Too Big to Fail

10 Key excerpts on "Too Big to Fail"

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  Too Big to Fail

  Policies and Practices in Government Bailouts

  • Benton E. Gup(Author)
  • 2003(Publication Date)
  • Praeger

    (Publisher)

  Recently, Bongini, Claessens, and Ferri (2001) found evidence of Too Big to Fail policies in the 220 Too Big to Fail handling of financial institution distress during the economic crisis in East Asia. Kaufman and Seelig (2002) examine the limitation on the access to de- positor funds as a possible cause for T B T F policies for banks in many coun- tries to banks. While the term Too Big to Fail is commonly used in the banking literature, its literal meaning is usually not made explicit. Literally, one could interpret the term as meaning that a firm is so large that it cannot fail. A more common usage of the term is, because a firm is so big, government intervention is necessary to prevent its failure. Alternatively, the expression could mean that because a firm is so big the government must prevent its failure. However, these usages beg the question of what is meant by "too big" and "failure." Typically, one thinks of T B T F applying to large firms where the creditors and/or share- holders are protected when the firm becomes insolvent. The protection comes, not from the law, but from government policy. Henry Kaufman (2001, p. 9) noted that "Historically, when they [the largest corporations] have fallen into serious trouble, the government—weighing the immediate social and economic costs—has shown a propensity to step in to shore up the faltering giants with loan guarantees, tax breaks and other subsidies." In the United States, frequently cited examples of firms that were Too Big to Fail have included Chrysler Corporation, Lockheed, and Continental Illi- nois National Bank. A frequently cited example in Europe has been Credit Lyonnais. All of these were large firms, both in a relative sense and in absolute terms. However, international experience has shown that smaller firms have also not been allowed to "fail" and, in fact, the term "failure" has a very different meaning in many countries.

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  Surviving the Debt Storm

  Getting capitalism back on track

  • Leigh Skene, Melissa Kidd(Authors)
  • 2013(Publication Date)
  • Profile Books

    (Publisher)

  5Too Big to Fail – too haughty to learn

  Small banks going bust has become a routine experience in the US, as 51 of them failed in 2012 compared with 92 in 2011. By contrast, governments fear that the failure of any large bank, regardless of its business model, would cause substantial collateral damage to the economy. Not only does the expectation that the government will always step in to rescue too-big-to-fail (TBTF) banks lower their cost of funding and raise their profits, but it also allows them to pocket the gains from their profitable investments while saddling taxpayers with the losses from their unprofitable ones.

  Democratic capitalism gives individuals the right to the profits of their successful investments, but at the cost of bearing the losses of their unprofitable ones. TBTF violates this quid pro quo, so it is undermining the capitalist system and, by extension, creating immense moral hazard and jeopardising democracy itself. Unsurprisingly, executives of financial institutions that believe they are TBTF have exploited their ability to pocket profits and saddle the public with their losses, which include exorbitant bonuses based on ephemeral short-term profits. Government-mandated mergers and acquisitions during and after the 2008 banking crisis have greatly increased the size of TBTF banks.

  TBTF is a perfect tool for the elite to exploit the public, and bankers are using their incredibly wealthy and powerful lobby to do just that. This long-running black comedy features the banking lobby bullying (read blackmailing) governments into sidelining public demands for bank reform, especially of TBTF banks, thereby penalising savers with negative real interest rates to keep propping them up, penalising borrowers with shrinking loans and, worst of all, greatly increasing systemic risk. The European sovereign debt/banking crisis will cause the failure of TBTF banks and the great danger is that one or more will prove to be too big to bail out.

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  Performing Utopias in the Contemporary Americas

  • Kim Beauchesne, Alessandra Santos, Kim Beauchesne, Alessandra Santos(Authors)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  203 steps that were taken in order to prevent a complete collapse of the entire financial system, he also signals that the individuals who compose the book’s “cast of characters” and who were tasked with mitigating the crisis “were not immune to the fierce rivalries and power grabs that are part of the long-established cultures on Wall Street and in Washington” (7). Ultimately, Too Big to Fail functions both to inform the average American of the day-by-day events of the most critical time of the 2008 financial crisis and to empower them for future decision-making processes. When it comes to taking out loans or making other financial decisions, Americans will most likely continue to rely on at least one of these large banks, as most are still in existence due to the decisions taken during the time that Sorkin details. To this end, the individual and familial utopian goal of home ownership that represents the crux of the American dream is not one that Too Big to Fail rejects or discourages; it rather highlights the care that an individual or a family should take if surrounded by the rheto- ric of predatory lending institutions whose promise-based performance might not constitute the wisest course of action for the average consumer. Sorkin’s book stresses the importance of making informed financial deci- sions over a sustained period of time, now that the account of what exactly happened (according to the author and his sources) during the most criti- cal days in the fall of 2008 has been brought to light. A CINEMATOGRAPHIC REPRESENTATION OF THE SEVERITY AND RAPIDITY OF THE CRISIS: TOO BIG TO FAIL BY CURTIS HANSON The need for the public to be informed about the sequence of events of the crisis so that they may be better equipped for future financial decisions is also at the heart of the film adaptation of Sorkin’s work. Directed by Curtis Hanson, the film Too Big to Fail is characterized by a heightened sense of urgency, much like its source text.

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  After the Virus

  Lessons from the Past for a Better Future

  • Hilary Cooper, Simon Szreter(Authors)
  • 2021(Publication Date)
  • Cambridge University Press

    (Publisher)

  148 6. ‘Too Big to Fail?’ WE NEED A PAYBACK THIS TIME bad to contemplate, was systemic – whole economy – fail- ures because ultimately banking is what oils the wheels of everything we do. Not everyone was happy with this. Mervyn King, the governor of the Bank of England, called it the ‘biggest moral hazard in history’ and he was probably right. 1 To paraphrase the argument, moral hazard is the temptation to push boundaries when you know someone else is on the hook if things go wrong. If I know that whenever I Image 15. Worker leaving Lehman Brothers’ European headquarters, Canary Wharf, 15 September 2008. Source: BEN STANSALL / AFP / Getty Images Lessons from the 2007–8 Financial Crash 149 spend too much on my credit card there is a rich relative who always obligingly pays it off, maybe it’s only going to encourage me to spend even more recklessly. ‘Too Big to Fail’ is exactly the same. Once business leaders believe the government will step in to support them no matter what happens, why wouldn’t they take a few more risks? Either their gamble will pay off or they’ll be bailed out – a one- way bet. Arguably, though, governments can deal with this by asking for some sort of payback for acting as backer of last resort. When faced with the prospect of mass business failures they may throw public money at the problem, but they have to come in hard behind with a crucial question that deals with the moral hazard. Specifically, that ques- tion should be: what will the public get in return? Or, in the case of a bank-induced crisis, what will you do to stop this happening again? That debate needs to happen swift- ly, while the government still has the upper hand. After the financial crisis there was a bit of this. In the UK, where finance had become so dominant in the economy, some banks were taken into public ownership, giving taxpayers the prospect of some future financial return.

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  Good Regulation, Bad Regulation

  The Anatomy of Financial Regulation

  • Imad A. Moosa(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Stern (2008) believes that “the too-big-to-fail problem now rests at the very top of the ills elected officials, policymakers and bank supervisors must address”. He also believes that TBTF represents greater risk and should be assigned higher priority than many would think. But Mishkin (2006) argues that Stern and Feldman (2004) “overstate the importance of the too-big-to-fail problem”. One explanation why politicians and regulators tend to overlook the TBTF issue is the very proposition that some financial institutions are so large that they pose systemic risk, in the sense that the failure of one of these institutions may cause systemic failure (the failure of the entire financial system). This sounds terrible, even apocalyptic, and it is intended to sound like that. How can an elected official vote in such a way as to create systemic risk that could cause the failure of the whole financial system? Instead, this official must vote to approve the bail-out of a failed institution. Would-be bailed-out institutions endeavour to portray themselves as posing systemic risk, arguing with politicians along the lines that “if you do not bail us out, the dire consequences of our failure will be catastrophic for all, including the government”. The fact of the matter is that there is no evidence whatsoever to support the claim that the failure of one big firm could bring about the total collapse of the financial system or the economy at large. True, the collapse of Lehman Brothers was painful, but it was not catastrophic. The decision to let it go was a good decision. The decision not to let the others go was a bad decision.

  Stern and Feldman (2004) suggest other factors as providing motivation for regulators to indulge in TBTF behaviour. Regulators could be motivated by personal rewards, such as the prospect of lucrative banking jobs, or because of fear of having banking failures under their watch (although it is definitely better than having a TBTF salvation operation under their watch). The government may also believe that when a bank is rescued, it can direct credit the way it desires. This is the capture theory in action: big financial institutions demand regulation in the form of bail-out from their captured regulators when they are in trouble and regulators respond positively for the very reason that they are captured.

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  Across the Great Divide

  New Perspectives on the Financial Crisis

  • John B. Taylor, Martin Neil Baily(Authors)
  • 2014(Publication Date)
  • Hoover Institution Press

    (Publisher)

  CHAPTER 12 “Too Big to Fail” from an Economic Perspective

  Steve Strongin *

  Strengthening the resilience of TBTF banks

  In assessing the resiliency today of the biggest US banks, the G-SIFIs1 —those that are often considered “Too Big to Fail” (TBTF)—it is important to disentangle the progress that has been made in shoring up their safety and soundness since 2008 from the lingering concerns and prejudices regarding their riskiness. As a community, we have required more and better capital and have implemented more conservative risk-management practices at the biggest banks, while we have at the same time reduced our belief in the power of markets and incentives to manage any remaining risk. We have increased supervisory oversight of the biggest banks even as we have continued to assume the likely failure of this supervision. We have better harmonized international information flows, communication, and approaches to critical safety measures beyond any historical expectation. But we have simultaneously become fixated on the remaining areas of imperfect cross-border coordination. Our attention, in short, has been drawn to the points of maximum difficulty, rather than to those of greatest economic importance.

  We should instead view improvements to the safety and soundness of the US G-SIFIs through the prism of economic importance. In our view, doing so demonstrates that they are far more resilient to economic shocks today than is widely believed. This is particularly easy to see once we make two subtle modifications to the prevailing narrative.

  First, a change in perspective: rather than focusing on the most challenging remaining obstacles to the resolution of US G-SIFIs—like derivatives and liquidity—we should emphasize instead the multiple lines of defense that have been strengthened or newly created to protect against their failure in the first place. We examine the resilience of the banks across each line of defense in sequential order. This is relevant because it is far more economically meaningful to fix the first and second lines of defense than to fix the fifth, unless the first few lines of defense are systematically ineffective. As we show, the improvements already made to the first two lines of defense—equity capital and the incentives it creates—have in fact been significant and robust. This makes the next lines of defense—the “debt shield” and the incentives it creates—unlikely to be used in the “normal” course. Instead, these additional lines of defense would only be necessary in inherently low-probability states characterized by unusual events and extreme conditions. We think they should be evaluated in this light, rather than as part of the “normal” resolution process.

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  After the Fall

  Saving Capitalism from Wall Street—and Washington

  • Nicole Gelinas(Author)
  • 2011(Publication Date)
  • Encounter Books

    (Publisher)

  CHAPTER 3 Too Big to Fail

  It is inconceivable that any major bank would walk away from any subsidiary of its holding company. If your name is on the door, all of your capital funds are going to be behind it in the real world. Lawyers can say you have separation, but the marketplace is persuasive, and it would not see it that way.

  —Walter Wriston, Citicorp chief executive, October 29, 19811

    These big banks have the ultimate anticompetitive government subsidy. They are Too Big to Fail, and regardless how mismanaged they may become, the buck will stop with the taxpayer.

  —Kenneth A. Guenther, executive vice president, Independent Bankers Association of America, New York Times, August 5, 1987

           

  INTERNATIONAL NEWSWIRES STARTED TO SPREAD THE rumors on the Tuesday before Mother’s Day, 1984. The nation’s eighth-largest bank, Chicago-based Continental Illinois, was in distress. It was about to submit to a Japanese takeover. Its holding company was exploring bankruptcy. By Thursday, Continental’s stock price had collapsed. Depositors whose accounts exceeded the FDIC’s $100,000 insurance ceiling withdrew their money, compelling usually discreet regulators to announce publicly that Continental would be able to meet its obligations. The depositors, along with other short-term lenders to the bank, ignored the statement. The next weekend, the Federal Reserve arranged for sixteen of the nation’s biggest banks to pump $4.5 billion into the faltering institution, hoping to restore confidence. The plan failed.

  By late spring, the government took a step that business reporters and editorial boards billed as unprecedented. The Federal Reserve and the FDIC, in their “race to save Continental and thereby sustain confidence in the nation’s banking system,”2

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  After the Fall

  Saving Capitalism from Wall Street and Washington

  • Nicole Gelinas(Author)
  • 2009(Publication Date)
  • Encounter Books

    (Publisher)

  CHAPTER 3

  Too Big to Fail

  It is inconceivable that any major bank would walk away from any subsidiar y of its holding company. If your name is on the door, all of your capital funds are going to be behind it in the real world. Lawyers can say you have separation, but the marketplace is persuasive, and it would not see it that way.

  —Walter Wriston, Citicorp chief executive, October 29, 19811

    These big banks have the ultimate anticompetitive government subsidy. They are Too Big to Fail, and regardless how mismanaged they may become, the buck will stop with the taxpayer.

  —Kenneth A. Guenther, executive vice president, Independent Bankers Association of America, New York Times, August 5, 1987

   

  INTERNATIONAL NEWSWIRES STARTED TO SPREAD THE rumors on the Tuesday before Mother’s Day, 1984. The nation’s eighth-largest bank, Chicago-based Continental Illinois, was in distress. It was about to submit to a Japanese takeover. Its holding company was exploring bankruptcy. By Thursday, Continental’s stock price had collapsed. Depositors whose accounts exceeded the FDIC’s $100,000 insurance ceiling withdrew their money, compelling usually discreet regulators to announce publicly that Continental would be able to meet its obligations. The depositors, along with other short-term lenders to the bank, ignored the statement. The next weekend, the Federal Reserve arranged for sixteen of the nation’s biggest banks to pump $4.5 billion into the faltering institution, hoping to restore confidence. The plan failed.

  By late spring, the government took a step that business reporters and editorial boards billed as unprecedented. The Federal Reserve and the FDIC, in their “race to save Continental and thereby sustain confidence in the nation’s banking system,”2

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  Measuring and Managing Liquidity Risk

  • Antonio Castagna, Francesco Fede(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  Chapter 3 Too Big to Fail

  3.1 Introduction

  In Chapter 2 we often referred to financial systemic risk and the related meltdown in the case of default by one or more banks considered “too interconnected” to be allowed to fail.

  This topic deserves great consideration because it is strictly linked to the issue of moral hazard. As stated previously, without symmetric and complete information on the financial system, moral hazard can arise as insolvent banks may act as merely illiquid ones by underinvesting in liquid assets and gambling for assistance. In the literature many authors have written about the moral hazard and the social cost related to saving insolvent institutions, and made clear they were against any form of support or rescue for them.

  We pointed out that in practice it is really difficult for central banks and supervisors to distinguish ex ante between illiquid and insolvent institutions. Nevertheless, we have already verified what can happen when a systemically important financial institution (SIFI) is allowed to fail: systemic meltdown and financial turmoil are not remote warnings to list in academic papers, they may become the worst and most dramatic side of a financial crisis.

  Box 3.1. Systemic risk

  The notion of systemic risk is closely linked to the concept of externality, meaning that each financial player individually manages its own risk but does not consider the impact of its actions on the risk to the system as a whole. As a consequence, the aggregate amount of risk in the financial system can prove excessive and, on account of interdependencies, larger than the sum of the risks of individual banks in isolation. At the same time, once the system has reached a certain degree of fragility, even an apparently small shock-such as the fall of the US subprime mortgage market in 2007—may trigger a disruptive chain of events.

  Box 3.2. How does the PDCF work?

  The Primary Dealer Credit Facility was introduced by the Fed on March 17, 2008. It is a lending facility, available to all financial institutions listed as primary dealers, and works as a repo, whereby the dealer transfers a security in exchange for funds through the Fed's discount window. The security acts as collateral for the loan, and the Fed charges an interest rate equivalent to its primary credit rate. The creation of the PDCF was the first time in the history of the FED that it had lent directly to investment banks.

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  Reconceptualising Global Finance and its Regulation

  • Ross P. Buckley, Emilios Avgouleas, Douglas W. Arner(Authors)
  • 2016(Publication Date)
  • Cambridge University Press

    (Publisher)

  First, share- holders normally care little for financial stability threats and much more about their returns on equity (ROE). Secondly, most modern financial institutions are too complex to be properly subjected to the rigors of market discipline. Even when shareholders and creditors have the right incentives to be effective monitors, balance sheet complexity will remain a challenging obstacle. 7 Moreover, any reliance on market discipline acting as a restraint to the operations of large and/ or interconnected banks entirely evaporated, reinforcing moral hazard (normally called too-big-to-fail (TBTF). This chapter intends to provide a balanced, all-encompassing, and in-depth discussion of the social utility of big banks in a fractional reserve banking system in the post-2008 context utilizing a very wide array of empirical and theoretical works. It will, thus, discuss the dilemmas surrounding the famed demolition of the TBTF bank in the postreform era. To this effect, the chapter will explain that while well calibrated structural reforms and special resolution regimes can certainly help to alleviate the TBTF problem in the banking sector, they will not eliminate it. At the same time, implementation of the suggested alternative of full-reserve, limited-purpose, or narrow-banking models would, in practice, create more prob- lems than it would solve. Arguably, until the present model of fractional reserve banking is radically overhauled, mostly through effective regulatory systems and structural reforms that 7 For analytical discussion see E. Avgouleas and J. Cullen, “Market Discipline and EU Corporate Governance Reform in the Banking Sector: Merits, Fallacies, and Cognitive Boundaries”, 41 Journal of Law and Society 28–50 (2014). Systemic Banks, Intractable Dilemmas 281 refocus global finance on long-term growth objectives, societies may have to provide a form of fiscal backstop to big (mostly ring-fenced or separated) commer- cial banks.

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