Too Big to Fail

2693 Words11 Pages
Can banks become “too big to fail”, and should they be allowed to stay that way? On September 15th 2008, the investment bank Lehman Brothers filed for bankruptcy. It was, and still is, the biggest bankruptcy filing in U.S. history , with Lehman’s holding $691 billion in assets at the time. The event was the catalyst for the current financial crisis. By the end of trading that day, $700bn had been wiped off the global stock markets. The Dow Jones had plummeted 500 points, its biggest drop since the terrorist attacks of 9/11 . Despite rumours and knowledge that Lehman’s was struggling, with its share price dropping daily, the huge drop in the financial markets was due to the huge shock. No-one had been expecting this, as it was anticipated…show more content…
Furthermore, their size and capital allows them to provide those services at cheaper rates than their smaller counterparts. The large banks can achieve much greater levels of economies of scale. Studies by Boyd and Heitz have shown that larger banks, (defined as having assets of over $50 billion), have higher scale economies than their smaller counterparts . The mean measure of scale economies in the banking industry is 1.145, whilst the larger banks had a mean of 1.25, implying that they were therefore 9.2% more efficient than the rest of the industry. They hereby estimated that the larger banks’ economies of scale increased their contribution to national output by 9.2%. These proponents argue that the social benefits derived from these economies of scale are beneficial enough to prevent the stricter reforms and changes being discussed by governments around the world from being implemented. One of the main arguments against banks becoming too big to fail is that a moral hazard problem occurs. Moral hazard is a basic economic concept, whereby one party entering a transaction will take more risky actions if they know they have insurance against the outcomes of those actions. At present, too big to fail banks have a variety of systems emplaced by the government, which protect them in the event that they run into financial difficulty. For example, in the U.S. the banks’ creditors get federal deposit
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