Too Big to Fail Movie Explained

We all know the 2008 financial crash brought down the whole world economy, but have you ever wondered what exactly the US government was doing when the 2008 crash was happening? There are many movies made about the 2008 crash. These movies cover different perspectives on the crash. For example, movies like The Big Short cover the investor’s perspective, and the movie Margin Call covers the investment bank’s perspective. Another movie about the 2008 crash is Too Big to Fail. This movie particularly focuses on the efforts made by the government to prevent the collapse of major American financial institutions.

2008 Crisis Movies

We have already covered “The Big Short” and “Margin Call” in previous articles. Too Big to Fail is a movie that takes place in 2008. In the other two movies, the names of most characters were changed. Too Big to Fail is a mixture of the actual events that happened during the crash, and the movie uses the real names of each and every character. Basically, this is the most realistic movie you will watch about the 2008 crash.

Summary of 2008 Crisis

During the 2008 crash, banks got greedy and gave out lots of home loans to everyone. When we say everyone, it means even the people who were not even able to pay it back. Banks believed in endless housing market growth, leading to widespread lending. When commercial banks gave these loans, they eventually sold them to investment banks. Investment banks bundled these loans together and created a financial product known as mortgage-backed securities.

This product was then sold to investors on Wall Street. Investors worldwide have poured billions into MBS products sold by US investment banks. But all these MBS products relied on risky home loans given to borrowers regardless of their creditworthiness. As loan defaults increased, MBS values fell, risking investors’ funds.

Credit Default Swaps

These investment banks knew that the loans added to these MBS products were risky. So to prevent their loss, they bought insurance on these MBS products.

These insurances were mainly provided by a company named American International Group, or, in short, AIG. This insurance were the credit default swaps. The idea was that if the mortgage-backed securities failed, then AIG would cover the cost as they insured them.

But the problem was that when all the MBS products started to fail, AIG had to pay for every single failing MBS. If an insurance company sells 100 insurance policies and collects a premium amount from all 100 buyers, then they can cover the cost of 10 to 15 buyers when they claim insurance. But if all 100 buyers claim the insurance at the same time, then it is almost impossible for an insurance company to pay them.

This is exactly what happened with AIG. All the MBS products were failing at the same time. So, AIG had to pay for everything, which made it impossible for them to pay back.

On top of that, all the investment banks had borrowed huge amounts of money to buy these home loans and sell them on Wall Street. So, they were also losing money. So basically, all banks were in trouble; some banks were in more trouble than others.

Bear Stearns Failure

Initially, in March 2008, Bear Stearns was on the brink of collapse due to its exposure to subprime mortgages and a loss of confidence among investors. The US government had saved Bear Stearns. To prevent the collapse of Bear Stearns, the Federal Reserve provided financial support to JPMorgan Chase, which then purchased Bear Stearns at a highly reduced price.

Problems of Lehman Brother

So when other banks like Lehman Brothers were facing the problem, they were expecting that the government would save them as well. But the government refused to bail them out. There were many reasons why the government did not help the Lehman brothers; one of the main reasons was the moral hazard.

The government had already saved the Bear Stearns so they were already facing criticism from the people. So, the government thought that if they bailed out Lehman Brothers, then it would send a message to the other investment banks that they could engage in excessively risky behaviour, and if they failed, then the government would always come to their rescue. So, the government allowed Lehman Brothers to fail, signaling that investment banks would not always receive bailouts.

Lehman Brothers was the fourth-largest investment bank in the US. When it failed, it sent shockwaves through the finance world. The bankruptcy of Lehman Brothers shattered confidence in the stability of financial institutions, leading to concerns about the health of other banks. 

Lehman Brothers had extensive interconnections with other financial institutions through various financial transactions. These connections included lending and borrowing in the interbank market, derivatives contracts, and repurchase agreements. Many financial institutions had invested in Lehman Brothers in one form or another.

When Lehman Brothers filed for bankruptcy, it created a situation of significant counterparty risk for other financial institutions. Counterparty risk is the type of risk that one party in a financial transaction will not fulfil its obligations. In Lehman’s case, its bankruptcy meant that other institutions faced potential losses on contracts with Lehman, and they were uncertain about whether they would be able to recover the full value of their investment.

Lehman made other banks to suffer

Outside of lending money to people in the form of different types of loans, these banks also lend money to other banks. This is known as the interbank lending market. Because of Lehman’s bankruptcy, other banks and financial institutions became hesitant to lend to each other. The interbank lending market froze, which is essential for banks to obtain short-term funding. Banks were concerned that they might not get their money back if they extended loans to institutions that had exposure to Lehman.

Collapse of Lehman Brothers

When this happened, these banks also asked Warren Buffet to help them with capital. Which he initially refused. So, these banks tried to get money from the big investment banks in other countries, like the UK.

They asked Barclays, the big bank in the UK. Barclays was interested in acquiring Lehman Brothers. However, the regulatory and legal obstacles in the UK made it difficult to complete a transaction, and the deal did not materialize.

In the US, the Bank of America was in talks with Lehman Brothers in terms of acquiring them. But this deal also failed, and Bank of America acquired Merrill Lynch in a separate transaction. The collapse of Lehman Brothers was not limited to the financial sector; it rippled through the entire US economy.

Effect on consumer market

Because of trust issues, interbank lending was frozen, and banks were hesitant to lend each other money. As banks had no money and were not borrowing, this ultimately had an effect on non-banking businesses, such as consumer product manufacturing companies. Non-banking businesses found it challenging to access loans, lines of credit, and other forms of financing, which hindered their ability to operate, expand, or invest. 

The financial crisis disrupted supply chains and impacted businesses that relied on the timely delivery of goods and services. Financial stress in the banking system made it harder for businesses to obtain the necessary working capital to pay suppliers, leading to supply chain disruptions. Because of this, businesses became more cautious about making new investments or hiring additional employees. 

Action by US Government

To solve this chaos, the US government needed to do something really quickly. Otherwise, the US economy would have collapsed.

The U.S. government had to make critical decisions about how to address the problems in the financial system, including whether to buy risky assets or provide capital injections to troubled financial institutions. The primary approach of the government was the Troubled Asset Relief Program, which initially aimed to buy all troubled assets these banks held but later evolved to include capital injections.

TARP fund

The original plan was to use TARP funds to purchase troubled mortgage-backed securities and other illiquid assets from financial institutions. This was the government’s preferred method for addressing the toxic assets clogging the financial system.

The TARP proposal required approval from Congress. And there were also questions about how to value and price these troubled assets accurately.

After the Lehman Brothers bankruptcy, the financial crisis deepened. People had lost their trust in the banking system. Banks were hesitant to give out loans, and it would have taken a long time for the government to buy all these troubled assets. So, instead of exclusively purchasing troubled assets, the government began to provide capital injections directly to financial institutions. This helped stabilize the balance sheets of these banks and increase capital buffers. Which ultimately unfrozen interbank lending and non-banking businesses started to run smoothly.

Capital Injection

The decision to provide capital injections was because of the urgency of the financial crisis. Concerns arose that the financial system was on the brink of collapse, requiring immediate action to prevent a full-scale meltdown. Investors saw capital injections as a quicker and more direct means of infusing capital into the banks and restoring confidence in the system. The US government came up with $700 billion to stabilize the collapse of the market. The US Treasury Department got it approved by the US Congress. Each investment bank was given a different amount depending on their balance sheets. For example, Goldman and Morgan Stanley each got a $10 billion capital injection.

Initially, $125 billion was given to nine banks, and later this amount reached $700 billion. The government also gave $85 billion to AIG to save it from collapse.

Conclusion

The movie Too Big to Fail portrays the US government’s struggle. Even though investment banks caused all this chaos, the US government had to bail them out to keep the economy running. The influence of the big investment banks is so great on the government that even after injecting billions of dollars of capital into these banks, The US government was not sure that these banks would use this capital for the right purpose.

The 2008 financial crash was the result of the ignorance and greed of the government and big banks. The government did not keep an eye on the bad loans given by the banks, and they didn’t do anything until the last moment. The people were unaware of what exactly was going on. But some people were aware of what was going on, and they made huge profits by shorting the housing market. To know how these people figured out potential crashes, you should watch these videos on our YouTube channel.

Watch Video