Bernanke: 'Too Big To Fail' Not Fair to Smaller Banks

Whether it’s AIG, the automakers or many of the beleaguered colossal Wall Street institutions – there’s a mantra that is repeated throughout the media – they’re too big to fail.

Perhaps it’s too little too late – after bailouts for Fannie Mae, Freddie Mac, AIG and the $700 billion Troubled Assets Relief Program (TARP) to prop up struggling banks, in addition to an $838 billion stimulus package that just made its way through the Senate. But Federal Reserve Chairman Ben Bernanke refutes the notion that any institution is too big to fail.

Bernanke testified before the House Financial Services committee on February 10 and explained that to the committee. He was asked by ranking Republican member, Rep. Spencer Bachus, Ala., what constitutes an institution that’s too big to fail.

“Your second point, that it’s not fair – I agree 100 percent,” Bernanke replied. “If I was a small banker, I would be very upset about this. Small bankers don’t have this protection. The ‘too big to fail’ problem is a serious, serious problem and it should be a top priority to greatly reduce this problem as we go forward with restructuring our financial system.”

Bachus asked if the solution would be for the government not to allow banks or other institutions to grow and become “too big to fail.”

“That would be one strategy,” Bernanke replied. “Other strategies include tougher regulations to provision, or as I had mentioned before – having a tough resolution regime, like the prompt directive action regime already in place for banks that would allow the government to come in at a stage before default and resolve the company in a safe and sound manner.”

 The media have used “too big to fail” frequently in their reporting, to the chagrin of free-market proponents, as Business & Media Institute adviser Don Boudreaux pointed out in a letter to The Washington Post recently.

“If they have reasonable potential to put these resources to good use in the future, Chapter 11 bankruptcy will likely uncover this fact and ensure that these firms are not disassembled,” Boudreaux wrote. “But if the only way to keep these firms operating is a government bailout, then taxpayers will be subsidizing the continue employment of gargantuan quantities of productive resources in unproductive pursuits. That's a recipe for economic stagnation. Popular sentiment has it backward: the bigger the unproductive firm, the more vital it is to let it fail.”

But journalists aren’t about to give up the “too-big” formulation. Citigroup, one of the nation’s largest banks, was also deemed “too big to fail” by an Associated Press article in November 2008.

“Taxpayers may be wondering why they're forking over more money to rescue yet another behemoth – Citigroup – even as their own nest eggs crack and jobs evaporate,” AP reporter Jeannine Aversa wrote. “The answer is that Uncle Sam thinks letting Citi fail is unthinkable.”