The debate over "too big to fail" companies has been ongoing in recent years, particularly following the 2008 financial crisis and more recently, the collapse of Silicon Valley Bank (SVB) on March 10,2023. The term "too big to fail" refers to large financial institutions or corporations whose collapse would have a significant negative impact on the economy and the broader financial system. Some examples of companies considered too big to fail include JPMorgan Chase, Amazon, and Goldman Sachs, among others. However, it's worth noting that the definition can vary depending on the context and industry. Other companies that may be considered too big to fail include major airlines, telecommunications companies, and pharmaceutical corporations.
One major concern with these companies is the moral hazard associated with allowing them to be too big to fail. If they know they will be bailed out by the government in the event of failure, they may take on excessive risk, knowing they will not bear the full consequences of their actions. This creates a culture of recklessness and contributes to the buildup of systemic risk in the financial system.
The collapse of SVB is a prime example of this moral hazard. According to reports, the bank invested heavily in mortgage-backed securities, ultimately leading to its collapse. This investment trend was part of a larger trend among financial institutions in the mid-2000s, seeking to capitalize on the booming housing market. However, as the market began to collapse in 2007, these investments proved to be increasingly risky.In fact, the collapse of the housing market led to the failure of many large financial institutions, including Lehman Brothers, Bear Stearns, and AIG.
SVB's collapse serves as a reminder that too big to fail companies can still make risky investments leading to their collapse, despite their size and power. This highlights the need for continued regulation and oversight to prevent the buildup of systemic risk in the financial system. Despite its size and importance to the local economy, the company was unable to survive a run on its deposits. Undoubtedly, bailing out these companies prevents a complete financial meltdown but also creates a moral hazard thereby leading to a situation where institutions continue to engage in risky behavior, which has led to the SVB crisis as the mortgage-backed securities has proven to be a risky investment in time past, hence one would wonder why SVB would heavily invest in it again.
It is worth questioning whether too big to fail companies should be allowed to redefine the rules of capitalism. This may involve rethinking the government's approach to regulation and antitrust enforcement, as well as considering alternative economic models that prioritize competition and decentralization over consolidation and centralization of power. One of the key concerns is whether allowing these companies to exist and continue to grow, despite their potential negative consequences, is consistent with the principles of capitalism.
Capitalism is based on the idea that companies compete in a free market, and those that are successful are rewarded while those that fail are allowed to go bankrupt. However, when companies become too big to fail, the rules of the game change. These companies can engage in risky behavior, knowing that they will be bailed out by the government in the event of failure, which undermines the principles of capitalism.
Moreover, the existence of too big to fail companies can stifle competition and innovation, as smaller firms may struggle to compete with the dominant players. This can lead to a concentration of power and wealth in the hands of a few large companies, which may not be in the best interests of consumers or society as a whole.
The focus should shift towards preventing the formation of companies that are too big to fail in the first place, rather than relying on taxpayer-funded bailouts as a solution. This could involve breaking up large companies to prevent them from becoming too powerful and dominant, promoting competition and innovation. As a society, we need to ask ourselves whether allowing companies to become too big to fail is ultimately in our best interests and whether alternative economic models that prioritize competition and decentralization should be explored.
On one hand, bailing out these companies can prevent a complete financial meltdown and avert potentially catastrophic consequences for the broader economy. It can also protect jobs, prevent a ripple effect of bankruptcies, and provide stability to financial markets. For instance when two of the world's largest airlines - Lufthansa and Qantas were on the brink of bankruptcy, Lufthansa received a €9 billion bailout from the German government, which helped to prevent the airline from going bankrupt due to the massive decline in air travel during the COVID-19 pandemic. As part of the bailout, the German government took a 20% stake in Lufthansa and also imposed several conditions, including a ban on dividend payments and restrictions on executive pay. Similarly, in March 2021, the Australian government announced a A$1.2 billion bailout package for Qantas and other airlines, to help them recover from the impact of the pandemic on air travel. As part of the package, Qantas received a A$500 million loan from the government, which helped to secure its future and prevent it from collapsing. However, both Lufthansa and Qantas have pledged to repay the government loans and return to financial stability in the coming years. Lufthansa has already made significant progress in this regard, with the airline reporting a smaller loss in the first quarter of 2021 compared to the same period in 2020.
As a potential solution to address the issue of moral hazard associated with too big to fail companies. If a company that was considered too big to fail ends up failing, its credit rating should be reduced, and it should be subject to closer regulatory scrutiny to prevent it from posing a systemic risk to the financial system in the future and be stripped off the title of the “too big to fail”. This could help incentivize companies to avoid excessive risk-taking. Additionally, such a measure could provide greater accountability and transparency to prevent companies from relying on the assumption that they are too big to fail.
The debate over taxpayer-funded bailouts also raises important questions about the role of government in managing economic crises. While some argue that bailouts are necessary to prevent widespread economic damage, others argue that they encourage risky behavior and are unfair to taxpayers who are forced to foot the bill.
Ultimately, the best way to prevent companies from becoming "too big to fail" is to encourage competition and to create a regulatory environment that discourages risky behavior. This may involve measures such as breaking up large companies or imposing stricter capital requirements and oversight. However, even with these measures in place, it's impossible to completely eliminate the risk of economic crises and company failures.
