The too big to Fail Concept
The TBTF subject in US perspective is first, a political issue. The citizens with their representatives perceive it unfair the rescues or bailouts of the large financial organizations using financial capital that are eventually made available by taxpayers. They see Wall Street being bailed out by Main Street (Barbara, 6). If the governments are supposed to shield the private organizations from collapse, market discipline in the economy will be undermined a condition that the critics of TBTF have described as desirable destruction. Competition is ultimately distorted while capital is economically misallocated. Inappropriate risk management as well as taking unwarranted risk is appreciated. Losses are entertained and it is at this point that taxpayers come into the scene (Truman, par.2). Explicitly or implicitly, governments are infused into the running of financial institutions and this alters the rules of the game. One consequence is a much concentrated financial entities structure, more likely to take unnecessary risk in addition to little evidence of the societal benefits, for example increased efficiency, lowered costs or better accessibility to credit. These are the issues that come with the TBTF concept that has regained popularity since the start of the economical global crisis (Truman, par.2). One of major companies in the United States of America which is referred as being too big to fail is the American International Group (AIG) (Truman, par. 3).
The Too Big to Fail Concept
Too Big To Fail refers to a phrase used to describe the idea used in economic regulation, that affirms that the main and the majorly interconnected business dealings are too large such that the government would not let them to be declare d bankrupt since such a failure could result to very disastrous effects to the entire economy of a country. Originally, the phrase was used to mean that a large and unified business was much diversified so that it was completely immune to failure (Truman, par.1). Therefore, such an enterprise had huge investments in many countries and a downturn of one of its portfolio would thus be easily counteracted by the prevailing successes in a different portfolio. This insulates any possible failure of the business. The premise was later dismissed by an almost worldwide economic recession it was still adopted but coined to refer to the first description given above. This phrase is also widely applied in referring to a policy of a government that entails bailing out businesses-- an issue which raises concerns of moral hazards to business operations. Since the beginning of the global financial meltdown in 2009, the phrase has been at center stage. The too big to fail policy may be applied by the governmental regulators to cushion a bank or large business which is so large such that its failure results to catastrophic effects not only to the country in question, but also the global economy (Barbara 4).
Examples of bailed out situations include the case in the 1970s in the United States of America, whereby the US government bailed out the Chrysler Corporation and in 1980s again it bailed out the Continental Illinois (a Chicago based bank). A more recent case represents the 1998 long term Capital Management that had implemented inappropriate investment decisions on a hedge fund and it was almost collapsing but was rescued by a New Yorks Federal Reserve, held in a group of banks. The intention of the government in bailing out these large banks or corporations is to protect the major banking organizations against the usual disciplines of marketplace since it considers such institutions so important to the economy and their failure would most likely lame the country both economically and financially. Essentially, these companies usually conduct businesses with so many of other companies such that their failure would mean either consequent failures of the companies they deal with, or a major downturn of their business partners (which are companies as well) (Guenther 2).
The supporters of the too big to fail concept hold that it sustains the stability of a country economically, while the critics of the concept suggest that it is usually an unnecessary risk that is not worth taking by the government (Barbara 7).
Remedies of the too big to fall problem
In the United States, the remedies of too big to fall problem are classified in four proposals. The first proposal involves breaking up the systematically essential institutions such that they are not individually so large and therefore the consequences of their failure to the economy will be eliminated. The second proposal entails separating riskier activities to unrelated organizations whose fall down would not have equal and direct adverse effects to the economy and generally the entire financial system. Thirdly, there is the employment of a combination of rigid modifications that either discourage extreme risk taking or launch cushions against its effects. Finally, the fourth proposal requires establishment of a unique resolution mechanism such that the collapse of systemically significant financial organizations can be administered to reduce the harm to the economic system and market without the involvement of a governmental bail out. However, each of the above remedies has got their supporters and merits as well as detractors and demerits (Ellison 77).
The first category of the proposals, which is the breaking down proposal, involves more issues that just downsizing the institutions by reducing the workforce or selling part of their enterprises, like it has already been done in many countries even without the support of the government. When fully applied, the approach entails breaking up the organizations into smaller unique entities having their own managements and shareholders, thus subjectively limiting their size. The problem with this approach is that no matter how small the institution, a collapse of any institution will always result in adverse economic problems. Moreover, if one big institution is broken up into say, 25 smaller units, all these units will have similar investment strategies, similar risk and disaster management policies and they will all experience similar losses and stresses. Therefore, financial effect of letting each of them fall is just the same as letting one large organization fall. For the second class of remedies which involves the separation of the riskier activities, also have its setbacks. The businesses do not have a consensus regarding the activities that are too risky. The question with this approach is, what about the organizations which are beyond the supervision parameter and are large and interconnected If these organizations are ignored, the TBTF problem will be made worse especially the burden on the taxpayers (Ellison 77-78).
The problem of enhanced regulation and supervision, which is the third group of the remedies of TBTF, includes the technical problem in designing and scheming retooled capital and investment structures. Again, there are ambiguities of the implementation of the regulations, because what will make one absolutely sure that for this time, the situation will be different There is no balance between the discretion left to supervisors and the regulators with rules set in advance. This leaves us with one question would an enhanced regime of regulation and supervision adequately contain the financial, political and economic costs of the moral hazard as well as eliminate problems of the TBTF Although this approach is more promising as compared to the first two, these technical problems are too substantial to be ignored. Therefore this leaves the final approach to the problem of TBTF which comprises resolution mechanisms that should be able to handle the failure of a major business without the intervention of the government. If it were possible to come up with such a resolution mechanism, it would be the best for clearing out the TBTF issue in the principal companies (Ellison 77). However, the possibility of such an approach is more theoretical than practical because to be able to manage big failure, a company must have invested heavily in other big companies that may serve as a cushion against major catastrophes. However, the major institutions are interrelated and the failure of one directly affects the others. As such, a composite and effective solution to the TBTF issue must embrace the concepts of these four approaches to be effective and be able to serve the country reasonably sound for a couple of decades (Ellison 78).
In addition to the four categories of approaches that have been discussed above, the former treasury secretary suggests that it is the collective responsibility of both the government and the citizens to reduce their dependence as well as the dependence of the too small to save businesses on a number of large organizations that engage themselves in extremely risky activities. This will help the nation to avoid worrying too much about the possible collapse of these businesses and organizations (Truman, par. 2).
Still the former chairman for the Federal Reserve presented some views of solving the too big to fail problem, but they were highly ignored by the Obama administration. In his view, the depositing banks should never be permitted to trade too aggressively. He said, Extensive participation in the impersonal, transaction-oriented capital market does not seem to me an intrinsic part of commercial banking (Truman, par. 5). According to his suggestion, the banks should only engage in trading with the aim of serving their customers and leave the big money transactions to the firms outside US governments safety net. The solutions offered by the former secretary to Federal Reserve and may not serve in the best interest to the economy although they may eliminate the too big to fail problem. This is because the two solutions are going to restrict trade and investments in the country that believed in open market and free trade. It will simply be a solution to one problem and creating another problem. Therefore implementing these solutions alone may not be sufficient in the long run to serve for the good the United States economy.
Conclusion
The accurate solution for too big to fail problem calls for more drastic choices. In addition to the insolvency government, such organizations should eventually be broken up and the unsecured creditor within the insolvent organizations should put their claims converted automatically into equity. A separation of the commercial banking from risky capital investment banking ought to be considered as well (Guenther, 3). This solution will involve more than just one step taken from the possible solutions, but a careful and reasonably consideration of the relationship between the suggested solution that will produce a lasting, composite and effective remedy to the too big to fail problem. However, whatever the route that the government may consider best in eliminating the bailouts of the large firms, it is fundamental that the breakup of either the interconnections or the capacity of the too big to fall firms be employed in solving the problem. For this remedy to produce the best solution to TBTF, the investment strategies of the broken up units of the big firms ought to be diversified such that the units do not invest in similar portfolios although they may be related and controlled under the same management. Breaking up the large firms and separating the investment portfolios of the subsequent smaller and medium firms is therefore key in solving the too big to fail problem because no firm will be too big to be considered a national or global disaster in the event that it declares bankrupt.