'Too Big to Fail' Financial Institutions: Policy Issues (CRS Report for Congress)
| Release Date |
Sept. 5, 2024 |
| Report Number |
IF12755 |
| Report Type |
In Focus |
| Authors |
Marc Labonte |
| Source Agency |
Congressional Research Service |
Summary:
Some financial institutions are perceived to be “too big to
fail” (TBTF), meaning that their failure would trigger
financial instability. Although the term TBTF is a popular
shorthand, “too interconnected to fail” is considered to be a
more apt phrase to describe these firms because they are the
key participants in a certain market or because their failure
would cause counterparties to fail. Size is a primary—but
not the sole—factor influencing interconnectedness. The
federal government does not recognize any firm as TBTF,
as it does not want to imply that it would provide assistance
to prevent the firm’s failure. But it does recognize some
firms as posing systemic risk.
TBTF has been a long-standing policy concern. Events in
2008 illustrated the systemic risk posed by TBTF
institutions, as the failure or near failure of several caused a
severe financial crisis and deep economic recession. Both
banks and nonbank financial institutions—including
investment banks Bear Stearns and Lehman Brothers,
insurer AIG, and government-sponsored enterprises (GSEs)
Fannie Mae and Freddie Mac—proved to be TBTF in 2008.
The Treasury, the Federal Reserve (Fed), and the Federal
Deposit Insurance Corporation (FDIC) provided these firms
(with the exception of Lehman Brothers) with so-called
bailouts—exclusive ad hoc financial assistance backed by
taxpayers to prevent their failure or facilitate their
(voluntary or involuntary) takeovers by solvent firms. This
eventually restored financial stability by giving financial
markets confidence that more large firms would not fail.
In 2023, the failure of three banks with over $100 billion in
assets (whereas the very largest banks have over $1 trillion
in assets) triggered bailouts: The FDIC used emergency
authority to guarantee the uninsured deposits of Silicon
Valley Bank (SVB) and Signature Bank. As this case
illustrates, some creditors (uninsured depositors) may
receive bailouts, but others (bondholders) or the banks
themselves—which were liquidated—may not.
TBTF raises concerns about fairness and reduces economic
efficiency if it causes moral hazard—the concept that an
actor will be more reckless if shielded from risk. In this
case, firms have an incentive to increase expected profits by
taking riskier positions—thereby increasing systemic risk—
if they believe the government will bail them out if those
positions result in debilitating losses.
