Too Big To Fail Problem

Introduction3

Research Questions3

Literature review3

The “Too Big to Fail” problem4

Examples5

First Pennsylvania Bank5

Continental Illinois Bank5

The Financial Crisis of 2007 - 20095

How big the “Too Big to Fail problem” is5

Remedies6

Acts of Congress6

Comparison7

Conclusion8

Appendix11

Too Big To Fail Problem

Introduction

“There are no atheists in foxholes or ideologues in a financial crisis.”- Ben Bernanke

The problem of too big to fail (TBTF) is not a latest one when dealing with financial policy but it has been highlighted after the inception of global recession and the financial crisis of 2007. The problem is discussed never like before specially the measures that were taken by the government to deal in the problem and rescue the major and large institutions.

A glance on the events with regards to TBTF problem allows us to conduct this research and also provides readers a chance to consider this as a foundation and to extend this research paper further with empirical evidences and statistics. This research paper is aim to address and amplify the following three questions.

Research Questions

What is the “Too Big to Fail” problem

How big the “Too Big to Fail” problem is

Which possible remedy is the best to address the TBTF problem

Literature review

Moosa (2010, pp.124-139) discusses the too big to fail problem in association with economic allocation of resources. According to him the too big to fail problem leads to degeneration and corruption of the economic and financial system because this problem makes the financial system to do misallocation of the economic resources of the country Stern (2009, p.1) projected the solution in these words: “The key to addressing TBTF is to reduce substantially the negative spillover effects stemming from the failure of a systemically important financial institution.” He further added, “Maintaining the status quo with regard to TBTF could well impose large costs on the U.S. economy. We cannot afford such costs. I encourage you to focus on proposals that address the underlying reason for protection of creditors of TBTF financial institutions, which is concern for financial spillovers. I have offered examples of such reforms.”

Richard Fisher, President of Federal Reserve Bank of Dallas said on the current scenario, “We recommend that TBTF financial institutions be restructured into multiple business entities, only the resulting downsized commercial banking operations -- and not shadow banking affiliates or the parent company -- would benefit from the safety net of federal deposit insurance and access to the Federal Reserve's discount window” (Bloomberg News, 2013).

The “Too Big to Fail” problem

Depositors or creditors of the largest banks; who are uninsured and are not entitled of receiving the guarantee; receive a promise of repayment from government by using purchase and assumption method. Initially for the purpose of assessment only asset size was included in measurement; but with the passage of time and rational increase in the complexity in the business world and organizational structures, now the other important factors have been added by the regulators also like complexity, structure, communication, linkage etc. The action is taken because the failure of a very large institute increases the probability of ...