Too Big to Fail



Too Big to Fail

Introduction

Too big to fail is a concept economic situation that describes a bank or other financial institution whose failure would have systemic disastrous consequences on the economy and by therefore finds him bailed out by the government since that bankruptcy risk is proven.

The main players in the international financial system take risks knowing full well they will be saved from bankruptcy if necessary by what governments call "bailout" taxpayer-funded. A financial system reform, initiated by Barack Obama in April 2010 and materialized in particular by the Dodd-Frank Wall Street Reform and Consumer Protection Act, is to limit the size of banks.

Discussion

The expression, Too Big to Fail, means that some companies are judged by the State too big to let them go bankrupt, especially in banking. It gradually spread to all major companies. This is one of many perverse effects of the intervention state, which encourages the taking of risk (moral hazard).This policy was developed in the United States with the Federal Deposit Insurance Act of 1950. It authorizes the U.S. federal government to assist a bank in trouble by lending or repurchase of assets as soon as "continuity of operations of the bank is essential to provide adequate banking service" to the economy. This clause has been invoked from 1969.

These public policies have powerful negative effects with moral hazard: knowing that the state let them down; banks have incentives to take excessive risks. Thus, in the case of bankruptcy of Lehman Brothers, a secret memo to its CEO, Richard Fuld, said in 2008 that relations were good with the Treasury and implied that excessive risk-taking could continue since the Treasury would save the company in a crisis. For these reasons, the Liberals are critical of such policies too big to fail (Kaufman, 2005).

Among the proposals made ??in the fight against too big to fail, include the dismantling of large banks (Henry Kaufman example: "too big to fail is too big to exist") or integration by the banks of the "protection" is guaranteed by a state tax on extra large establishments. It is also proposed to increase bank capital, to partition a bank with its subsidiaries, or force them to adopt a holding company structure. For libertarians, the monopoly of money issue is the fact that the central bank is a leading cause of too big to fail in banking:

The problem is that these banks, whatever they are, have a kind of parachute, which is the lender of last resort, the central bank. And therefore, they take risks. The central bank generates a so-called moral hazard: it distorts the calculations and people are venturing into bad investments. (Philip Simonnot, The euro is counterfeit money that is why it is in crisis). When the lender of last resort exists (to avoid systemic risk, it is claimed), it is an incentive to take too many risks. We will pool the cost of risk while profits will remain individual. The consequence is precisely that it creates a ...