Too Big To Fail Financial Institutions in the 2008-2009 Great Recession

Introduction

The great recession crisis was one of the worst economic crisis United States since the great depression in 1933. Although its effects were felt worldwide in the global economy, the United States economy was worst hit by the crisis mainly because it is the largest economy in the world. In addition, the US is one of the largest consumer markets of world goods and with decreasing consumption, the effect spread wide along to the other countries as well. Among the most affected countries were European Union countries and Japan. The economies of the countries affected took quite a period to recover fully from the impact of the recession (verick & Islam, 2011). Some of the businesses that were affected by crisis were the banks and other financial institutions. However, as the US banks have grown over time, they were considered too big to fail despite of the challenges of the recession. Despite their size, these big institutions equally felt the effect of the crisis with some of them given government bails in order to stay afloat during the crisis. The essay analyzes some of the impacts of the 2008 crisis on these too big to fail financial institutions. It also focuses and how their series of failures affected and prolonged the recession.
Companies are referred to be too big due to the essential roles they play in an economy and their failure is regarded a disaster (Kaufman, 2014). During the 2008 economic crisis, banks like JP Morgan, Citi bank and the bank of America were renamed as too big to fail during the crisis. The government also played a significant role of bailing some of these companies to help them survive the crisis (Labonte, 2013). Large financial institutions especially on the banking sectors had highly invested in the backed security mortgages. When the American housing markets collapsed in 2006, it created a housing bubble that sent financial shock waves to the banks as investor confidence decreased greatly in the industry. Unless the intervention from the government, the too big to fail financial institutions will have collapsed during the crisis.
It is estimated the crisis led to a loss of over 20 trillion dollars’ worth of assets in the United States. The recession began in mid-2007 and quickly expanded in what was referred to as the hosing bubble. Analysts indicate the effects of the crisis were so huge because the first indicators of the impending trouble were ignored. The banking sector was the worst affected because they had huge investments in mortgage securities. When the investors choose to withdraw, the government had to intervene e to prevent these institutions from total collapse. The banking sector was the worst affected because they had huge investments in mortgage securities. When the investors choose to withdraw, the government had to intervene to prevent these institutions from total collapse. Although the crisis was officially announced to be over in June 2009, the devastating effects to the economy took years to recover. The bailout of these big banks had a significant effect to the federal budget. This increased to national debt.

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Rationale

Since the 2008 crisis, the term-phrase too big to fail has been used causing a sharp interest. Although the economic crises were known to everyone, some people have attached different meanings to the phrase. The too big to fail has become a controversial term since the 2008 crisis and the idea become so applied in economic concepts. These financial institutions have been surrounded by controversy if they should be dissolved to smaller banks and financial institutions. In choosing this topic, I found it both interesting and significant to understand, analyze and report the role of these too big to fails financial institutions in the economic crisis of 2008. In addition, the debate n if the big to fail financial institutions should be broken down to smaller banks also made the topic interesting to analyze to provided informed contribution to the debate.

Explanation

Large United States banks and foreign banks are classified as too big to fail. These banks are worth over $5o billion and their roles are overseen by the financial stability oversight council of the United States. These banks are subjected to high standards in capital and given a special status that includes a higher supplementary ratio. Other benefits that these companies enjoy include low borrowing rates, which are not enjoyed by other smaller financial institutions.
However, the financial crisis of 2008 has significantly affected the status and privileges of the TBTF institutions. The $ 50 billion threshold of assets that a bank must possess to enjoy the status was raised to $500 billion to enhance the regulation of these institutions. The new policies adapted from the crisis they are also required that these companies provide budget resolutions and public disclosure. This was intended to protect the taxpayers and avoid the use of public funds to fund these companies in a bailout and a repeat of the 2008 situation.
The large Banks in the United States hold the majority of the total assets in the industry. Twenty fourteen statistics indicate that the banks hold over 52% of the assets in the industry. Out of the 38 banks that enjoyed the TBTF status in 2008, only three of these companies held over 40% of the total banking deposits in the industry (Bernanke, 2010). Such a higher percentage meant that these financial institutions had a significant impact on the economy of the United States. The 2008 crisis forced out some of the banks from the markets, which directly contributed, to growth of the large financial institutions remained in the market through merging and acquisitions of smaller firms.
Just as their impact on the economy are big, too big to fails financial institutions pose unique problem. A failure of such institutions could have a devastating effect to the economy and several other third parties. This has left the government at the center of providing a rescue bailout as for the case of the 2008 crisis (Wheelock, 2012). Their influence in market can also affect the activities of the security market. Due to their size, it is difficult that smaller firms can absorb these companies. This implies that the thought of such firms failing can create a series of additional problems in the market that they operate.
The existing policies that regulate the operations of these large banks were formulated after the 2008 crisis. The prior policies did not consider the possibility of these banks failing or becoming insolvent. The continued bailouts by the government to these financial institutions have initiated a mixed public reaction. However, the systematic risk that they pose to the economy is the main reasons behold the bailout. In response to such crisis as 2008, government has introduced massive reforms to the TBTF institutions including the raise the assets threshold from $50 billion to $500 billion to the companies enjoying such status. In addition, the introduction of an oversight authority mandated to oversee their operations.
The belief that such large firms are too big to fail was disapproved with the 2008 crisis. Companies like Lehman Brothers that did not survive the recession exposed major faults of these banks. Worse still, the size of these banks meant that smaller firms could not come to their rescue, which also indicated a problem in liquidating their assets to cover their expenses. The government was forced to bails out the TBTF institutions as a counter measure to avoid the collapse of the entire financial system, which could have devastating effects to the economy.

Conclusion

Several lessons can be learnt from the role that TBTF institutions contributed in the 2008 crisis. First, despite the role that these institutions play in a country’s economy, they pose an impending problem in times of a crisis. The government is forced to spend taxpayers money to bailout these institutions to avoid the economic disaster that there failure can cause. In addition, there failure can also affect the operations of the entire banking industry affecting other smaller institutions as well because of the large percentage of the deposits that these banks hold. In my assessment, there is need to formulate policies that prevent merging and acquisitions of smaller to form large institutions past a certain set threshold. Existing TBTF institutions should be broken down to the smaller banks to avoid a repeat of bailing out companies with public funds as 2008 crisis recession.

References

2007-09 Financial Crisis – Timeline – Slaying the Dragon of Debt – Regional Oral History Office – University of California, Berkeley. (2011). Retrieved from http://vm136.lib.berkeley.edu/BANC/ROHO/projects/debt/financialcrisis.html

Bernanke, B. S. (2010, September 29). FRB: Testimony–Chairman Ben S. Bernanke–September 2, 2010. Retrieved from https://www.federalreserve.gov/newsevents/testimony/bernanke20100902a.htm

Islam, I., & Verick, S. (2011). The Great Recession of 2008–09: Causes, Consequences and Policy Responses. From the Great Recession to Labour Market Recovery, 19-52. doi:10.1057/9780230295186_2

Kaufman, G. G. (2014). Too big to fail in banking: What does it mean? Journal of Financial Stability13, 214-223. doi:10.1016/j.jfs.2014.02.004

Labonte, M. (2013). SYSTEMICALLY IMPORTANT OR” TOO BIG TO FAIL” FINANCIAL INSTITUTIONS*. Journal of Current Issues in Finance, Business and Economics6(1), 39.

Wheelock, D. C. (2012). Too Big To Fail: The Pros and Cons of Breaking Up Big Banks. Retrieved from https://www.stlouisfed.org/publications/regional-economist/october-2012/too-big-to-fail-the-pros-and-cons-of-breaking-up-big-banks