Mar 24, 2023 - Economy

How "too big to fail" banks became a symbol of safety

Illustration of a humongous piggy bank looming over a city skyline bathed in rays of light.

Illustration: Brendan Lynch/Axios

Once upon a time, "too big to fail" was shorthand to villainize big banks — these days, it's a way to say "your money is safe."

Why it matters: The shift in meaning raises the possibility that more banks will become too big to fail (TBTF) — through regulation or simply through consolidation.

  • The number of banks in the U.S. has been falling steadily since the 1980s, and crises tend to accelerate that process, says Aaron Klein, a senior fellow at Brookings.

State of play: Since the collapse of Silicon Valley Bank and Signature Bank, depositors have pulled money out of regional banks, i.e., the ones small enough to fail.

  • They put their money into big banks, viewed as safe.
  • “As things started getting scarier and the regional banks’ stock prices started getting hit, it became clear that the only place you’re totally safe is the too-big-to-fail banks,” an executive at an accounting firm who changed banks recently told the New York Times, summing up the vibes.

Zoom out: The term TBTF was all over the place in the years after the financial crisis, a way to slam both financial institutions for excessive risk-taking that nearly cratered the economy — and the regulators who bailed them out with taxpayer money.

There are two components at play in TBTF, Klein explained in a 2016 essay.

  • Too big: The notion that some financial institutions are just too large, and distort markets or threaten financial stability.
  • To fail: A bank is so interconnected with other institutions that its failure would create panic or broad financial instability.
  • Coming out of the financial crisis, Congress tried to fix the second part with Dodd-Frank, legislation that made failure less likely by requiring the banks designated as systemically significant to adhere to stricter rules. The fight to break up the banks, and fix "too big," didn't quite materialize.

The Dodd-Frank regulations are part of the reason that TBTF is viewed differently now, says Michael Madowitz, director of macroeconomic policy at the Washington Center for Equitable Growth, a progressive think tank.

  • Dodd-Frank's regulations have given the biggest banks the patina of positive branding in recent weeks. A "stamp of approval," he says.

The intrigue: Not only do bank customers now seem to like TBTF, but smaller banks also want the designation or at least some version of it that indicates how important they are.

  • While SVB and Signature Bank were allowed to fail (investors will be wiped out), the FDIC still swooped in and made uninsured depositors whole. The idea was to stave off systemic risk.

What they're saying: Big banks might be a "safe port" in a crisis like the current one, concedes Dennis Kelleher, the CEO of Better Markets, a nonprofit that advocates for tighter regulation. But they "still pose an existential threat to the country's financial system, economy and people."

  • That's because being too big to fail doesn't eliminate the risk of failure, it just shifts the costs of failure to taxpayers. It's a "de facto nationalization of gigantic banks and bankers," he says.
  • If banks take "imprudent risks" or make poor investments they should fail for the same reason that any private business should fail, says Michael R. Strain, an economist at the American Enterprise Institute.
  • "We don't have a world where every bank can fail. We have a world where most banks can fail," he said. "I think we want to preserve that."
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