How the Biggest Banks Got Too Big to Fail

During the 2008 Financial Crisis, people around the country became acquainted with a new phrase: too big to fail. Banks like Bank of America were facing a serious cash crunch as subprime borrowers defaulted on mortgage payments and did not have enough liquidity to meet their own obligations.

Retail, commercial, and investment banks across the country met their demise, the FDIC was covering bank deposits, and the United States government stepped in to ensure we could avoid a complete economic collapse. As iconic investment banks Lehman Brothers and Bear Sterns were headed into full-scale failure, the government bailed out the banks deemed too big to fail. But how did banks become so big that the entire economy could be destroyed by a small group of businesses? It was a long, winding road that starts hundreds of years ago.

Before They Were Chase and Bank Of America

Chase and Bank of America are two of the largest financial institutions in the world. Included in America’s largest banks, these two monster financial institutions control trillions of dollars.

JP Morgan Chase traces its roots to the days after the Revolutionary War. In 1799, Aaron Burr founded a waterworks company called The Manhattan Co. This company laid piping throughout lower Manhattan. Burr expanded the company to make loans, underwrite bonds, and take on commercial banking business.

While the piping business closed its doors in 1842, the financing arm lived on as The Bank of The Manhattan Co. Through a series of mergers and acquisitions, the company eventually became Chase Manhattan Bank in 1955. In the year 2000, Chase Manhattan Bank merged with John Pierpoint Morgan’s financial institution to create JP Morgan Chase. As of today, JP Morgan Chase has nearly $2.5 trillion in assets and employs 246,000 workers.

Bank of America’s history goes back to 1904. Founder Amadeo Peter Giannini opened The Bank of Italy in San Francisco, also a major figure in the founding of insurance giant Transamerica. In 1922, Giannini established the Bank of America and Italy and merged with Bank of America, Los Angeles in 1928. Like JP Morgan Chase, this financial institution has undergone many mergers and acquisitions including acquiring Countrywide Financial and Merrill Lynch during the 2008 financial crisis. The bank currently holds $2.2 trillion in assets and employs 210,000 individuals.

JPMorgan Chase and Bank of America are the two largest banks in the United States followed by Wells Fargo ($1.9 trillion in assets), Citigroup ($1.8 trillion in assets), and Goldman Sachs ($896 billion in assets). These top five banks hold $9.2 trillion in assets. That is more than the annual GDP of every country in the world aside from China and the United States. The third biggest economy in the world is Japan with an estimated 2016 GDP of $4.7 trillion.

The Economic Impact of Collapse

If any of the largest United States financial institutions went bust, the ripple effect would be felt worldwide. Each of these banks serves millions of businesses and individuals. If any were to disappear, it would be disastrous.

These banks acted very irresponsibly in recent decades and handed out mortgage loans to borrowers with little money down. In some egregious cases, banks gave out loans where the homeowner had negative equity from the start. This was a recipe for ruin.

Many of the loans contained complex language and confusing terms for borrowers. Despite having bad credit, banks rushed to hand out loans to subprime borrowers. Sometimes the banks were able to sell the loans to large national mortgage companies like Fannie Mae and Freddie Mac. In other cases, the loans were lumped together and the risk was sold in the form of mortgage-backed securities.

Both large banks and insurance companies like AIG held billions of dollars in these bonds and bad mortgages on the books, and when balloon payments kicked in and home values declined in some markets, the homeowners could no longer afford to pay their bills. These mortgages and mortgage-backed securities put these trillion dollar companies on the brink of failure.

Some of the largest banks in the nation did fail. Lehman Brothers, Wachovia, Bear Stearns, Washington Mutual, IndyMac, Colonial Bank, and many other banks did fail in the wake of the financial crisis. I had a CD at a small bank in Colorado, New Frontier Bank, and received a check from the FDIC when it went out of business in 2008.

Many of the smaller banks either closed or were purchased by another, stronger bank. But the biggest banks were deemed “too big to fail” and bailed out by the United States government.

What Is “Too Big to Fail?”

In October 2008, the United States government enacted the Troubled Asset Relief Program or TARP. The initial TARP use was to inject capital into the shaky banks. The government spent $105 billion to buy preferred stock in Bank of New York Mellon, Goldman Sachs, J.P. Morgan, Morgan Stanley, Bank of America/Merrill Lynch, Citigroup, Wells Fargo, and State Street. The government also bought stock in or loaned funds to AIG, Citigroup, Bank of America, General Motors, Ford, Chrysler, and a number of community banks. When the dust settled and loans were repaid, TARP ultimately led to a $25 billion profit for the government.

There is no exact number that defines too big to fail, but to ensure a financial crisis does not take place again, congress passed the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. This law requires financial institutions to hold higher cash reserves to ensure continued liquidity even in the event of a recession.

Senator Bernie Sanders believes that if a bank is too big to fail, it is too big to exist. He is a vocal advocate of breaking up the largest banks to ensure no single financial institution’s failure would threaten the entire economy. The effort to break up the big banks has been met with little if any action and is unlikely to lead to any major results in the foreseeable future.

Are They Still Too Big to Fail?

With assets larger than the economies of most countries, the big banks are undoubtedly too big to fail. Mergers and acquisitions continue in the financial industry and the banks continue to grow. No one knows what the future holds for these massive banks, but they are certainly still too big to fail.

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