“Too big to fail” is a concept invoked in three episodes of The Bob Zadek Show to describe institutions whose collapse is thought to threaten the broader economic system, and which are therefore not permitted to fail. The episodes apply the phrase to large banks, to small businesses excluded from pandemic relief, and to the United States federal government itself.
Continental Bank and the Bank Bailouts
Bob Zadek introduced the concept in the December 20, 2020 episode, telling guest Chris Edwards that during the last financial crisis and earlier ones, the phrase “too big to fail” had been heard. He said it was applied first a long time ago to Continental Bank in Chicago, which he described as the first major bank to fail, and he placed that failure in the ’70s, adding that he might be mistaken. He said it was applied later to large brokerage houses, investment banks, and banks during the financial crisis early in the 21st century. Banks and other financial institutions were felt to be too big to fail, he said, because there would be a systemic failure in the whole economy if these entities were allowed to fail. He told Edwards they could discuss on another show whether that was correct, said he thought it was not, and proposed assuming it was correct or partially correct Is it too late to step back from the edge of fiscal insanity? (2020).
Zadek then extended the principle to the sovereign. If a bank is too big to fail, he asked, isn’t the United States too big to fail, and wouldn’t the world have to bail the country out and extend its debt on the condition that it got its house in order. He asked whether the principle “too big to fail” had any impact on Edwards’s dire prediction.
Edwards answered that the scare and the worry is not that the U.S. federal government goes bankrupt. It will not go bankrupt, he said, because it has enormous taxing power and can rely on raising massive amounts of taxes. The problem, he said, is that it creates an economic death spiral: the higher taxes are raised, the more the private sector is killed, and the less revenue flows into Washington because the private sector is shrinking. He said the real fear is that interest rates will spike and the federal government’s interest costs will start rising. That year, he said, the federal government was going to spend about $350 billion on interest costs, and that could easily become much higher, doubling or tripling. The government would have to find fresh money somewhere, and the fear is that it will massively raise taxes, killing the private sector and the standard of living. He also described inflation as a threat and as a tax on working people, average folks and lower-income folks, saying rich people can get around the inflation problem but regular folks cannot when the price of food, clothing and housing rises quickly as the government runs inflation to get rid of its debt Is it too late to step back from the edge of fiscal insanity? (2020).
Earlier in the same episode, Edwards had described how a debt crisis happens. The federal government can borrow at a very low interest rate, he said, and he did not think that would last. He noted that the current Congressional Budget Office projection assumes 10-year Treasury bonds stay at no more than 3% over the next decade. Historically, he said, when countries get into crisis, accumulate too much debt, and creditors around the world get scared, interest rates spike. He cited Greece a decade earlier, where government borrowing rates spiked, interest payments became a much bigger share of the budget, and the situation became like a death spiral. He said interest rates there spiked up to 15% or more for years, the private sector was killed, and even a decade later Greek living standards were still down 20% or more from 15 years earlier. He said economists do not know when this will happen, but it has happened in other countries, including Puerto Rico, and it could well happen to the U.S. federal government Is it too late to step back from the edge of fiscal insanity? (2020).
Too Small to Matter
The August 15, 2021 episode with Carol Roth turned the phrase around. Roth, described by Zadek as an investment banker and economics writer, contrasted the treatment of banks during the Great Recession with that of small businesses in 2020. When banks took on too much risk and caused incredible havoc to the economy not just in the US but worldwide, she said, they were told they were “too big to fail.” By 2020, small businesses were shut down through government mandate, through no fault of their own. The way they were treated, she said, yields two theses: either they were “too small to matter” or they were “too hard to control” Carol Roth on the War on Small Business (2021).
Roth said it does not matter whether one attributes the outcome to government incompetence, nefarious intentions, or difficulty of navigation, because the outcome is the same. She framed the issue as decentralization versus central power. About half the economy before COVID was in the hands of about 30.2 million small businesses, she said, which represents the free market, freedom, choice and transparency. The other half is in the hands of about 10 to 15,000 big businesses. When a politician is trying to get lobbying dollars, campaign support, or move the needle, she said, it is frankly easier to deal with that few entities. She said the issue is that as we move toward central planning, we get more of an unholy triumvirate between big government, big business, and big special interest, at great expense to economic freedom and wealth creation, and that this played out in real dollars and cents over the last 17 months Carol Roth on the War on Small Business (2021).
Zadek’s framing in that episode was that government responds only to political pressure, not to objective measures, and he asked why small business, which he said accounts for approximately half of business activity and 99.9% of the number of businesses, was totally ignored. He compared small business unfavorably with lobbies such as the South Florida sugar lobby, which he described as one family in one area of one state that in effect dictates world sugar prices and yet has profound political clout. He asked Roth what accounts for the numbers on the one hand and the lack of collective political power on the other, so that small businesses did not get their share of the COVID goodies Carol Roth on the War on Small Business (2021).
Moral Hazard and the 2023 Bank Rescues
The March 20, 2023 episode with Arnold Kling connected too big to fail to moral hazard. Zadek said the concept of moral hazard was in the news every night during the last alleged financial crisis, 2008 and after, the era of The Big Short, which he called his favorite economics financial motion picture and said bears watching once a year. He asked Kling what moral hazard is and what it has to do with the bailout of Silicon Valley Bank, which he called a bailout and attributed to Janet Yellen, along with the bailout of Signature Bank and perhaps First Republic Bank and other banks that might follow Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Kling said the concept originates in the insurance industry. He gave the example of building a house in Western Florida, with a choice between building near the Gulf or a mile or two inland: if you have flood insurance and know you will have it, you might as well build on the coast because it is much nicer there. That, he said, is the moral hazard of having insurance. Insurance is a good idea, but it creates an incentive to overlook or downplay a risk. In banking, he said, moral hazard shows up in deposit insurance. A prudent bank that does not pay too much to depositors and does not invest in the riskiest loans competes with a bank that gambles, makes risky loans, and lures depositors with higher interest rates. The risky bank is in some sense subsidized by deposit insurance, a “heads I win, tails the FDIC loses” situation. It therefore becomes incumbent on the insurer, in this case the FDIC, to regulate banks, just as a fire insurer makes sure building codes are followed and a sprinkler system is installed Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Kling said the moral hazard problem is exacerbated because many banks are in a milder version of Silicon Valley Bank’s position, with portfolios a little underwater and a lot of formerly uninsured deposits. Now that those deposits have insurance backing, he said, in theory nothing stops such banks from luring in billions of dollars of deposits and taking them to Las Vegas, so to speak, making a big bet. If it wins, shareholders get a lot of money and executives pay themselves big bonuses; if it loses, it may not hurt them much because a bank in a dicey situation may already be unable to pay big dividends or bonuses. He said the moral hazard in the whole system has gone way up and will mostly be exploited by the owners and managers of banks that are not in good shape, which in the 1980s were called “zombie banks” Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Zadek offered a second, underreported version of moral hazard focused on depositors rather than bankers. He said he believed the corporate treasurers who kept large uninsured sums with Silicon Valley Bank truly believed that yes, they were uninsured, but who cares, because the government will step in under some version of “too big to fail,” although Silicon Valley was not too big to fail. On the assumption that the government simply will not let depositors with deposits lose money, he said, they did not pay attention to whether Silicon Valley Bank was good for the money. If it were assured that a depositor would lose the money when a bank failed, he said, corporate treasurers would in his judgment be more prudent about spreading money around so it is not uninsured. He described this as the other version of distorting market behavior, whereby banks were able to get deposits when perhaps their balance sheet did not deserve it Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Kling was skeptical that depositors can be made to bear the risk. He said it is really difficult to expect even a professional corporate treasurer to walk into a bank and examine everything and figure out how risky it is, and that he could not do it himself. He pointed to complicated banks with derivative books, and said that to understand that Silicon Valley Bank was risky you have to understand that it was not hedging its portfolios well, because other banks have just as many long-term bonds but do things like interest rate swaps. He said he does not want a corporate treasurer to have to ask every bank what its derivative book looks like under this scenario and that scenario, and that the banking system cannot be organized that way. He said there need to be people in the private sector with skin in the game, not just the FDIC on one hand and everybody else risk-free on the other. The proposal he likes best, he said, is contingent capital: long-term bonds in the bank that transfer ownership from shareholders to bondholders if the bank’s net worth falls below a certain level, so that bondholders evaluate the risk and monitor the bank. He said that is about the only way to transfer the risk to the private sector, and that transferring it to depositors is pretty hard Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Zadek proposed privatized deposit insurance, analogous to commercial credit insurance, with an insurance company doing the deep dive a treasurer cannot do. Treasurers would buy the policies, premiums would be tiny and rated based on the bank where the money is deposited, and banks would have to compete on credit quality to get deposits. Kling responded that private insurance has worked before and that banks can get together and do mutual insurance, which he said is sort of what was going on with First Republic as they spoke, though he did not know how the banks providing liquidity to First Republic were being compensated. He said that just because it is workable does not mean it will ever happen here, and that it is not politically what is going to happen. He said what he thinks is happening is that the banking system has been at least ratcheted up the amount of nationalization Arnold Kling: We Just Nationalized the Banking System—Now What? (2023).
Across episodes
The three episodes show the phrase migrating from banks to small business to the sovereign. In December 2020, Zadek raised too big to fail as an analogy for the United States itself and asked whether the world would have to extend U.S. debt on conditions; Edwards answered that the federal government will not go bankrupt because of its taxing power, and redirected the danger to interest-rate spikes and an inflation tax. In August 2021, Roth inverted the phrase for small businesses, calling them either too small to matter or too hard to control, and located the outcome in a shift toward central planning and an alliance of big government, big business and big special interest. In March 2023, Kling and Zadek treated the concept through moral hazard, with Kling explaining deposit insurance as the mechanism and proposing contingent capital, and Zadek proposing privatized deposit insurance and describing uninsured corporate treasurers as the underreported side of the problem. The later treatment is more granular about mechanism; the earlier treatments are broader about who gets protected and who does not.
What the sources do not cover
The excerpts do not state the outcome of any of the bank failures discussed, the terms of any bailout, or the legal authority under which depositors were protected. They do not give the founding date or statutory basis of the FDIC, the details of the Congressional Budget Office projection beyond the 3% figure, or the resolution of the First Republic situation. Zadek’s recollection of Continental Bank is explicitly hedged, and the excerpts do not confirm the date or the bank’s status as the first major failure. The excerpts also do not state whether any of the proposed alternatives—contingent capital or privatized deposit insurance—were ever adopted.