Banks Bailouts: Too Big to Fail

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Louisiana Tech University Why are some financial institutions “too big to fail”? Discuss the various implications for the Fed and government policies? By Carlos Estrada Econ 312 002 Dr. Ali Darrat February 18, 2014 Can banks become “too big to fail”, and should they be allowed to stay that way? The policy “too big to fail” refers to the idea that a bank has become so large that its failure could cause a catastrophic effect to the rest of the economy, and so the government will provide support, in the form of perhaps a bailout or oversee a merger, to prevent this from happening. This is to protect the creditors and allow the bank to continue operating. If a bank does fail then this could cause a domino effect throughout the economy. When a bank that is so important to the economy shuts down the operation, the consequences are huge. Everyone working at the bank would suddenly be unemployed, companies that rely on the bank for loans or just regular bank activities would suffer a huge set back which could also mean that they have to shut down too. Banks weren’t always consider too big to fail, mostly because no one believed that a bank would ever fail. During the Depression, hundreds of banks became insolvent and depositors lost their money. In this time banks were allowed to fail because there were no regulations. As a result, the U.S. enacted the 1933 Banking Act, sometimes called the Glass-Steagall Act, which created the Federal Deposit Insurance Corporation (FDIC) to insure deposits up to a limit and prohibited banks from selling and buying securities from their costumers or selling mutual funds. In exchange for the deposit insurance provided by the federal government, depository banks are highly regulated and expected to invest excess customer deposits in lower-risk assets. Because of the Glass-Steagall Act commercial firms were not allowed to own banks

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