with $1.0 billion or more in assets are listed here). Assets of the banks listed here are figures provided by ...
General
* Corporatocracy
Corporatocracy (, from corporate and el, -κρατία, translit=-kratía, lit=domination by; short form corpocracy) is an economic, political and judicial system controlled by corporations or corporate interests.
The concept has been used ...
* Lender of last resort
A lender of last resort (LOLR) is the institution in a financial system that acts as the provider of liquidity to a financial institution which finds itself unable to obtain sufficient liquidity in the interbank lending market when other facil ...
* Zombie company
In political economy, a zombie company is a company that needs bailouts in order to operate, or an indebted company that is able to repay the interest on its debts but not repay the principal.
Description
Zombie companies are indebted businesses ...
, and zombie bank
A zombie bank is a financial institution that has an economic net worth less than zero but continues to operate because its ability to repay its debts is shored up by implicit or explicit government credit support. The term was first used by Edw ...
Works
* ''Too Big to Fail (book)
''Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves'', also known as ''Too Big to Fail: Inside the Battle to Save Wall Street'', is a non-fiction book by Andrew Ross Sorkin ch ...
''
* ''Too Big to Fail (film)
''Too Big to Fail'' is a 2011 American biographical drama television film directed by Curtis Hanson and written by Peter Gould, based on Andrew Ross Sorkin's 2009 non-fiction book '' Too Big to Fail: The Inside Story of How Wall Street and Washin ...
''
* '' Abacus: Small Enough to Jail''
Notes
Further reading
*
*
*
*
*
*
*
Who is Too Big to Fail?: Does Title II of the Dodd–Frank Act Enshrine Taxpayer Funded Bailouts?: Hearing before the Subcommittee on Oversight and Investigations of the Committee on Financial Services, U.S. House of Representatives, One Hundred Thirteenth Congress, First Session, May 15, 2013
Who Is Too Big To Fail: Are Large Financial Institutions Immune from Federal Prosecution?: Hearing before the Subcommittee on Oversight and Investigations of the Committee on Financial Services, U.S. House Of Representatives, One Hundred Thirteenth Congress, First Session, May 22, 2013
Federal Reserve – List of Banks with Assets Greater than $10 billion
{{Wealth, state=autocollapse
History of the Federal Reserve System
Federal Deposit Insurance Corporation
Bank regulation in the United States
Banking crises
Great Recession
Matthew effect