Too Big to Fail
The concept that certain financial institutions are so large and interconnected that their failure would trigger systemic economic damage.
What is Too Big to Fail?
Too big to fail (TBTF) describes financial institutions — large banks, insurance companies, or other systemically important entities — whose collapse would cause such widespread economic damage through interconnections, counterparty exposure, and confidence effects that governments feel compelled to prevent their failure. The TBTF designation creates a moral hazard problem: knowing they will be rescued encourages these institutions to take on excessive risk. The 2008 financial crisis saw unprecedented TBTF bailouts, including $700 billion through TARP and emergency rescues of Bear Stearns, AIG, and Citigroup. Post-crisis reforms, including the Dodd-Frank Act, created enhanced supervision of Systemically Important Financial Institutions (SIFIs) and living will requirements.
Example
In September 2008, the US government allowed Lehman Brothers to fail — triggering a global financial crisis that cost millions of jobs and trillions in wealth. Days later, it reversed course and rescued AIG with an $85 billion emergency loan, fearing that AIG's collapse would trigger cascading defaults on trillions of dollars in credit default swaps held by financial institutions worldwide. The contrast illustrated the TBTF calculation: some banks are deemed simply too connected to fail.
Source: Federal Reserve — Systemically Important Financial Institutions