Grappling With the Reality of "Too Big to Fail"


Washington Post columnist Neil Irwin stopped by to discuss his book, The Alchemists: Three Central Bankers and a World on Fire. It's a great read on the history of central banks, including how they responded to the financial crisis and the challenges they face in the future.

The financial crisis made it clear that "too big to fail" is a real problem that must be addressed. In this video segment, Neil explains some of the measures that have been taken in hopes of keeping the burdens of private institutions from falling on the public's shoulders again. A full transcript follows the video.

Morgan Housel: Do we have questions for Neil?

Audience Member: How many times in the financial press have we heard a lot about this concept of "too big to fail?" We haven't heard so much about it lately. Do you think that "too big to fail" institutions are an actual problem for us, and if so, (unclear)?

Neil Irwin: Yeah, clearly the crisis showed that "too big to fail" was real. It's kind of revealed by the fact that any time some of these giant institutions seem to be at risk, we found -- the government, the Fed, the Treasury -- found ways to bail them out and keep them from going under.

The one exception was Lehman Brothers, which turned out to not be a terribly good experience for anybody.

The question is what do you do about it? It certainly violates any basic principle of capitalism, to have these institutions that exist to make money for private shareholders, and yet if they fail, it's on all of us. It's a "heads we win, tails you lose" kind of scenario, when these institutions exist.

The question is not, "Will there be big financial institutions?" It's, "What can we do as a society to make sure that they either are not able to take the risks that would enable them to fail, or that when they do fail they can be allowed to fail without all of us having to pay the bill?"

The question is whether the strategies that the global regulators have taken on to try and do that have been enough.

The Dodd-Frank Act, the Basel III capital regulations that come out of this same building in Basel, Switzerland; the strategy has been, "All right. We're going to enhance oversight and have regulators be much more in their business. We're going to have resolution plans to make clear, 'This is what your autopsy would look like, if you were to go bankrupt,' and we're going to have higher capital requirements. You're going to have to rely less on leverage, less on borrowed money, and have a bigger buffer in case you do suffer losses."

The basic stance is, given all that, if you as a large bank decide, "I don't want to be so big," and you decide to sell off some units or shrink, or however you decide to do it, that's fine. Maybe that's not such a bad outcome, and we've seen some of that.

We've seen some of the major banks close divisions, and that's a direct response to some of the tightening of the vice grip that's happened on the regulatory side.

What we still don't know the answer to is, has all that been enough? Has that created a world where, over time, we will not have too-big-to-fail institutions, and/or they will be sufficiently regulated, sufficiently sound, that it's not really an issue?

I think the jury's still out. I think we just don't know. I think there's a lot about this financial regulatory world where we have to learn by doing, and it's hard to know from first principles how it's going to work out.

I wish I had a more definitive answer for you, but I think the answer is, "They're trying." The question is, will it be enough?

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Originally published