Too Big to Fail: Too Big to Bail

Large banks have historically benefited from an implicit guarantee known as too big to fail. The idea is that even if not legally obligated to do so, governments may have to provide assistance to financial institutions whose bankruptcy could lead to a destructive domino effect throughout the entire financial system.

The logic invoked in defense of too big to fail is that it serves at least two important functions: it can calm skittish depositors who would otherwise withdraw their funds from the bank, causing a panic and a run on the bank that would surely force it into insolvency, and it can protect investors who would otherwise likely see the value of their entire investment wiped out by panic.

The problem is that with so many large banks struggling for survival, taxpayers are now facing upward spiraling bailout costs in the hundreds of billions (and possibly trillions) of dollars. Too big to fail has become too big to bail.