Too Big To Fail

For those interested in the background of the current recession the Federal Reserve Bank of Dallas 2011 report makes interesting reading and reveals that 52 percent of all the assets held by the entire banking industry have now become aggregated into the hands of just five companies. The top 10 banks now account for 61 percent of commercial banking assets, substantially more than the 26 percent of only 20 years ago and the top 10 institutions possess wealth that equates to roughly half of America’s annual gross domestic product.

It explains how the housing bust and recession disabled the financial system. "...Struggling banks could not lend, slowing economic activity. Massive layoffs followed, pinching household and business spending, which depressed stock prices and home values, further reducing lending. These troubles brought more layoffs, further reducing spending. Overall economic activity bogged down.The chain reaction that started in December 2007 became the longest recession in the post-World War II era"

"Greed led innovative legal minds to push the boundaries of financial integrity...All booms end up busts. Then comes the sad refrain of regret: How could we have been so foolish?" the report reads "...For capitalist economies to thrive, weak companies must go out of business. The reasons for failure vary from outdated products, excess industry capacity, mismanagement and simple bad luck. The demise of existing firms helps the economy by freeing up resources for new enterprises, leaving healthier survivors in place."

The term Too Big To Fail disguised the fact that commercial banks holding roughly one-third of the assets in the banking system did essentially fail, surviving only with extraordinary government assistance. "In essence, dealing with TBTF financial institutions necessitates quasi-nationalization of a private company, a process antithetical to a capitalist system... The rationale for providing public funds to TBTF banks was preserving the financial system and staving off an even worse recession. The episode had its downside because most Americans came away from the financial crisis believing that economic policy favors the big and well connected. They saw a topsy-turvy world that rewarded many of the largest financial institutions, banks and nonbanks alike, that lost risky bets and drove the economy into a ditch. These events left a residue of distrust for the government, the banking system, the Fed and capitalism itself..."

The Dallas Fed details how it views the idea of "Too Big To Fail" as a severe "perversion of capitalism."
"Here are some ways TBTF has violated basic tenets of a capitalist system:
Capitalism requires the freedom to succeed and the freedom to fail. Hard work and good decisions should be rewarded. Perhaps more important, bad decisions should lead to failure—openly and publicly. Economist Allan Meltzer put it this way: “Capitalism without failure is like religion without sin.”
Capitalism requires government to enforce the rule of law. This requires maintaining a level playing field. The privatization of profits and socialization of losses is completely unacceptable. TBTF undermines equal treatment, reinforcing the perception of a system tilted in favor of the rich and powerful.
Capitalism requires businesses and individuals be held accountable for the consequences of their actions. Accountability is a key ingredient for maintaining public faith in the economic system. The perception—and the reality—is that virtually nobody has been punished or held accountable for their roles in the financial crisis.
The idea that some institutions are TBTF inexorably erodes the foundations of our market-based system of capitalism"

Dallas Fed president Richard Fisher argues, the risk of a “Too Big To Fail” institution collapsing, which gave lawmakers the impetus for unprecedented financial bailouts in 2008, obstructs capitalism itself. Fisher warns that “megabanks” have become so powerful that they threaten the Fed’s ability to conduct monetary policy. “Perhaps the most damaging effect of propagating [too big to fail] is the erosion of faith in American capitalism,” he explains “Diverse groups ranging from the Occupy Wall Street movement to the Tea Party argue that government-assisted bailouts of reckless financial institutions are sociologically and politically offensive. From an economic perspective, these bailouts are certainly harmful to the efficient workings of the market.”

The full report.