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The End of "Too Big to Fail" Bailouts? Can It Be? Nah, It Can't.

By Jonathan R. Tung, Esq. on December 02, 2015 | Last updated on March 21, 2019

The Federal Reserve Board adopted a rule earlier this week that, in theory, precludes it from rescuing individual companies that claim status of "too big to fail." Has your cynicism kicked in yet?

The change was implemented following much controversy and teeth gnashing over the government's decision to shell out $85 billion to rescue AIG, making it one of the -- if not the --biggest government bailouts in modern history.

Bailing Everyone Out

Bailouts are surprisingly technical when it comes to the legal aspects. The rule has nitty gritty details for legal analysts and market watchers to tear through, but it broadly allows the Fed only to bail out the financial system as a whole, and not individual companies. "Wall Street," as laymen generally know it, is made up principally by a small group of exclusive banks and financial institutions known as "institutional investors" on which much blame for the 2008 Financial Crisis is placed.

Under the new rule, the Fed may create emergency funds that can be used potentially by any of five big Wall Street firms, but it cannot favor company over another. Remember AIG and Lehman Brothers? Yeah, kind of like that. The new rules are essentially final changes to the 2010 Dodd-Frank financial reform laws that sought to effectively respond to rampant market speculation.

Money, Money, Money

Government bailouts have left many household names tarnished -- names like JPMorgan Chase & Co. Chase was lent huge amounts of capital to save a purchase of Bear Stearns gone sour, a purchase many politicians said left taxpayers holding the bag.

But the Fed's use of emergency spending power seemed to go all over the place. It rescued AIG, but let Lehman Brothers go belly up. Then it rescued Citigroup multiple times.

Political Posturing?

Proponents of the move applaud it as a giant step against what economist refer to as moral-hazard: in this case, the phenomenon of poor economic choices being encouraged through government subsidy. But some critics have cynically dismissed the final rules as being ineffective against abuses of the current financial system and have suggested that even more drastic changes should be made. Whatever the case, it seems here that the law is very much influenced by the moral sentiment against the finance industry right now. Let's see how well it sticks.

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