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The Bankers Who Warned About 'Too Big To Fail'

With offices, assets and contracts around the world, AIG posed a threat to the global financial system.
Dan Kitwood / Getty Images
Getty Images
With offices, assets and contracts around the world, AIG posed a threat to the global financial system.

Gary Stern and Ron Feldman, colleagues at the Federal Reserve Bank of Minneapolis, say they've worried for years about banks growing "too big to fail."

That has become a common theme of this economic crisis, as the government speeds to the rescue of major banks and insurers like AIG. It's also the basis of a book that Stern, the Minneapolis Fed president, co-wrote with Feldman, a senior vice president. Titled Too Big to Fail: The Hazards of Bank Bailouts, it sounds like something rushed into print amid the economic crisis. But, no, it first appeared in 2004.

Feldman says they couldn't help noticing that much of what they predicted has come to pass, as the government has stepped in and bailed out institutions seen as too big to fail: AIG, Fannie Mae and Freddie Mac, as well as major banks.

"Certainly, 'I told you so' did run through my mind," Feldman admits.

Early Signs Of The 'Too Big' Threat

The two got a firsthand look at the "too big to fail" phenomenon in 2001, when a broker-dealer firm in Minneapolis got into trouble. The firm's counsel made an interesting argument: If it was allowed to go under, the lawyer said, it could disrupt economic activity in the Midwest. That turned out not to be true, but Stern and Feldman say the idea that government might be expected to step in is dangerous, because it encourages people to take risks they shouldn't.

Their book, which has just been reissued in paperback, proposed a series of changes that are now being considered at the highest levels of government. Leaders in Washington have talked about establishing a "systemic risk regulator" — an idea Stern and Feldman wrote about five years ago.

"Right now, we don't have an entity — an oversight entity, a government entity — that thinks to itself, 'What happens if this institution gets into trouble and is going to fail. What would we do about it at that time?' " Feldman says. "The primary focus of most supervision is to prevent them from getting into trouble. And I think it sounds like a generic thing — 'Well, you change your focus.' That's not trivial. That's important. Because it's by focusing on what we would do if they got in trouble that this stuff gets revealed."

Procedures To Avoid Banks 'Going Nuclear'

If large institutions fail, they argue, the system needs something akin to the procedures nuclear reactors have when they get into trouble — some way to safely shut the institution down. That would make it clear that the government won't be coming to the rescue, which in turn should discourage risky behavior.

Stern and Feldman were in Washington, D.C., recently on what amounts to a book tour: a talk at the Brookings Institution. Much of the discussion centered on next steps in solving the financial crisis, but some in the audience wanted to know why the authors' warnings in Too Big To Fail hadn't been given more attention.

Among the luminaries in attendance was former Federal Reserve Chairman Alan Greenspan. He says he considered the quandary of "too big to fail" when he was in office, and he has thought about it more lately, too.

"Fannie and Freddie were not too big to fail," he says. "How do I know? That's what the law said. On the debentures, when they used to be physical paper, it literally said, 'These instruments are not protected by the full faith and credit of the United States government.' "

Greenspan says no government official could really say otherwise.

"Indeed, I always took the position when I ended up [testifying on Capitol] Hill that Fannie and Freddie were not too big to fail," Greenspan remembers. "Needless to say, my fingers were crossed behind my back. But you cannot have that position and still argue that the federal government has credibility."

Copyright 2023 NPR. To see more, visit https://www.npr.org.

David Kestenbaum
David Kestenbaum is a correspondent for NPR, covering science, energy issues and, most recently, the global economy for NPR's multimedia project Planet Money. David has been a science correspondent for NPR since 1999. He came to journalism the usual way — by getting a Ph.D. in physics first.