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What does the Term "Too Big to Fail" Mean?

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  • Last Modified Date: 11 September 2016
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The catchphrase “too big to fail” is used to describe financial institutions believed to be so critical to economic health that they cannot be allowed to fail if they develop financial troubles. When such entities appear to be in trouble, government assistance may be provided to help them correct the problem and reestablish themselves. The economic policy of stepping in to prevent failure of key businesses became a topic of much discussion and debate during the financial crisis of the 2000s, when government bailouts of major companies and industries were used in an attempt to stabilize the economy.

There are several arguments behind the idea of a business being too big to fail. The first is that some businesses are so large, they can make up a significant part of an economic sector, and their failure could cause the sector to crash, damaging the economy. In addition, the failure of companies large and small has the potential to take other businesses down with them, as all companies maintain professional relationships with partners like suppliers. When a major source of orders disappears, a smaller company may flounder, and a ripple effect is created.

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In addition, the failure of big companies is seen as a blow to consumer confidence. When a company is too big to fail, it plays a prominent role and investors may rely on the company's fortunes as a bellwether for the economy. If the company fails, investors may panic, pull out of other investments, and create more economic problems.

Critics of the concept argue that no business should be so large that it can cause economic damages if it goes out of business. These critics say that a better way to handle major company failures would be to limit them by breaking companies up, preventing them from getting too large, and allowing companies to fail if they are in economic trouble. A survival of the fittest approach to economic welfare argues that companies should not be rewarded for being on the verge of failure with assistance from the government.

The application of “too big to fail” was somewhat uneven in the eyes of some critics. Some large companies that might have expected government assistance were allowed to fail, while others were not. Critics pointed to the selective support for specific businesses and economic sectors and suggested it interfered with the operations of the free market and undermined investor confidence.

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jessiwan
Post 7

Does the government have the right to use taxpayers' money to bail out privately owned companies? I don't think the government can do this without our consent.

latte31
Post 6

@Icecream17 - I understand your argument, but how do you explain the financial situation of General Motors and that of Ford. General Motors took a huge bailout while Ford did not.

Ford posted profits despite not taking any bailout dollars so I think that large companies that are suffering financially can restructure and come out from bankruptcy better and leaner if they are left alone to figure it out.

I think that when the federal government gets involved it creates more problems and the money is wasted somehow. I wonder how come some companies are considered too big to fail while others aren’t.

For example, why was Lehman Brothers allowed to fail, but Goldman Sachs survived and given bailout money? I think that we should be fair to all companies and stay out and let them resolve their own issues. Not everyone is meant to stay in business.

GreenWeaver
Post 5

@Icecream17 - I know what you are saying, but I can understand the banks hesitation in lending money because they made too many bad loans and are still dealing with the aftermath.

I realize that the banks were the ones lending the money, but there were many government programs that highly encouraged banks to lend to people that had a less desirable credit profile in order to boost homeownership.

Since Fannie Mae and Freddie Mac backed these loans the banks were safe. The problem is that now Fannie and Freddie are having financial problems as well. I think that we should not force a bank to loan money to anyone.

If you have the money saved up and

decent credit profile then you should get the loan. If you don't have enough of a down payment or poor credit then you should be denied until you can improve your credit profile.

I also think that many people wanted to take advantage of the incredible gains in the real estate market. So there were a lot of parties at fault. I can understand the government giving money to these banks because I think that many are too big to fail.

icecream17
Post 4

@SauteePan -I understand that the financial system is important, but in a capitalist country aren’t businesses held accountable for their failures? This is what makes businesses more careful than others and what makes some businesses thrive while others fail.

If the United States government offers bailouts whenever a large company gets into trouble then they are never accountable for their business decisions.

Many of the largest banks received federal bailout dollars because they were too big to fail and lending has not improved. In fact, there is a much stricter lending standard in which many people do not qualify for loans.

The banks are essentially sitting on this money and not lending to businesses and to people looking to buy homes. So I don’t understand how this money helped the general public. It looks like it helped the banks.

SauteePan
Post 3

I understand the idea of too big to fail because the public does get a little shaken up when a large company goes bankrupt. I think that this would be worse when you are talking about a bank.

The thought of a large bank becoming insolvent is so hard for people to stomach that the government stepped in to save these too big to fail banks when it was obvious that their losses due to the failing housing market were among the largest in history.

Since our banks are the backbone of our financial system, to see a series of large banks collapse would have a rippling effect to other banks not only domestically, but internationally as well.

It really would have been too ugly to watch and the United States did not want to have a repeat of the Great Depression.

wander
Post 2

@ letshearit - I think that the idea of companies that are too big to fail goes completely against the idea of a free market and the heart of capitalism. Having a business that is immune to suffering from its mistakes because of its size is a ridiculous model that we need to move away from.

It is understandable that some corporations own so much that their downfall can put thousands of people out of work, but I think they should still be allowed to fall. Where one has gone under another will rise. Besides, bailing out companies just gives them license to make the same mistake again.

letshearit
Post 1

A good example of a company that was "too big to fail" was AIG during the financial crisis we experienced in 2008.

This company employed so many people and had their hands in so many pots, that their bankruptcy and closure would have sent shockwaves around the world and caused huge issues for the banks that used them to insure their assets and handle their liabilities.

Many people were pretty angry about the AIG bailout as it cost the American government billions of dollars.

Do you think we should bail out these "too big to fail" companies, or let them sink?

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