Understanding the Modern Positions on Too Big to Fail
The term “too big to fail” is used by policy makers and regulators referring to private financial entities that are deemed too important for the country’s economy. The term would refer to financial institutions that would have tremendous impact of on the country’s economy if they go down or declare bankruptcy. As a result, the government steps in to assist these companies so that they can get back on track. Bail outs given out to large financial entities are one of the many government actions for companies that are “too big to fail.”
In US, the idea of providing assistance for companies at this magnitude started in the 50s. Through Federal Deposit Insurance Act of 1950, companies will receive aid from the government until they can get back on track. However, it wasn’t used much before because it lacks support from many politicians.
Controversy on Government Assistance
Companies referred to as “too big to fail” is often considered as a very dangerous entity for the government and general economy. Many critics against companies of this magnitude fear that these companies will not necessarily decide what’s best for the general economy. These companies are there for profit and they will continue to make risks since they know they can count on the government for bail outs. Eventually, these companies will never practice market discipline as they would receive assistance if they show signs of trouble. Another criticism over government assistance for these companies is that the government money is placed on the hands of private individuals instead of using them or making them available for public use. While the goal of the government assistance for companies that are too big to fail is to stabilize the economy which indirectly benefits everyone, tax payers will never see real significance of the aid in their daily lives.
Three Positions for Too Big to Fail Companies
Position #1: Increased Authority
The most popular solution considered by the government today on these companies is to provide aid with additional strings attached. As already indicated, there is always a concern about these companies as they might consider risky decisions that could cost the company – but that would not happen since there is the government to bail them out. To prevent this, one proposal is to take over the company or at least have greater influence on business decisions. This is a popular solution since the government’s interest will be followed instead of purely profit-oriented decisions.
Critics on this decision often point out on the government’s capability on taking over the company. The first problem with this decision is that the government is not equipped enough to handle institutions at this size. One department handling key decisions for nearly trillion-dollar companies can be very challenging. Another criticism to this position is the possibility of a backlash. When government’s preference is used and longer aims in achieving profit, its chance of growing will be limited eventually bringing the company down once again.
Position #2: Let Them Fail
This position is very simple as it requires no effort from the government. Letting a company fail or declare bankruptcy is also a considered option for the government as bail-outs or handing out assistance to these companies cost billions of dollars. Unfortunately, tax money will be used to help these companies. Some argue that in allowing the companies to tank, smaller players could take over which could be easily regulated.
On the other hand, critics can easily point to recent history as proof that this concept is good in moral standing but dangerous for national economy. A good example is the Lehman Brothers that declared bankruptcy in September 2008. The government allowed the financial institution to go down and it caused considerable damage in the economy felt until today.
Position #3: “If they’re too big to fail, they’re too big.”
The above statement is a direct quote from former Federal Reserve Chairman Alan Greenspan. He made this statement in October 2009 when USA is in the center of economic woes. He argues that these banks should be broken up to the point that they are allowed to fail. Aside from Greenspan, this position is also supported by other economic experts as they see these companies as dangerous elements or an economic time bomb if they are not dismantled.
This position is gaining traction and support because it provides a good solution that would benefit the government and the financial sector. The government doesn’t have to give hand outs to banks and the financial sector would improve because of the healthy competition. Consumers will be the biggest winner because no taxes are spent for bail-out and competing financial institutions will provide better services.
These are the three popular positions considered by the government, politicians and economists for companies too big to fail. Each of position provides some advantages and challenges that could cause the rise or fall of the country’s economy.