The “Too Big to Fail” Problem

By Saule T. Omarova. Full text here.

“Too big to fail”—or “TBTF”—is a popular metaphor for a core dysfunction of today’s financial system: the recurrent pattern of government bailouts of large, systemically important financial institutions. The financial crisis of 2008 made TBTF a household term, a powerful rhetorical device for expressing the widely shared discontent with the pernicious pattern of privatizing gains and socializing losses it came to represent in the public’s eye. Ten years after the crisis, TBTF continues to frame much of the public policy debate on financial regulation. Yet, the analytical content of this term remains remarkably unclear.

Taking a fresh look at the nature of the TBTF problem in finance, this Article offers a coherent framework for understanding the cluster of closely related, but conceptually distinct, regulatory and policy challenges this label actually denotes. It identifies the fundamental paradox at the heart of the TBTF metaphor: TBTF is an entity-centric, micro-level metaphor for a complex of interrelated systemic, macro-level problems. While largely unacknowledged, this inherent tension between the micro and the macro, the entity and the system, critically shapes the design and implementation of the key post-2008 regulatory reforms in the financial sector.

To trace these dynamics, this Article deconstructs the TBTF metaphor into its two basic components: (1) the “F” factor focused on the “failure” of individual financial firms; and (2) the “B” factor focused on their “bigness” (i.e. relative size and structural significance). Analyzing post-crisis legislative and regulatory efforts to solve the TBTF problem through this simplifying lens reveals critical gaps in that process, which consistently favors the inherently micro-level “F” factor solutions over the more explicitly macro-level “B” factor ones. It also suggests potential ways of rebalancing and expanding the TBTF policy toolkit to encompass a wider range of measures targeting the relevant systemic dynamics in a more direct and assertive manner.