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Too Big to Fail

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“Too Big to Fail” is a coherent exposure of events that were plaguing and terrorizing the US financial system from May to October 2008, and spawned the consequent 2008-2012 global recession. The plot of the story revolves around the actions of the United States Secretary of the Treasury Henry Paulson who attempts to bridle the catastrophe. The United States has become a nation where the government and large national corporations are so interconnected that a failure of these corporations can have a detrimental effect on the economy, especially when considering that these corporations hold the key to America’s jobs. This is the “too big to fail” problem because as the government’s duty to support the people, government regulators need to be instituted, such as allowing important institutions to be recipients of central banks, to ensure corporate America’s prosperity. This often acts as a safety net for large corporations. However, a problem is that the government, through the reserve funds of central banks, can lose a significant amount of capital bailing out large corporations from bankruptcy. This is especially true when considering the fact that corporations experiencing financial instability will often find themselves in a constant need of financial support from the government.

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Richard S. Fuld, CEO of the investment bank Lehman Brothers tried to attract the direct investment to his bank, but the investing interests were not on fire with enthusiasm to invest into this bank. They were careful not to deal with the so-called toxic assets of the company, which were connected to the real estate sector. Moreover, the United States Treasury refused to offer any sort of bailout to the investment bank as it did with Bear Stearns previously. A number of legal and physical entities (Warren Buffet and Korea Development Bank) finally decided to invest into the company, but Richard Fuld turned down their offers, as he considered them understated. He entertained plans of selling the company with its toxic housing assets, which could not but fail the sales deal.

On the other hand, Secretary of the Treasury Paulson took strikingly different measures to resolve the problem. As a result of his actions, Bank of America and British Barclays expressed their personal interest in purchasing Lehman’s “good” assets. However, Bank of America refused to clinch a bargain finally and concentrated its attention on Merrill Lynch. Barclays expressed its willingness to invest into Lehman; it would have invested if the Financial Services Authority had not refused to sanction the deal. Lehman was bereaved of the last chance for survival. The debacle of Lehman forced Henry Paulson to order Richard Fuld to declare bankruptcy. It was essential that this be done before the Asian financial markets open, in order to prevent their drop.

Unexpectedly to Paulson and his team, the initial reaction of Wall Street and political interests to the Lehman’s bankruptcy was favorable. Enthusiastic Paulson carried out a press conference and made it clear that the Treasury would not encourage moral hazard. However, he soon found out that Lehman’s counterparty risk had severe repercussions for the entire financial market, which started plummeting impetuously. At the same time, AIG experienced a liquidity crisis. It could not pay its insurance liabilities, as the mortgage market collapsed. Paulson and his collaborators thought that if they had let AIG collapse, the company would have declared a default on all the insurance payments. Such a “demarche” could have played havoc with the American financial system, as well as that of the whole world. The United States Treasury provided the emergency cover to AIG, as the latter was not a bank and possessed certain assets.

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Ben Bernanke, the chairman of the Federal Reserve System, advocated that in order to resolve or prevent the occurrence of similar situations in future the Congress should adopt an appropriate law, which would authorize the Treasury to intervene. Henry Paulson took a jaundiced view of the perspectives of passing this legislation two months before the elections. He was afraid lest the United States Treasury publicly confess that it could not cope with the crisis singlehandedly. He was even more afraid that the Congress could blatantly refuse to render the assistance.

Bernanke and Paulson made concerted efforts to persuade the Congress that urgent measures were indispensable. Bernanke stressed that, “despite the fact that banks borne the main brunt of the full-blown crisis, it was the paucity of issued credits that turned the Wall Street Crash of 1929 into the Great Depression”. He continued by saying that this time the situation could have had much more severe repercussions. The legislation did not pass because too many Republicans vote against it. This triggered an immediate decrease in the Dow Jones Industrial Average of more than 600 points. A tremendous wave of panic ensued and the ci-devant President George W. Bush in his ardent address persuaded the Congress to adopt the legislation. It became known as the Emergency Economic Stabilization Act of 2008. The Wall Street Reform and Consumer and Consumer Protection Act, also named after its “founding fathers” the Dodd-Frank Act, was another response of the US legislature to rescue the financial system.

Another problem is that since this support is, in a sense, guaranteed, corporations will increase their speculations in high-risk decisions, oftentimes involving investment banks, being aware that the government is there to bail them out. There are some possible solutions to these problems however. For one, it should be enforced that large corporations stay away from high-risk investments in investment banks and focus on bolstering their own capital and liquidity instead. This will in effect stabilize the corporation itself, strengthen market discipline, and allow corporations to be liable for their own financial instability. Another solution is to restrict corporations from becoming too complex and interconnected to the government, as these may lead to a liability that the government is unable to support and could pose higher risks to the economy in general. Congress has also tried to deal with this problem accordingly. The Dodd-Frank Act is the “most comprehensive financial reform since the Glass-Steagall Act.” This act has many tenets such as the overseeing of Wall Street, stopping banks from speculation, and reforming the Federal Reserve. Government regulators, such as this act, are crucial in securing financial instability.

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The recipe for success, however, would be to minimize the chance of these corporations’ fail. America’s automotive industry giants like Chrysler, as well as banks and insurers like American Industrial Group (AIG) are edifying examples of the “too big to fail” problem. The automotive industry used to be a significant industry in America. However, the 2003-2008 energy crises discouraged consumers from purchasing SUVs, the primary models of many Americans linked with General motors, Ford, and Chrysler. Therefore, with fewer energy efficient models to offer, sales started plummeting and corporations like Chrysler were approaching bankruptcy. Chrysler is a big corporation to which millions of Americans owed their jobs, and in order to save these jobs the government had to intervene and help. This is one of the reasons why it would be beneficial to restrict corporations from becoming too complex and interconnected with the government. Inevitably, these corporations could drag the economy down through constant bailout ballots.

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