How Much Does ‘Too Big to Fail’ Matter?

One thing that’s throwing me off a bit in the debate over how much effort to put towards breaking up large banks is this notion of focusing on the idea of being “too big to fail.” That is, an institution getting so large that its failure will send intolerable ripples through the rest of the industry/economy, making it imperative that the public not allow such a failure. This is, obviously, the motivating factor behind the bailout of the financial industry and, to a lesser extent, General Motors.  But it seems to me that the concept of resolution authority mostly eliminates that need. The problem with allowing even a relatively small firm like Lehman Brothers to fail is the overall impact it has on the entire industry, essentially creating a panic. Given those sorts of circumstances, some sort of public authority needs to make sure a failure doesn’t happen. But if the FDIC has the authority to seize failed shadow banks and unwind them orderly and slowly, that theoretically takes care of the problems associated with panics and failures. This, of course, is why we don’t have panics related to deposit banks anymore; there’s a process in place for managing these kinds of failures that’s well understood by the industry, and people can anticipate what it means for their firms. Plus, receivership eliminates the problem of failed banks flooding the market with assets, devaluing similar assets on everyone else’s balance sheets. In this sort of structure, no one is too big to fail, because receivership is there as a sort of safety net to slowly manage the collapse of the bank. There are other problems associated with large banks to be sure, so I think the excess attention paid to failures is probably distorting more than it’s clarifying.