40 Pages Posted: 6 Mar 2010 Last revised: 24 Jul 2010
Date Written: March 5, 2010
Financial institutions labeled Too Big To Fail (TBTF) are those whose insolvency could shake the foundations of our economy. This paper presents a history of the government bailout doctrine which has become a blank check for economic giants. Eight recent examples of the doctrine’s invocation are compared with three recent examples of government refusal to follow TBTF. Nineteen financial conglomerates that recently participated in “stress testing” can easily be identified as eligible for TBTF.
Recognizing the cost of TBTF, reviewing the FDICIA fix in federal legislation that did not fix the problem of TBTF, analyzing the role of systemic risk and economic bubbles in TBTF, reconsidering the desirability of financial industry consolidation, and recommending steps to address the moral hazard issues arising from market expectations regarding TBTF lead to the conclusion that with vision and resolve, Congress can end TBTF and protect our financial system from key mistakes of the past.
This article makes the case for ending TBTF bailouts by reducing the size and interconnectedness of large financial conglomerates. Potential mechanisms to accomplish that end include: (1) Imposing size caps that limit continued expansion of financial conglomerates through internal growth and acquisitions; (2) Ending government-assisted acquisitions that allow the largest institutions to grow even larger – at public expense; (3) Reinstating true fire-walls between banking and commerce; (4) Returning to meaningful anti-trust enforcement; (5) Immediately initiating reform measures such as increased capital for large institutions, subordinated debt requirements that enhance market discipline, enhanced systemic risk monitoring and regulation, and better advance planning for liquidating large complex financial institutions; and (6) As a longer term measure, commissioning a carefully researched report on how to most effectively divide the existing conglomerates into manageable component parts that will no longer be Too Big To Fail.
Ending TBTF will be no easy task. Yet, the costs of doing nothing to address the problem have proven to be devastating.
Keywords: Too Big to Fail, Financial Industry, Financial Conglomerates, Corporate Bailout
JEL Classification: K2, K23
Suggested Citation: Suggested Citation
Graham, Ann, Bringing to Heel the Elephants in the Economy: The Case for Ending 'Too Big to Fail' (March 5, 2010). Pierce Law Review, Forthcoming; Texas Tech Law School Research Paper No. 2010-18. Available at SSRN: https://ssrn.com/abstract=1565584