A Look at the Too Big to Fail Theory

The term "too big to fail" became part of the national vernacular following the market crash of 2007. Various institutions, perhaps most notably the insurance giant AIG, were bailed out by a large government incentive paid for through US tax dollars and federal debt. The justification for this bailout was simple: if capitalism were allowed to run its course without government intervention, these large entities would collapse, posing considerable risk to the entire infrastructure of the macro economy of the US. Although many policy makers believe the bail out was necessary and subscribe to the belief some institutions are simply "too big to fail," most are concerned about the long-term implications of this policy.

Thinking Short-Term

The use of a too big to fail classification is very short-term. The bailout is designed not to save the company as a whole but to save individual stake holders, investors and depositors in the institution. For example, when AIG was at risk of falling to the systemic risk exposed in the 2007 crash, the government provided $85 billion to temporarily take over the structure. If it had not done so, the companies who had supplied premiums to AIG for decades would have been entirely exposed to lack of coverage and liability risks. With a too big to fail bank, the short-term thinking is simple: the economy needs large institutions that can provide low interest rate loans and services in order to help stimulate the economy back from recession. Allowing these banks to fail could halt the entire credit cycle and consumer confidence.

Government Intervention in the Long-Term

The argument against bail outs of too big to fail institutions is not typically a short-term argument. Instead, economists are concerned with the long-term implications of government intervention. For example, they are concerned with how the United States will transition out of its ownership role with AIG or GMC when the time comes to do so. They are additionally concerned with the need to continually bail out institutions who reach too big to fail status in the future.

Deficit

One potential consequence of continually bailing out a large institution is the growth of a federal deficit. It can be easy to think of the federal deficit as an intangible number that has no impact on the day-to-day cycle of the economy. In reality, economic policy such as taxation and government services rely on the amount of liquidity a government has. With a large deficit, taxes rise sharply, and this may even decrease private investment in the market for fear the future tax on profits will be higher than the gain.

Lack of Consequence

Perhaps the biggest concern with the too big to fail theory is the fact it relieves large institutions of immediate consequences for bad policy. Small businesses must continually be concerned with the effect of poor business or financial decisions. Large companies deemed too big to fail will not be subject to the rules of capitalism. They will be permitted to make bad decisions and retain their prominence on the market. This concern is a primary reason President Barack Obama spoke out against the too big to fail classification in early 2010.


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