Report From the White House: Too Big to Fail, and Getting Bigger

As advocates for shareholder rights, we strive to make sure our members are heard on important matters that affect all of our portfolios. That's why the White House asked for feedback from the Motley Fool community and agreed to answer your questions. Here is the fourth installment of our interview with Austan Goolsbee, chief economist for the President's Economic Recovery Advisory Board.

Search on the phrase "Too Big to Fail," and you'll get 28,000 references to the now-ubiquitous term for behemoth businesses that the government cannot allow to fail because the broader economy is tethered to the same cement galoshes. (See also: "Bailout," "moral hazard," "Freddie Mac (NYSE: FRE  ) ," "Fannie Mae (NYSE: FNM  ) ," "Bear Stearns," "AIG (NYSE: AIG  ) ," "Citigroup (NYSE: C  ) ," et al.)  

"Too Big to Fail" was a hot topic in the call for questions for David Gardner's and my meeting with the White House to discuss the administration's push for financial-industry regulation reform. Here are some examples.

  • Coconnor55 wrote: "'Too big to fail' and unregulated markets need to be addressed. All markets need to be transparent and public -- no shadow markets."
  • blaueskobalt invoked the name of the former IMF chief economist: "Simon Johnson recommended progressive capital requirements for banks as a way to incentivize them to become smaller so that 'too big to fail' was no longer a reality with the biggest banks. Are you considering this policy? If not, why not?"
  • TyrantBone said: "I would support having the agencies consolidated as long as the innovation was still allowed. Can't we force banks to take less leverage when 'bigger than life' financial products are gaining steam? Maybe not harm innovation, but limit abuse."
  • Edfinn1 suggested: "No one is too big to fail, or smarter than the market. If institutions have cross-collateralized fancy new instruments, or designed new instruments too complicated to be explained and underwritten in a reasonable way, it's a fraud, a Ponzi or fattening. … To think anyone is too big to fail removes all discipline from the market, and rewards the insiders, management and entrenched few concentrated shareholders who cause huge losses to the market and the country. … Stop the regulatory shopping that allows an AIG or Enron to opt for regulation by the most captive, least able agency. Break up any entity that is 'too big to fail,' and restore discipline to the market."

Here's what Austan Goolsbee, chief economist for the President's Economic Recovery Advisory Board, had to say about big business failures and how the administration plans to handle future bailout situations.


The White House's plan to prevent future bailouts
The administration has a regulatory reform proposal (links to PDF document) that outlines how it plans to decouple insolvent businesses from the broader economy and prevent future late-night phone calls from distressed companies seeking bail.

The plan requires that "all financial firms that pose a significant risk to the financial system at large are subjected to strong consolidated supervision and regulation." A newly created eight-member Financial Services Oversight Council, chaired by the secretary of the Treasury, is responsible for that oversight. Gone is the SEC program that had been on investment-bank babysitting duty.

Under the proposal, the Federal Reserve will conduct regular stress tests of companies that meet the council's criteria for being "too big to fail." It will also look at capital standards for banks and bank-holding companies, and it will force federal oversight on non-bank financial firms, such as industrial banks credit-card banks, by turning them into traditional bank holding companies. Also on the council's agenda: figuring out what to do with Fannie Mae and Freddie Mac.

In a nutshell, the word to Wall Street is this: Break the rules and we'll wind down your business, break it up into pieces, fire management, or shut you down completely.

Size isn't everything
Being big doesn't necessarily make a bank bad. The real damage was done when gigantic institutions waded into complex financial products like credit default swaps. Bank executives saw big dollars and a way to skirt the rules by trading in a virtually unregulated security.

Fool members have suggested reinstating laws governing the separation between banking and non-banking business to provide a buffer between risky business practices and the economy at large. See yesterday's installment of this series, "Would Glass-Steagall Have Saved Us?," for the administration's response.

This is our time to speak up
The Fool is a hotbed of engaged and informed citizen-investors. And this is merely the beginning of our involvement. We'll be covering and commenting on this proposal and other bills the entire time, and we're committed to keeping our conversation with the administration going and representing you, our community of Fools. Enter your comments below about financial-regulation reform and what changes you, as an individual investor, want the administration to make.

Tomorrow on, we talk with Goolsbee about the possibility that regulation will stifle innovation. columnist Dayana Yochim invests only in financial vehicles that can be described on the back of a single cocktail napkin. She owns no interest in any company mentioned in this article. The Motley Fool is investors writing for investors.

Read/Post Comments (12) | Recommend This Article (24)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 20, 2009, at 4:57 PM, paulbverizonnet8 wrote:


    My understanding is that when i buy a car, the finance company can not punish me for early repayment of the loan, and they can not load most of the interest onto the beginning of the term, the interest has to be evenly distributed along the payment of the entire load. I mean loan.

    I want the housing lenders to have to do this too. I want them to make the loan escrow papers to be clear, with no hidden costs, and I want them to be available to be seen and read in their entirety, before I put a down payment on a house.

    Love: Paul B.

  • Report this Comment On October 20, 2009, at 7:24 PM, bbell46356 wrote:

    Get serious, the problem wasn't caused by lack of regulation. Banking has been, is and will be one of the most regulated industries on the planet. Government forced banks to make bad loans on housing and then incented them by having Fannie and Freddie buy them.

    If these banks are too big, break them up. Why not?

  • Report this Comment On October 20, 2009, at 7:33 PM, xetn wrote:

    Since when has government been a good manager of anything? Why should there even be a concept of "to-big-to-fail"? I guess the idea now is it ok to take big profits but not any loses. Or maybe the idea of "to-big-to-fail" is just an excuse to bailout the friends of the politicians. For example, just look at the tremendous influence of Goldman Sachs:



    Name Current Title in Obama Former Goldman Sachs

    Administration Title

    Dianna Farrell Deputy Director, National Economic Council Financial Analyst

    Stephen Friedman Chairman, President’s Foreign Intelligence Board Member (Chairman, 1990-

    94; Director, 2005-)

    Advisory Board

    Gary Gensler Partner and Co-head of Finance

    Commissioner, Commodity Futures Trading


    Robert Hormats Undersecretary for Economic, Energy and Vice Chairman, Goldman Sachs

    Agricultural Affairs, State Department Group

    Philip Murphy Ambassador to Germany Head of Goldman Sachs,


    Mark Patterson Chief of Staff to Treasury Secretary, Timothy Lobbyist 2005-2008; Vice

    President for Government



    Advisor to Treasury Secretary, Timothy

    John Thain President and Chief Operating

    Officer (1999-2003)




    Name Title in Prior Administration Former Goldman Sachs


    Henry Paulson Secretary, Treasury 2006 - 2009 Chairman and CEO (1998-2006)

    Neel Kashkari Assistant Secretary for Financial Stability, Vice President, San Francisco; led

    Treasury (2008 – 2009) Information Technology Security

    Investment Banking Practice

    Undersecretary for Economic, Energy and

    Reuben Jeffery Managing Partner Paris until 2002

    III Agricultural Affairs, State Department (2007 –


    Robert Steel Under Secretary for Domestic Finance, Vice Chairman - 2004

    Treasury, (2006 – 2008)

    Steve Shafran Advisor on setting up TARP to Treasury Private equity business in Asia

    Secretary, Henry Paulson 2008 until 2000

    Edward C. Advisor on setting up TARP to Treasury Co-head of Goldman’s

    Forst Secretary, Henry Paulson 2008 investment management


    Dan Jester Advisor on setting up TARP to Treasury Deputy CFO

    Secretary, Henry Paulson 2008

    Kendrick R. Advisor on setting up TARP to Treasury Chairman of Goldman’s financial

    Wilson III Secretary, Henry Paulson 2008 institutions groups

    Joshua Bolten White House Chief of Staff (2006 – 2009) Executive Director, Legal &

    Government Affairs (1994-99)

    Partner and Co-head of Finance

    Gary Gensler Undersecretary, Treasury (1999-2001) and

    Assistant Secretary, Treasury (1997-1999)

    Robert Rubin Secretary, Treasury 1995-1999 Vice Chairman (1987-90)


    Name Title in Prior Administration Former Goldman Sachs


    Robert Zoellick United States Trade Representative (2001-2005), Vice Chairman, International

    Deputy Secretary of State (2005-2006), World (2006-07)

    Bank President (2007 -)


    Name Federal Reserve Title Goldman Sachs Title

    William C Dudley Current President/CEO Partner and managing director -


    Stephen Friedman Former Chairman of the Board – Board Member (Chairman,

    2009 1990-94; Director, 2005-)


    Name Position/Title Former Goldman Sachs



    Edward Liddy Board of Directors

    Duncan Niederauer Chair/CEO NYSE Managing Director - 2007



    Former Goldman Sachs




    Partner (1998-2001)

    Malcolm Turnbull Federal Leader, Liberal Party, Australia.

    Mark Carney Governor, Bank of Canada Managing Director Goldman

    Sachs Canada until 2003

    David Watson Monetary Policy Committee, Bank of England Chief European economist

    Romano Prodi Prime Minister of Italy (1996-1998 and Paid adviser/consultant 1990 -


    2006-2008) and President of the European

    Commission (1999-2004)

    Mario Draghi Governor of the Bank of Italy (2006- ) European Deputy

    Chairman/Partner until 2006

    Partner 2004 - 2006

    Massimo Tononi Italian Deputy Treasury Chief



    Do you really think that what the treasury secretary and the Fed are doing is not being influenced by this group? Perhaps the reason the Lehman was was allowed to fail was to scare the Congress into approving TARP, so the friends of Paulson could reap a big reward.

    Government regulation and interventions are evil and provide a legal means to steal from the citizens and give to big business. This new proposal will be just more of the same, under a new name.

    The Fed already controls all banking in the US, how come it didn't stop all of the toxic waste from being created? It was complicit in this operation by creating massive amounts of money out of thin air, maintaining artificially low interest rates and low bank reserves.

  • Report this Comment On October 20, 2009, at 11:54 PM, thisislabor wrote:

    GS and Treasurey.... where to start. oh nm... we all know anyways what GS is being used for now.

    moving along.

    Break the bank up now that your finished with it.


  • Report this Comment On October 21, 2009, at 12:01 AM, thisislabor wrote:

    Yes, it is just size that caused this. Stop lying to us. Seriously, I am getting sick of listening to that. If these banks had been 1/10th or 1/20th the size this problem wouldn't have happened.

    You can keep saying that yes because we didn't know that this would happen it isn't their fault so allowing them to grow bigger is ok as long as we regulate them, but guess what we and you know the truth you just don't want to admit it. Are you on the payroll, too?

    If nothing else listen to blausekobalt:

    "Simon Johnson recommended progressive capital requirements for banks as a way to incentivize them to become smaller so that 'too big to fail' was no longer a reality with the biggest banks. Are you considering this policy? If not, why not?"

  • Report this Comment On October 21, 2009, at 2:14 AM, megabuc wrote:

    CITIBANK IS SO BROKE IT HAS BEEN CLOSED BY THE FED. $500 BILLION UNDER THE TABLE GIFT LOAN was given to Citibank to stay in business, by the Fed. Citibank can only report FRAUD STATEMENTS that are signed by the Bandit. Everything thing Citibank reports is a LIE. Citibank died in 2009. Citibank will make Madoff look like child playing as their FRAUD is over ONE TRILLION DOLLARS.

  • Report this Comment On October 21, 2009, at 8:34 AM, dudemonkey wrote:

    Did anyone ever think to ask why Goldman Sachs has such an incredible hold over our government's financial arms? And did anyone ever stop to think there might be a correlation between that and their ridiculous bonuses while the rest of the country is trying to figure out how to make it through the week?

    This didn't cross my mind until after TMF went to the White House.

  • Report this Comment On October 21, 2009, at 10:48 AM, Gorm wrote:

    Seemingly banking is NO longer responsible to community. The BIG banks earn most from trading, not lending. Banking used to be fiduciary. Now it seems banks take in the deposits, and leverage those deposits to maximize their earnings, not fulfill an essential role in our communities.

    Banks may qualify their attitude, saying they are always looking for suitable lending opportunities. Fact is banks are fearful of capital loss, uncertain about this economy and aren't interested in lending but to the most pristine of borrowers, at HUGE spreads to cost and only then with material down payments. (Banks are resorting to old lending standards demanding skin in the game.) Talk to dealers of cars and RVs. Financing is a significant drag on sales.

    SO, it is time we downsize these diversified financial conglomerates so they FULFILL the role of their charter, not just maximize earnings for shareholders.

    For the good or our economy, no recovery is possible without a willing and able banking system as Americans are borrowers, not savers.

    So, I say bust them up and force them to choose so they operate within the realm of their charter. They should NOT be allowed to play it both ways, ie Goldman who seeks commercial charter to gain the benefits and then make all their money at the trading desk.

  • Report this Comment On October 22, 2009, at 5:04 PM, neutrinoman wrote:

    The problem isn't Goldman or JP Morgan. They're banks with good practices that mostly avoided the bad mortgage crap.

    Most of the TARP money isn't going to the banks, but to Fannie and Freddie. They're the problem, in the end probably $450 billion that won't be paid back.

    We're seeing the twilight of the Bailout State. It only works when all those implicit and explicit guarantees aren't invoked. Once they are, they start losing their power, but only at huge expense: large federal deficits, wasted capital, and declining dollar.

    The "too-big-to-fail" banks are a result of 15+ years of bad Fed and FDIC policy that cajoled large banks to get even bigger by buying small, failing banks. As the big banks grew, they got weaker, not stronger, by absorbing bad bank balance sheets. Those small, failing banks should have been closed and their depositors paid off by the FDIC -- far cheaper than what's happened over that time: investment bubbles supported by cheap credit, wasted capital, and the cost of propping up failure.

  • Report this Comment On October 22, 2009, at 6:23 PM, neutrinoman wrote:

    One more thing: they haven't yet learned the real capitalist slogan: not Gordon Gecko's "greed is good," but "failure is good."

    Don't promise that "no one will fail," and don't waste more scarce savings propping up failure.

  • Report this Comment On October 23, 2009, at 1:24 PM, offthepools wrote:

    Breaking the "too bit to fail" corporations up is the only way to go then capitalism can work the way it is supposed to. Company A makes a risky bet (like the banks did) and loses. It goes out of business and Companies B, C, D who did not take that risk benefits from the increased market share of Company A's customers.

    Capitalism is a reasonable system if you let it run its course. If you dont you get an ever widening spread between rich and poor and eventually that is going to cause significant social unrest. Then lookout...

  • Report this Comment On October 23, 2009, at 6:00 PM, farrockgrad wrote:

    The whole concept of "too big to fail" is backwards to my way of thinking. And the Government is encouraging more of this by having large institutions absorb smaller, struggling ones. In fact, i think they should force overly large companies to have to breakup into smaller pieces so that the "too big to fail" situation can't arise.

    large doesn't mean more efficient! it means more bureaucratic and powerful which in my opinion is not good for the American public/consumer.


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