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The contemporary global economy operates under the principles of economic control. The nature of operations of firms in individual economies is highly determined by the actions that are taken by governments. It is argued that the problems that are experienced in economies often emanate from the actions of a number of players in these economies. One of the main issues that stirs a volatile debate in the operation of the global economy is the ‘Too Big to Fail’ (TBTF) problem.
This problem emanates from the assertion that a number of economic institutions are considered to be precious to economic survival, thus they are highly supported by governments in order to prevent them from collapsing (Friedman and Kraus 43). In this paper, it is argued that the TBTF problem lacks the desired economic rationality. Consequently, the TBTF can be a major factor enhancing crises in economies.
This paper critically discusses the TBTF problem. The paper begins by describing the meaning and economic implications of the TBTF problem. This is followed by a critical look into what can be considered as the possible remedies to the problem. The paper heavily draws its argument from the recent global financial crisis and the subsequent actions that were taken to address the crisis.
Understanding the TBTF problem
It is vital to understand the meaning of the TBTF problem before explicating the economic implications of the problem. One of the critical questions to pose at this point is whether the TBTF is a problem or just an assertion.
The TBTF is an economic idea that implies that a number of businesses are critical to the economy of a state, thus they cannot be allowed to slumber. Some of the business institutions that are considered to be critical to the survival and economic sustenance of national economies, as pointed out by the TBTF problem, are large banking institutions. The failure of such institutions is considered to be trivial to the working of a national economy.
Whenever these institutions face problems, governments are forced to go overboard in an attempt to prevent the collapse of these institutions. The implication for declaring any economic institutions to be ‘too big to fail’ is that the government is always forced to make an economic intervention into the problems that affect the institution. This intervention often occurs when the problem in the company keeps swelling, thus the company takes an external dimension (Friedman and Kraus 43-44).
The main argument or hope is that the intervention by the government can help the company to solve the problem, thus stabilizing its functioning. What ought to be asked is whether such interventions have helped to stop institutions from collapsing. It is also critical to explore the aftermath of such actions by governments on the functionality of the other institutions and the economy at large.
A substantial number of people have argued that such actions are often counteractive to the functioning of the national economy, and even beyond. It is critical to draw examples from the real economy in order to get an understanding of the issues that surround the ‘too big to fail’ problem (Friedman and Kraus 43).
The problem and remedies of the ‘Too Big to Fail’ assertion
A substantial number of researchers have ascertained that the idea of ‘too big to fail’ has prevailed for a relatively long period of time. However, the real utilization of the assertion came out openly during the recent economic crises that were witnessed during the early 2000s.
The future of the too big to fail syndrome lies at crossroads. A lot of criticisms, both positive and negative, have been subjected to the subject of the ‘too big to fail’ syndrome. It is critical to establish how the assertion worked out during the recent economic crises to understand its relevance and the negatives that are associated to its use in the economy (Barth, Prabha and Swagel 1).
Whether the ‘too big to fail’ assertion is a tangible step in economic function remains to be a subject of debate. What is evident is that the too big to fail assertion was greatly utilized by governments during the global financial crisis that was witnessed between 2007 and 2009. It is argued that the crisis emanated from the actions of the big financial institutions.
In spite of this, policy makers adopted the ‘too big to fail’ as a critical measure of rescuing large financial institutions from collapsing. As mentioned earlier in the paper, the argument behind the application of TBTF was that it could rescue the big institutions from collapsing. It should be noted that the big financial institutions, like banks and large insurance firms, hold a lot of public finances, and their collapse can have detrimental impacts on the well being of the economy (Barth, Prabha and Swagel 1).
As noted in the recent global financial crisis, a substantial number of shareholders in the big financial institutions in the United States still incurred a lot of losses. This happened irrespective of the actions taken by the US government to bail out the institutions. In a number of cases, shareholders suffered more because of the measure to save the big institutions.
However, it is argued that the action also favored bondholders, as well as other creditors in the big financial institutions by making the losses infrequent. In the United States, massive losses have been made by shareholders and bondholders in Washington Mutual and Lehman Brothers. These amounted to the destabilization of the financial market, thus the government would not leave these institutions to collapse and bring about a stalemate in the operation of the financial markets.
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However, it came out that smaller financial institutions that had been impacted by the developments in the large financial institutions did not receive direct back-up from the government, leading to their collapse and the subsequent losses by the shareholders who had invested in these institutions (Barth, Prabha and Swagel 1).
The ‘Too Big to Fail’ as a moral hazard
As pointed out earlier in this paper, the ‘too big to fail’ syndrome has been subjected to a lot of criticism. While it can be said that it managed to save most of the big financial institutions from collapsing and attained its goal, many economic commentators have argued against the TBTF problem. One of such commentators is Liu, who termed the TBTF action as a moral hazard in the realms of economic operation.
The argument of Liu revolves around the conducts of banks and other large financial institutions. Moral hazard is often utilized in the financial sector, especially in the banking circles. It describes the tendency of banking institutions to make hasty decisions, like making bad loans, with hopes that they will be bailed out by funds from the Federal Reserve or other global economic institutions such as the International Monetary Fund.
The bailing of financial institutions by finances from taxpayers is seen as a moral issue, which implies the lack of economic responsibility on the side of the financial institutions that fail to take full responsibility for their actions. While it is a sign of responsibility of governments to protect the economy by safeguarding the investments of the public in the institutions, it encourages lack of proper financial accountability in terms of the decisions that are made by the financial institutions (Liu, para. 1-2).
Friedman and Kraus (43) observed that managers of most of the financial institutions that have been mentioned above made the decisions knowing well the economic consequences of such decisions. As such, the main problem, which is also a discouraging factor for the bailout of the economic institutions as argued by the proponents of the TBTF action, is the knowledge of the institutions that they are ‘too big to fail’.
This encourages the loss of moral obligation by the management of these institutions. The ‘too big to fail’ theory is often inconsistent with other economic theories, for instance theory of corporate compensation, that are critical to offering logical and evidence-based solutions to economic turmoil in big institutions. Such actions were implemented in the late years of the 20th century when the Illinois Bank was crumbling in 1985.
The bank was bailed out, but actions were later taken against the management of the bank. What should be asked at this juncture is the extent to which some of the proposed measures of dealing with the problem of ‘too big to fail’ can be implemented. An action like complete liquidation is dependent on a ray of other factors, whose failure to observe, could result in complex economic problems (Friedman and Kraus 43).
A number of economic researches have developed possible solutions to dealing with the problem of TBTF. These researchers emphasize on the essence of saving big institutions from failing by pointing out that it helps to recover the investments made in these institutions by the public. One of the arguments is that once an institution has been saved, the authorities have the mandate to determine the future existence of the institution.
Among the options include utilization of power that is vested in the authorities to dispose the institution. Possible actions include recapitalization of the institution, the cleaning up of the institution, merging the institution with other institutions in order to strengthen its operation or even liquidation of the institution. By doing this, the problem of moral hazard in the rescue of economic institutions through bailout is checked (Feldstein 259).
What has been noted in a number of commentaries is that the failure of big firms results in massive losses by the society. Therefore, it is unethical for the authorities to sit aside and watch these firms collapse because they hold a lot of value and worth to the society and the economy of a given nation.
What ought to be explicated is the factor that surrounds the failure of the firms (Targeted News Service, para 1-10). Drawing from the argument by Feldstein (260), there should be a post evaluation of the firms in order to ascertain the reasons behind their collapse. This is the main step that can guarantee the public the security of their investments in the big firms. This can also be used to enhance positive economic actions in other firms, thus discouraging the aspect of dependency on bailout (Feldstein 260).
The other argument about the TBTF problem revolves around globalization of the world economy. Therefore, the relevance and economic interconnect of the financial institutions to other institutions and their significance to the operation of national and international economy is something that has to be given a critical look.
A notable example is the intervention by state agencies like the the Federal Deposit Insurance Corporation in the problems that were facing the Continental Illinois, the then seventh largest financial institution in the United States. Economists later came to acknowledge the relevance of the bailout by postulating that failure to bail the institution would have resulted in complex problems in the US economy and far beyond (Targeted News Service para 7).
The ‘too big to fail’ problem is an economic philosophy that has been exercised for a long period of time. As observed in the paper, there are diverse arguments that point both the positives and negatives of the utilization of the assertion. Arguments that back the utilization of the philosophy revolve around the critical role of a number of key business institutions in the economy and the impact of their collapse.
On the other hand, opponents of the assertion point to the fact that utilization of the TBTF syndrome creates a moral hazard in the economy. In order to eliminate the issue of moral hazard in the utilization of the assertion, opponents come up with a number of measures, among them liquidation, recapitalization, merging, or checking the management of these institutions. However, each of these actions has their impacts, which means that the issues surrounding the TBTF syndrome will remain critical in the global economy.
Barth, James R., Apanard Prabha and Phillip Swagel. Just How Big is the Too Big to Fail Problem?, 2012. Web. https://www.wharton.upenn.edu/
Feldstein, Martin S. Economic and Financial Crises in Emerging Market Economies. Chicago: University of Chicago Press, 2003. Print.
Friedman, Jeffrey, and Wladimir Kraus. Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation. Philadelphia: University of Pennsylvania Press, 2011. Print.
Liu, Henry C. K. Too Big to Fail versus Moral Hazard. Asian Times Online, 2008. Web. https://www.asiatimes.com/
Targeted News Service. Solving the Too Big to Fail Problem. (2012, Nov 15). Targeted News Service. Web.