Why Can’t We Let Too-Big-to-Fail Companies Fail?

BY Ray Suarez  January 6, 2010 at 12:43 PM EST

Question: Paul, I want to ask you about the “bigness” issue — “too big to fail.” If the big corporations produce most of the economy’s products, such as those companies listed in the Dow & S&P 500, percentage-wise, but employ fewer people percentage-wise given the amount they produce, then why should we care if these “too big to fail companies” go down? Since they privatize the profits and socialize the costs/risks and do not employ the bulk of Americans, can we say let them die in peace?

Paul Solman: I’m afraid not. Or more to the point, OTHERS are afraid not. The reason they’ve been saved is that when one wasn’t — Lehman Brothers, thought NOT too big to fail — the world financial system pretty much froze. No one dares chance that again.

The real question, then, is why we haven’t done anything about the problem, why we haven’t created strong incentives or even regulations to force financial institutions to become smaller, and thus less of a threat to the system as a whole, as George Schultz suggested to me in this recent interview.

At the annual economics convention in Atlanta this week, where everyone seemed to agree that something needs to be done, I asked Paul Krugman this question:

Paul Solman: So why isn’t it happening?

Paul Krugman: Well, you know the old line: It’s very difficult to get a man to understand something when his salary depends on his not understanding it. And in this case you might say it’s very difficult to get a member of Congress to understand something when his campaign contributions depend on his not understanding that. This is as raw an incidence of the power of money in preventing us from doing something that everybody knows we should do that I’ve ever seen.

PS: Will we then, are we then fated to not doing anything?

PK: You know the next couple of months will tell. I think if President Obama puts his weight behind it, if there’s a real push from the chattering classes on this, which obviously has got to include me, that we can get something. It will probably fall short of what you’d like but there are people who want to leave their mark. I think Barney Frank doesn’t want to go down as the Tsar of Finance in the House of Representatives who failed to do anything about the greatest crash since the Great Depression.