Woes of Protecting Businesses ‘Too Big to Fail’

Published January 30, 2011

In two articles just three days apart, The Wall Street Journal unintentionally showed the world much of what is so wrong about the federal government protecting some businesses because they are “too big to fail.”

On Dec. 27, there was an article headlined “Bailed-Out Banks Slip Toward Failure.” And on Dec. 30, a story was headlined “Banks Open Loan Spigot.”

The first article told us, “Nearly 100 U.S. banks that got bailout funds from the federal government show signs they are in jeopardy of failing.” It refers to smaller banks that received the money. They’re in jeopardy because of what the second article reported: “Some big U.S. banks are starting to increase their lending to businesses as demand for loans rises and healthier banks seek to grab customers from weaker rivals.” These were the banks deemed “too big to fail” and given taxpayer money on that assumption.

The near-collapse of these big banks caused the financial crisis. Their near-collapse was caused by the “toxic assets” the banking behemoths had purchased. Those toxic assets consisted mainly of bad mortgages, which went bad because lenders had recklessly, fraudulently and stupidly issued the loans. They also invested in “mortgage-backed securities”— securities backed by recklessly, fraudulently and stupidly issued loans.

Ah, but the big banks are healthy now, thanks to the American taxpayer and the Federal Reserve’s ability to push a button on a computer to put a string of zeroes after any digit for any bank the Fed chooses to help. Without the electronic magic that created money for them, these big banks would no longer exist. They’d have been broken up and their assets sold to other banks, including smaller ones that are now in trouble because the big banks have a competitive advantage: an implicit government guarantee.

Investors and customers know they can’t go wrong if they do business with a “too-big-to-fail” bank, because the government will not let it fail, no matter how recklessly, fraudulently or stupidly it is run. That’s a big marketing advantage for Bank of America and other “too-big-to-fails,” and a big disadvantage for the many smaller banks whose existing and potential customers know they can fail.

So the big banks capture growth that otherwise would be going to the smaller banks.

How ironic that many of the struggling smaller banks would probably be stronger today if only they had been able to take over the assets of the big banks that would have failed without government interference. Instead, small banks continue to fail, at least in part, because the government interference that was meant to “save” the financial system has impaired their ability to compete with the firms that were most responsible for nearly wrecking the system in the first place.

And how ironic that as the big banks become even bigger, and the financial system puts more of its eggs into one “too-big-to-fail” basket, the danger to the system becomes even greater.

Steve Stanek ([email protected]) is a research fellow at The Heartland Institute in Chicago.