Too Big To Fail

In the weeks after Lehman Brothers collapsed, governments faced a brutal choice.

If they let the major banks fail, the damage would be catastrophic — savings accounts wiped out, credit markets frozen, businesses unable to make payroll. The interconnectedness of the financial system meant one collapse could trigger dozens more.

So they chose to rescue them. Hundreds of billions of dollars in public money flowed into the institutions that had created the crisis. In the US, the Emergency Economic Stabilization Act authorised $700 billion. The UK part-nationalised its major banks. Central banks around the world slashed interest rates to near zero and began creating money on a scale never seen before.

The logic was pragmatic: these institutions were too big to fail — meaning their failure would damage everyone, including people who had done nothing wrong.

But here’s what too big to fail actually means in practice: the profits are private and the losses are public. When the bets paid off in the years before 2008, the bonuses were extraordinary. When the bets collapsed, taxpayers covered the gap. The risk had been socialised without anyone’s consent.

The homeowner who had borrowed more than they could afford? Foreclosure. The retiree whose pension fund held mortgage-backed securities? Losses. The bank executives who had designed and sold those products? Largely intact, many with bonuses still paid.

This wasn’t a malfunction. It was the logical outcome of a system where certain institutions are protected from the consequences of their own decisions.

Tomorrow: what governments did with the money printer after 2008 — and why it never really stopped.

— The Daily Bit