'Too Big To Fail' is explained in detail and with examples in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Too Big To Fail refers to the disturbing but proven concept that some businesses have become so enormous and systemically important that the jurisdictional government has no choice but to save them from failing with whatever means necessary. The governments feel they must deliver material assistance to the firms in order to prevent a catastrophic rogue wave effect from reverberating across the entire economy.
The simple explanation for how a company can be so important to an entire economy is this. When such an enormous firm fails, all of the companies that count on it for parts of their revenue can also be compromised and fail, as well as its debt holders and ancillary services providing companies that work with the failing massive firm. Jobs then become eliminated en masse. For this reason, the expenses involved with a simple bailout or government backed guarantees of the mega corporation are significantly less than the cost of overall widespread economic failures. It explains why governments will often opt for the bailout as the less expensive answer to the moral problem.
Too Big To Fail especially pertains to commercial banks and financial services firms. These financial companies are so critical for the United States’ and other Western economies that it would create havoc and spread financial ruin if they declared bankruptcy. Because of this, the American and British governments especially opted in the Global Financial Crisis of 2008-2009 to spare the banks and other financial service firms.
They saved the bank creditors and holders of counter party risk. As an unwished for side effect, they allowed the managers and company board members to keep their enormous salaries and incredible bonuses. Throughout the last years of the 2000’s, the United States’ Federal Government doled out approximately $700 billion in order to shore up such critical failing corporations as Bear Stearns, AIG, and the major banks which stood on the edge of financial ruin.
It was investors’ total evaporation in confidence of the major financial institutions that led to their near-downfall back in the years 2008 and 2009. Especially the investment banks ran into trouble as they had become unbelievably leveraged (to the tune of from forty to one and eighty to one) when suddenly their mortgage loan-based assets and derivatives plunged in value as the subprime mortgage crisis spiraled out of control. Both stake holders and creditors quickly began to have doubts in their financial solvency as their balance sheets crumbled.
The defining moment in the Too Big To Fail crisis erupted when the government did not step in to prevent Lehman Brothers investment bank from failing. This has become widely known as the “Lehman moment.” As widespread chaos erupted in the financial markets, regulators suddenly became painfully aware that these largest companies were so intricately connected that it would take enormous financial bailouts in order to stop literally half of the U.S. financial sector from collapsing.
Once the bailouts had intervened to save the major Too Big To Fail investment banks, only two remained standing. Even the survivors Morgan Stanley and Goldman Sachs were both forced to convert to traditional commercial banks so that they could be backstopped by the FDIC. Bear Stearns was effectively wound down, Lehman’s skeleton was bought out by Barclays of Great Britain, and once-mighty Merrill Lynch became a subsidiary of Bank of America. The shadow banking industry had all but disappeared overnight.
The government then attempted to address the issues of Too Big To Fail financial firms. The U.S. Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The idea was to create restrictions which would make it far more difficult for such conditions to flourish again. They hoped to sidestep having to extend other bailouts in the future.
The Act made the financial institutions create forms of “living wills” so that their plans are in place in order to rapidly liquidate assets if they have to file for bankruptcy. An internationally based consortium of financial regulators came up with a new set of rules in November of 2015 to force the major global banks to raise their capital by $1.2 trillion more in additional debt funding which they are able to convert into equity or write off if they suffer catastrophic losses again.