Causes and Consequences Of the “Too Big To Fail” Policy

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Table of Contents

Introduction
Causes of Too-Big-to-Fall Policy
Recent Incidents Relating to this Policy
Consequences of Too-Big-to-Fall Policy
Conclusion
References

Introduction

The Lehman Brothers and Enron are names that are still very memorable in the minds of many Americans. The Lehman Brothers was a company that was one of the biggest employers in the United States. It had about 27,000 employees who directly depended on it for survival. The country also benefited from the revenues generated from this firm as tax (Bonnick, 2010).

Enron was another company that was so prosperous in this country and it was expected to be one of those firms that would remain competitive in this industry for a long time. However, this was not to be. In 2001, this firm closed its operation after filing for bankruptcy. It was so dramatic and it took time before the American society finally appreciated the fact that this firm actually fell.

The same case was with the Lehman Brothers. This firm was one of the most prosperous in the country, and it was expected that with its continued expansion, it would be in a position to employ more Americans and lower the rate of unemployment.

However, the incident that took place in the onset of 2008, which culminated into its closure in September 2008, was a surprise to many. This firm was expected to be operational for years on end. Unfortunately, it bowed out of the market in the most shameful manner.

Too-Big-to-Fall is a policy where the government would feel obliged to come to the financial rescue of a firm that is very large and employs large number of people, and therefore its fall would result into a serious economic crisis in the country.

In this economic policy, the government would determine the consequence of the fall of the firm and of the amount of money needed to bail out the firm, and if it realizes that the consequence of the fall of the firm would be more devastating to the economy, then it would consider bailing out the firm. This policy has seen various large financial firms rescued during difficult economic times in the country (Goodlet & Howe Institute, 2010).

Too-Big-to-Fall policy was meant to ensure that the economy of the country is not interrupted by a fall of a large company that has a huge impact on the economic status of the firm. Most of the beneficiaries of this policy have been financial institutions, especially large banking institutions.

This can be attributed to the fact that the financial institutions have direct impact on the economic status of the country, and their fall can result into an instant negative effect on the economy of the country. Some of the renowned financial institutions that have received financial support from the federal government of this country include Bank of America, Citigroup, JP Morgan, and Wells Fargo among others (Green, 2009).

Other large firms like AIG, General Motors, and Chrysler also had to be bailed out by the government to help them from eminent fall.

Causes of Too-Big-to-Fall Policy

Proponents of Too-Big-to-Fall policy argue that some firms are very large and their operations are interconnected to so many other firms that their fall may lead to the fall of many other firms. They argue that these large firms employ so many individuals in the country, and their closure would result in loss of jobs for so many people in the country.

The government would not only loose tax earned from the profits earned by the firm, but also the pay as you earn tax that is gotten from these employees. The banks are good examples of such firms.

A bank like the Citibank has so many other large institutions in the country depending on it for normal financial operation (Baumol & Blinder, 2012). A closure of this bank would not only mean that these other firms would lose their savings, but they will also loose time and other resources transferring their accounts to a new financial institution.

These proponents argue that the cause of bailing out the firm is to ensure that they regain their stability and therefore not forced out of the market. General Motors was in a serious financial crisis and had to come up with a policy that would help it reverse its financial downturn. When it became apparent that this firm was not in a position to save it from the eminent fall, the federal government came in and intervened.

The government bailed the firm out and the benefits are clear for everyone to see. The firm has managed to gain its ground, and it is currently doing very well in this economy (Eisenlohr, 2010). It is still one of the major employers in the country and it is giving the federal government good revenues in the form of tax.

Although this policy has received criticism from a section of the society members, many people trust this policy as it gives new life to large, but financially challenged firm. Some argue that this policy is a risk that a country should not be put into, given the fact that the success of the firm is not guaranteed.

The critics argue that this policy may encourage fraud in some quarters, always expecting the government to come to their aid when they are in the brink of falling. They insist that firms should have the ability to ensure their sustainability, and if a firm fails to implement policies that would ensure that it remains competitive, then it should be left to naturally find the right path to success, and if it fails, then it should be left to die naturally.

The above argument has some truth, but it should not be implemented in a country that expects to have a flourishing economy from various firms. It is important to understand the rationale behind this policy. The policy is not only meant to ensure that employment of some section of the society is maintained, but also to protect the revenues the government gets from such firms.

It is also meant to protect other firms that have business relationship with the firm. General Motors is related to many other firms as customers and suppliers.

When this firm is declared bankrupt and it closes its operations, it will not only affect the employees of this firm, but other firms’ employees too, that depended on this firm for their operations. There would therefore all the need to ensure that this firm operates successfully to ensure that the economy of the nation is not interfered with.

Recent Incidents Relating to this Policy

MCI WorldCom, Compaq, Woolworth’s, General Foods Corp, DeLorean Motor Co., Arthur Andersen, The Pullman Co., Standard Oil, Pan Am, Eastern Airlines, Merry-Go-Round, and PaineWebber are some of the firms that were declared bankrupt and sent out of operations when the world thought that they were at the peak of operations. Compaq was once the biggest seller of personal computers in the world.

It was the face of PC and for a long time many people thought this firm was too big to fall. However, the twenty first century saw the emergence of new firms in the industry that brought about unprecedented competition. Compaq entered a merger with Hewlett Packard Company and that marked its end.

Enron was another firm that was brought to its knees in 2001 after recording a profit of $ 111 billion the previous year. This firm was considered very successful, and by 2000, this firm was one of the largest employers with about 22,000 employees. The public considered this firm very prosperous, and it was expected to be the face of the country’s economic growth in this century (Sorkin, 2010).

When the firm was declared bankrupt the following year, it was not easy to comprehend incidents that lead to this. According to Moosa (2011), the government was not only slow in response to the woes of this company, but exhibited serious indifference that towards it.

The above list, which is not exhaustive, is a clear indication that the country lost billions of dollars in revenue from the possible tax that would have been collected from the firms and its employees. Currently, there is a 6 percent rate of unemployment in the country.

When the number of possible employees that would be working for these defunct firms is estimated, it would be realized that currently, the rate of unemployment in the country would be less than one percent. This clearly demonstrates that the government has all the reasons to bail out these firms. Their presence in the country is very beneficial to the economy and the social well being of the citizens of the country.

The government has therefore come to the realization that some firms cannot be left to fall because of financial crisis. This is especially so following the fall of Lehman brothers that brought serious ripple effects to the economy of the United States (Garnaut & Llewellyn-Smith, 2009).

The country has since bailed out so many firms that were in the brink of falling. As stated above, most of the institutions that this firm has bailed out are financial institutions. This is so because of the interconnection of this firm with other firms in this economy.

Other firms that have benefited from this program include Oakland Municipal Credit Union, M&T Bank, Maryland Financial Bank, CitiMortgage, Inc., Whitney Holding Corp, JPMorgan Chase subsidiaries, and Fannie Mae among others. The list of the firms that have been bailed out by the government is very long, and the effect of this move by the government is visible.

These firms were in the brink of falling, and were it not for the quick move by the government; they would be in the list of the firms that were forced out of operations. These firms give billions of revenues to the government in form of tax. They also employ so many Americans and they have positively affected the reduced rates of unemployment in the country.

Consequences of Too-Big-to-Fall Policy

Too-Big-to-Fall policy comes with some serious consequences. During the 2008/2009 recession, the government was under pressure to finance various government projects, and pay out reoccurring expenditures. The country was barely able to support its expenses. It was so unfortunate that it was during this time that various firms in the country faced serious financial problems.

Various financial institutions were struggling to meet their financial obligations. The government was well aware that although it was facing serious economic constrains, it would be suicidal to let these financial organizations, and other large firms fall.

The country was well aware of the fact that the ability of the country to recover from the recession was directly based on the success of these firms. The country had to come to their rescue as soon as possible despite the economic challenge it was experiencing.

The country had to resort to borrowing from other countries in order to resolve its internal problems. The United States therefore borrowed a lot of money from various nations, especially from China in order to be in a position to restore sanity in the US economy. This consequence was not pleasing to many of the Americans who, for a long time, have considered China’s economic growth as inconsequential.

The country had to swallow its pride and accept help from a country that has grabbed most of its market in the emerging economies, especially in Africa and parts of Asia. The consequence of this heavy borrowing was that this country was getting weaker in the face of the expanding economies like China, India, and Brazil.

The consequence of this policy has however proven to be positive in the end. Although it cost the country a lot of money to construct the country’s falling firms, their revival has increased employment opportunities in the country.

There is reduced dependency as most of the Americans are gainfully employed in various fields of their qualifications, thanks to the revival of these firms. These firms have also managed to pay back the amount of money they borrowed from the government, besides the regular tax that they continue to pay (Moosa, 2011).

The economy of the country is very attractive, and some firms that were bailed out have been able to increase their presence internationally. This means increased profits for the firms and for the country.

From the gains gotten from this, the country has been in a position to pay, in parts, the debts that it took from other countries. The economic growth of the country is also positive, a sign that all is well with the country economically. It proves beyond any reasonable doubt that the policy is very effective.

Conclusion

The United States has witnessed the fall of some of the biggest companies that had their presences in all parts of the world. The government was heavily affected each time such a firm fell, especially the loss of employment and the ripple effect such firms had on the economy in general.

Too-Big-to-Fall policy was therefore brought forth to help ensure that large firms that were connected to various other firms are bailed out when facing serious financial woes. This policy has saved various firms from falling. Although it has hurt the country financially, the long run benefits supersede the costs.

References

Baumol, W. J., & Blinder, A. S. (2012). Macroeconomics: Principles & policy. Mason, OH: South Western, Cengage Learning.

Bonnick, K. (2010). Why too big to fail?: How the regulatory system failed the American people. S.l.: Authorhouse.

Eisenlohr, E. (2010). Fairy tale capitalism: Fact and fiction behind too big to fail. S.l.: Authorhouse.

Garnaut, R., & Llewellyn-Smith, D. (2009). The great crash of 2008. Carlton, Vic: Melbourne University Publishing.

Goodlet, C., & C.D. Howe Institute. (2010). Too big to fail: A misguided policy in times of financial turmoil. Toronto, ON: C.D. Howe Institute.

Green, L. (2009). America: Too big to fail. S.l.: Outskirts Press.

Moosa, I. A. (2011). The myth of too big to fail. New York: Palgrave Macmillan.

Sorkin, A. R. (2010). Too big to fail: The inside story of how Wall Street and Washington fought to save the financial system–and themselves. New York: Penguin Books.

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