Sunday, September 20, 2009

The Economic Fallacy Of 'Too Big Too Fail'

By Taylor Conant

The onset of the financial implosion two years ago brought with it an ongoing dialogue about the 'Too Big To Fail' (TBTF) doctrine of government intervention into the financial sector. According to TBTF, some financial institutions, such as major insurers like AIG or large money-center banks like Citi and BofA, are deemed to be too large and too centrally interconnected in the US and world financial systems and economies to be allowed to be recognized as insolvent and taken through bankruptcy resolution.

As all government interventions do, TBTF has experienced mission creep and other, non-financial institutions, have also been brought under the TBTF-umbrella, such as auto-manufacturers GM and Chrysler. According to proponents of TBTF, these companies were also too important to the economy and financial system (via unemployment impacts) to be allowed to fail, although clearly the extension of this 'safety net' was more about practical political favoritism than economics, much like the original, flawed theory of TBTF for finance itself.

There's a major problem with TBTF-- taken to its logical ends, it is guaranteed financial suicide. Why? TBTF implies a totalitarian pursuit of 'failure insurance' for the institution under consideration that potentially puts the entire economy at risk.

When a business is deemed to be TBTF, it means the government stands ready to backstop any and all losses that business has incurred and might incur from that point forward. TBTF means that if the business is operating in a market which is dying, or if it is employing a business strategy that can not make money, the government will continue to pour resources into the sinkhole with no limit in sight. If TBTF-promoters mean what they say, it's theoretically conceiveable that the government could sacrifice the financial well-being of the rest of the economy, including its own precarious financial situation, in order to keep one 'strategically important' institution that is TBTF, solvent.

Most likely, it won't go that far, and you're probably reading this thinking it's ridiculous to even consider that such a thing might happen.

But consider something that is, in a way, even more ridiculous-- if TBTF is not followed to its logical end and is instead abandoned at some point along the path of total systemic insolvency, then it means that someone, somewhere is responsible for making a calculation along the lines of determining that TBTF has gone far enough and that it is no longer 'worth it' to go any further.

How do they make that kind of a calculation?

When a firm faces insolvency, it is a result of a market calculation being handed down that deems the firm to be a failure in the pursuit of profits and financial solvency. Insolvency for a firm means that the firm is sufficiently inefficient, sufficiently mismanaged and sufficiently out-of-touch with consumer needs, as communicated through the market, to be supported by consumer activity on a voluntary basis. In other words, through a multuplicity of cost-benefit calculations performed by the totality of individuals supporting the market in question, further patronage of the firm in question is deemed to be 'not worth it.'

TBTF is an end-run around this verdict by politicians who are nothing more than calculating socialists. They seek to replace the individual subjectivity of market participants about a given institution's value to society, with their own 'objective' considerations of the value or worth to these same market participants. When market participants say, "It's not worth it," the calculating socialist says, "Yes, it is." This is economic chauvanism.

But because TBTF is financial suicide, there is some point where even the calculating socialist must change their mind and agree with the market. Until that point is reached, market participants can only sit and wonder how much of the rest of the economy the calculating socialist will deem worthy of sacrifice to the institution which is TBTF. And when that point is reached, the question remains, how did the calculating socialist calculate it?

In its latest incarnation, TBTF has already cost the private economy hundreds of billions of dollars. And as we're in the early innings of this sick game, before it is all through it will surely cost the private economy hundreds of billions more.

TBTF policy is screwing us all. Eventually, there's some point whre it will have to stop. Let us all hope that the calculating socialists determine that point has been reached sooner rather than later.

Taylor Conant writes about economics, politics and liberty from Southern California. He believes the world would be a better place if more people minded their own business.

Copyright 2009 EPJ Group LLC


  1. hey, why dont u mind your own business instead of bothering/asking people to mind.

    oh, i just did that. Isn't it circular ?

  2. Anon,

    Good one. Did not see that coming.

    I don't work for government and I don't spend my days speechifying the nation, passing regulatory interventions into the economy or stealing money and redistributing it to others, so I feel I am doing a-okay on the nosiness front.

  3. I think the viewpoint behind this text is missing one central (not just crucial) element: the financial forces that are felt, but not seen. I’ll skip all the pertinent points but one: Bernanke “doesn’t know” where the money went, except that it’s “institutions in Europe and other countries.” Well, what if those supremely persuasive institutions want to sell their sizable positions (in almost everything) without losing too much profit, and they need time and a strong rally (in almost everything) to do that. Once that is done, nothing is too big to fail any more. On the contrary, almost everything is ripe to fall in an instigated panic sell-off, and the best of it bought back on the cheap. This game would obviously be bigger than GS and “the boyz” combined. They are just hounds, and there should be a hunter. Then TBTF is not an economic suicide, it’s a part of a hunting expedition. I fully realize there can be no sufficient proof for all that, but this viewpoint incorporates various “strange” facts (e.g. Bernanke “doesn’t know”) and makes (pillaging) sense, doesn’t it?

  4. Anon2,

    Yes, I think I see what you're saying. You're exploring a 'practical' purpose behind TBTF policy, which I don't necessarily disagree with you on your finding. I was trying to explore the 'theory' of TBTF and demonstrate that if it's followed in a logically consistent way it means economic suicide. Therefore there's a point where it must be given up if that fate is to be avoided, which was my second point... how do these calculating socialists decide when that point is reached? That's probably where your idea comes in.

    Good work!

  5. The word socialism is always used to describe the corporate bailouts. In actuality this policy is the merging or corporate and government interests. This is known as fascism. The Obama administration may use socialist language to describe the saving of workers' jobs by government intervention, but at the end of the day the jobs are still lost and the only parties benefiting are big government and big business. Let's call it what it is, fascism. We have found the enemy and it is us. The wretched, stinking flower of fascism has bloomed before our eyes.

  6. Anon3,

    Let's consider socialism a couple of ways, a strict definition and a loose definition, and see if you still have a problem with my general use of socialism:

    Strict socialism-- governmental (social) control of the means of production
    Loose socialism-- socialization (via government) of economic costs, wherein individuals and firms in an economy incurring costs do not necessarily pay that cost themselves, with the part of the cost they do not pay (all or some) socialized onto taxpayers and other members of the economy.

    I think my usage of socialism is both fair and accurate. I agree, fascism is at play, and it would be a more specific term to use. But fascism is just a specific form and kind of socialism, with a specific intended aim and goal.

    I think the article works whether fascism or socialism is used. They're equivalent terms given the circumstances.