Too Big To Fail Essay

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The term too big to fail refers to a corporation, an organization, or an industry sector that is considered by the United States government to be too important to the overall health of the economy to be allowed to fail. Beginning in the 1980s, the term was applied to the banking industry during the Continental Illinois Bank and Trust Company crisis. When Continental Illinois approached insolvency because of bad speculative investments, the Federal Reserve guaranteed Continental’s liquidity needs. Eventually, the federal government spent $4.5 million to bail out Continental. When quizzed by the Senate Banking Committee why the Federal Reserve and the Federal Deposit Insurance Corporation did what they did, the regulators responded that they were concerned about the size of the bank (the seventh largest nationally), the number of smaller banks with significant portions of their capital invested in Continental Illinois, the specter of depositor panic and bank distress, and the potential disruption of national payment and settlement systems.

More recently, the government engaged in its biggest financial bailout in history. Bad mortgage investments essentially froze the credit market by September 2008. The first move by the government was to force Bear Stearns to be taken over by Morgan Stanley. Not wanting to engage in renewing the precedent of government bailouts, the government let Lehman Brothers enter bankruptcy. The demise of Lehman Brothers shook the investment markets, and the domestic and global stock markets plunged. The government then reversed itself and invested an initial $50 billion in AIG, eventually raising that investment to over $100 billion. Finally, the U.S. government approved over $700 billion to rescue the financial markets, taking equity positions in a number of banks in doing so. The rationale for the expenditure of nearly $850 billion was that the banking system was “too big to fail.”

Ironically, while our largest banks may be deemed too big to fail, the smaller so-called community banks may be too small to fail. The FDIC reports the failure rate among banks with assets of $1 billion or more is seven times greater than among banks with less than $1 billion in assets. These community banks are outperforming large banks on most key measures, such as return on assets, charge-offs for bad loans, and net profit margin.

This is remarkable when one considers that just three institutions—Citigroup, Bank of America, and JPMorgan—hold more than 30 percent of the nation’s deposits and 40 percent of bank loans to corporations. Unfortunately, while there were 14,000 such community banks in 1985, today there are less than 8,000. In addition, a number of large banks who received the government bailout have announced that they may be using the money to acquire these more successful community banks.

Other Industries

The intervention by the government to rescue the financial community has raised the question of whether other industries are “too big to fail.” For example, until recently, the three companies that controlled the U.S. auto industry, despite competition from foreign automakers, still controlled significant global market share. In addition, the U.S. auto industry invested in manufacturing technologies that lowered the cost of production domestically, and steadily outsourced production to control labor costs. Relatively cheap fuel prices in the United States also helped the auto industry.

In recent years, however, the auto industry has run into an almost “perfect storm” of problems. First, foreign automakers made increasing inroads in market share, particularly in the smaller-car market. Second, the auto industry had to deal with increasing “legacy” costs—as more union workers retired, more industry resources were diverted to pension and medical costs. Third, a weakening economy and rising fuel prices changed consumer preferences from large sport utility vehicles to smaller cars. Finally, a severely tightened credit market helped crater vehicle sales. By the end of 2008, two of the three car makers—GM and Chrysler—were facing bankruptcy. Citing the notion that the auto industry was “too big to fail,” the government approved some $18 billion in loan guarantees.

How many more industries will be deemed “too big to fail” is hard to determine as of this writing. What is clear is that this heretofore rather obscure term has taken on new meaning in the global economy.


  1. A. Frank, “Too Small to Fail,” Washington Monthly (November/December 2000);
  2. Goodman, “Too Big to Fail?” New York Times (July 20, 2008);
  3. Millbank, “The Nomination That’s Too Big to Fail,” Washington Post (January 15, 2009);
  4. Stern and R. Feldman, Too Big to Fail: The Hazards of Bank Bailouts (Brookings Institution Press, 2004).

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