When we discuss different economic systems, one of the critical points where they differ is the government’s involvement in a country’s economy and various sectors. Communists and Capitalists have debated this topic for decades, only to find that a moderate way out is probably the best. But well, what is ‘Too big to fail’?

Basically, it’s like the most valuable player for your favourite IPL team. Too big to fail is a phrase used to describe businesses or entire business sectors which are so deeply ingrained in a financial system or economy that their failure would ensure that disaster prevails (sips coffee and looks at you, 2008) Some people like to take a different perspective while looking at the ‘too big to fail’ companies or sectors. They believe these companies or organisations are so big that they just can’t fail. (sips coffee louder and laughs at you Lehman Brothers) That surely isn’t true, as we had all seen, with even firms like JP Morgan Chase literally chasing every cent they could find during the Global Financial Crisis of 2007-08. Policymakers, however, take a slightly different and more policy-oriented and risk-averse approach towards the same. They believe that since these companies or sectors are so crucial to the functioning of the economy, they must not be allowed to fail by the government.

One simpler and slightly milder example would be Yes Bank in India. When the grand Yes Bank story came to a standstill, RBI had to step in and restructure the bank, eventually leading to Yes Bank becoming an associate of the State Bank of India, and financial turmoil and lakhs of Indian households averted. In the case of the entire banking-investment banking system during the financial crisis of 2007-08, eventually, the taxpayers’ money had to be spent by the government to prevent the collapse of the entire financial system. This is where this debate takes relevance for the common man.

Financial institutions are often considered ‘Too big to fail’, and this notion came to the centre stage during the global financial crisis. While some economists believe that the government has to try and save such institutions to ensure that the common man does not suffer any further, some others believe that certain firms grow so big in size that if they do fail, they become ‘Too big to save’. In fact, a lot of studies have claimed that some banks actually prefer to be too big to fail, just to have that status in the eyes of the government so that they can be saved when the time comes. (And you can ignore your money, taxpayers.) In a famous article in the Economic Policy Review, it was found that too big to fail banks took more risk if they expected a future rescue. And this wasn’t just the case in the USA or other developed western economies; they studied over 200 banks in about 45 countries and found that after an increase in government support, the tendency of impaired loans increased dangerously. In simple terms, this means that these ultra-large banks are taking advantage of their market capitalisation and over-utilising their resources with an unhealthy risk appetite. Too much criticism for banks anyway, they’ve suffered multiple crises in the past, and I’m sure they will give rise to many more crises in the future. It’s human nature to be greedy, and we surely can’t choose to return to the barter system to avoid such failures.

Let’s come to the present and look at another ‘Too big to fail’ sector in a different economy. Real estate in China. I’ve already covered bubbles and real estate in a past article, which you can read here. By now, you’ve all probably heard of ghost cities in China, which are an unfortunate set of residential areas with no residents (it’s dark, not funny). China, much like other developing economies, once had most of its population in rural areas. Soon, however, with the majestic growth that the country saw, a large part of its population started shifting to the urban regions, creating an obvious increase in demand for housing. If you’ve taken Microeconomics 101, you know that in a free-to-enter-and-exit economy, whenever demand increases, existing companies start earning more enormous super-normal profits, and hence other players enter the industry to meet the rising demand. However, real estate is not an industry where companies can enter or exit easily. It requires heavy investment and a lot of support from the market itself.

However, think from the point of view of a real estate entrepreneur in China, maybe a decade or two ago. You saw that half your country was moving towards the urban regions, there was an unprecedented demand for housing, and you had a chance to move in. You take land for lease from the Chinese government, take massive loans from banks, both Chinese and international, and you enter the superb market hoping to make healthy profits. Here’s where you go wrong, you don’t complete your existing projects just because you overestimate the demand, and instead, you start taking more loans from the banks to fund newer projects. This, as the reader might notice, is an endless vicious circle. And this is somewhat the case with Unitech in India too, a real estate giant which eventually had to be saved by the government (although the founders are in jail, I suppose). Unlike Unitech in India though, this problem in China is a little more severe. Real estate contributes to 14-15% of China’s GDP, and if we include upstream and downstream sectors, it comes to around 25% of the GDP, as estimated by JP Morgan. And just in case you did not know, China’s GDP is HUGE; such a large portion of China’s GDP is very crucial for the world as a whole.

Here’s where banks reappear in this discussion. They have lent too much to Chinese Real Estate companies, who aren’t able to sell their property anymore, aren’t able to complete some of the projects they undertook, and hence are stuck in a loop. The people who own some houses in the ghost cities are waiting for the prices to go up (which won’t happen anytime in the near future), and because their assets are lying useless, they don’t have the additional income they thought they would. Soon, both real estate companies and the common population will start defaulting on their loans. This, in fact, has brought a company called Evergrande (or the China Evergrande Group) into the news, which has crossed all the barriers set by the Chinese Government for extension of debt, and now faces a major crisis. I, however, don’t blame this on any of the industries, banks, common people, or even on the government. Bubbles are as natural to human beings as sucking nectar from flowers is to honeybees. We overvalue things, we take a lot of debt, we act greedily, and then one day the party’s over. The only thing common here with the discussion of Too big to fail is the industry as a whole. Such a large contributor to the GDP and to urban employment in a country just can’t be allowed to fail, for it will cause another domino effect perhaps like the 2008 Global Financial Crisis.

To me, these giants which are like red blood cells in the blood of the economy of any country, often seem to be overestimating their prospects, and the eventual sufferer in all these cases seems to be an ordinary citizen. Call it ‘Too big to fail’, ‘Too big to save’ or ‘Too big to be allowed to fail’, you should probably keep an eye on the sectors and industrial giants in your country too. If you see that some debts just don’t seem logical, trust me, it’s another bubble waiting to burst.

Thanks for reading! I hope you’ve enjoyed reading this article. You can find me on Linkedin and GitHub.