Too Big to Fail": Economics & Implications

[j93]

Does anyone know if any economist are studying the implications of this concept? I have never heard of economic theories with assumptions that there are multiple businesses that cannot faile due to their size. There are also questions about the implications is has for the actions of CEO's of these companies obviously this would encourage them to take higher risks. Effectively this concept also creates more companies in this category by offering bailout money to large companies which they can use to takeover smaller companies therefore creating more companies that are "too big to fail".

 

[turbo]

The phrase is inaccurate. The philosophy is that some business are too big to be allowed to fail, implying that corporate-welfare or some other intervention must be undertaken to prop them up when their managers make bad decisions.

 

[j93]

The phrase is inaccurate. The philosophy is that some business are too big to be allowed to fail, implying that corporate-welfare or some other intervention must be undertaken to prop them up when their managers make bad decisions.

Exactly but the government never takes it over ala Fannie Mae so the phrase is effectively accurate unless the government fails because its pretty much the same company only leeching for survival off the government but once its healthy its back to being owned/run by the same individuals.

 

[Astronuc]

Exactly but the government never takes it over ala Fannie Mae so the phrase is effectively accurate unless the government fails because its pretty much the same company only leeching for survival off the government but once its healthy its back to being owned/run by the same individuals.

The US government (Treasury & Federal Reserve) actions have been somewhat inconsistent.

Fannie Mae and Freddie Mac were put into Conservatorship, while AIG received captial (cash) injection - all considered too big to be allowed to fail. The concern was with there collapse, the entire global financial system would collapse - as opposed to a partial collapse.

Bear Stearns and Lehman Brothers were allowed to fail - and the consequences were considered more limited (i.e. not as big an impact if AIG failed).

Apparently the current situation is unprecedented, although there are similarities to the Great Depression and other recessions.

 

[j93]

I guess the title is not descriptive enough. I meant companies like AIG or Citibank who just receive money because they are considered "too big too fail" but are not taken over. These are the type of companies of companies I was referring to in OP and those that I believe that are the most interesting because they are like regular corporations but with a special property that they are not allowed to fail but are not taken over.

 

[Astronuc]

I guess the title is not descriptive enough. I meant companies like AIG or Citibank who just receive money because they are considered "too big too fail" but are not taken over. These are the type of companies of companies I was referring to in OP and those that I believe that are the most interesting because they are like regular corporations but with a special property that they are not allowed to fail but are not taken over.

AIG and Citigroup are regular corporations, as are other financial companies, e.g. Bank of America, JP Morgan Chase, . . . .

Fannie Mae and Freddi Mac are Government Service Enterprises, which although not guaranteed by the US government, nevertheless were taken into Conservatorship, which effectively means the US government is supporting (guaranteeing) them.

One would have to read the minds of Paulson, Bernanke, Geithner et al to understand the reasoning behind the actions taken with respect to taking over some companies and not others, or bailing out AIG and not Bear Stearns or Lehman Brothers. In recent revelations, it seems AIG has greater liabilities (obligations/ losses) than first understood.

It's still unclear with respect to current writedowns or losses. Citigroup CEO Vikram Pandit released an internal memo - Text of Citigroup memo sent by CEO Pandit - that was leaked to the public. It had the effect of reversing the fall of the Citigroups shares and the Dow. On the other hand, it did not discuss other potential losses, nor the fact that the company has received billions of subsidies (capitalization).
http://marketplace.publicradio.org/display/web/2009/03/10/pm_citigroup/

Kai Ryssdal: First things first. It's important to point out that what Citigroup said today wasn't exactly official in the SEC sense of the word. CEO Vikram Pandit broke the news of the black ink in an internal e-mail to Citi staffers. Word got out as word tends to do. And good news of any kind out of the financial sector was all Wall Street needed to hear. So thank Citigroup for today's 379 point bounce on the Dow. I'm sure they'll appreciate it because I don't think they've been getting many thank you's lately. But, and seriously you knew there'd be a 'but' here, you have to bear in mind Pandit didn't talk about all those troubled assets Citi still has to keep marking down. Marketplace's Jeremy Hobson reports from New York.
. . . .
April 17th in Citi's case, which is when investors and employees will get, as the late great Paul Harvey would say, the rest of the story.

The Citi news, which broke the market's long losing streak was a surprise for many investors, especially the short sellers who had been unloading stocks as they bet that Wall Street was going to keep falling. They were forced to quickly buy stocks back, and contributed heavily to Tuesday's 379-point surge in the Dow.

http://biz.yahoo.com/ap/090315/wall_street_week_ahead.html

 

[j93]

Youre right they were originally inconsistent but it seems like nobody ever mentions of taking any companies into a government conservatorship. I am wondering what that would mean for the basis of capitalism the idea that you can have companies that fall into trouble they are always given a lifeline based on their size.

 

[Astronuc]

Here is some thinking about AIG and the potential consequences of its failure, or the failure to intervene and prevent its failure.

As A.I.G. Lists Firms It Paid, Anger Boils Over
http://dealbook.blogs.nytimes.com/2009/03/16/as-aig-lists-firms-it-paid-anger-boils-over/

. . . .
The Fed chairman, Ben S. Bernanke, appearing on “60 Minutes” on CBS on Sunday night, said: “Of all the events and all of the things we’ve done in the last 18 months, the single one that makes me the angriest, that gives me the most angst, is the intervention with A.I.G.”

He went on: “Here was a company that made all kinds of unconscionable bets. Then, when those bets went wrong, they had a — we had a situation where the failure of that company would have brought down the financial system.”

In deciding to rescue A.I.G., the government worried that if it did not bail out the company, its collapse could lead to a cascading chain reaction of losses, jeopardizing the stability of the worldwide financial system.

The list released by A.I.G. on Sunday, detailing payments made between September and December of last year, could bolster that justification by illustrating the breadth of losses that might have occurred had A.I.G. been allowed to fail. Some of the companies, like Goldman Sachs and Société Générale, had exposure mainly through A.I.G.’s derivatives program. Others, though, like Barclays and Citigroup, stood to lose mainly because they were customers of A.I.G.’s securities-lending program, which does not involve derivatives.

But taxpayers may have a hard time accepting that so many marquee financial companies — including some American banks that received separate government help and others based overseas — benefiting from government money.

. . . .

So far $170 billion has been put into AIG, and a lot of that has been paid to companies like Goldman Sachs, Société Générale, Deutsche Bank, Barclays, Merrill Lynch, Bank of America, . . . . Some of the companies, ones based in US, have also received injections of capital from the US Treasury.

AIG report on payouts:
http://graphics8.nytimes.com/packag...bailout-disclosed-counterparties/original.pdf

Truly a global economy suffering from a global mess.

 

[Astronuc]

AIG chairman inherits retention bonus mess
http://news.yahoo.com/s/ap/20090318/ap_on_bi_ge/aig_outrage

. . . .
The clamor over compensation overshadowed AIG's weekend disclosure that it used more than $90 billion in federal aid to pay out to foreign and domestic banks, including some that had multibillion-dollar U.S. government bailouts of their own. AIG is the single largest recipient of government assistance — a company whose financial transactions were so intricate and intertwined that it was considered simply too big to fail.

In an essay published Wednesday in The Washington Post, Liddy wrote: "The company's overall structure is too complex, too unwieldy and too opaque for its component businesses to be well managed as one entity. So the strategy we continue to pursue ... is to isolate the value in the company's component parts, capture that value to pay back money owed to the government, and allow AIG's healthy insurance companies to continue to prosper for the benefit of policyholders and taxpayers."
. . . .

The 'bailout' to AIG (and other institutions) is supposed to be paid back to the Treasury. In theory, Treasury will then retire debt.


AIG Firestorm Raises Alarm For Other Firms
http://www.washingtonpost.com/wp-dyn/content/article/2009/03/17/AR2009031703565.html

Some on Capitol Hill say the financial industry should be smaller and its jobs less lucrative.

AIG, which received more than $170 billion in emergency federal aid, has become the chief exhibit for both sides of the debate. Executives say they must pay retention bonuses to keep employees who are unwinding its Financial Products division, which nearly brought down the insurance giant with trading in exotic derivatives.

But a former senior Financial Products executive who spent eight years at the firm disagreed. Because the division is shrinking and no longer seeking new business, many workers have lost their relevance. The only key positions are employees who are working to extricate AIG from $2 trillion worth of outstanding contracts, the executive said.

"The guys who are getting paid all the big money are not really the ones who are important to the company," he said.
. . . .
AIG, once the world's largest insurer, now is in decline. Some administration officials say they would like new authority from Congress to wind down the company.
. . . .

Yet - if the government hadn't intervened, it appears that AIG would have failed, and many of its customer, the counterparties in the Credit Default Swaps (CDSs) would have had additional losses on top of the mortgage and securities losses. Left to itself, the world financial markets would have collapsed, and likely the Great Recession would have become another Great Depression.