Chapter 1: Why Some Banks Can Never Be Allowed to Fail

September 2008: When Risk Became Global

On a September morning in 2008, the world watched Lehman Brothers collapse. Within hours, markets froze, banks panicked, and ordinary people queued at ATMs in fear. A phrase once confined to financial insiders spilled into headlines and dinner-table conversations: too big to fail. It captured the unsettling reality that some institutions had grown so large and so entangled with the global economy that their downfall threatened everyone.

But Lehman was not the beginning of the story—only the moment the world understood its stakes. The logic of too big to fail was decades in the making, rooted in the way modern societies think about risk itself. To see how big banks became untouchable, we need to trace how risk evolved: from a sailor’s hazard on rocky seas to a statistical illusion in the age of finance.

Risk: From Seafaring Danger to Statistical Illusion

The word risk has a colorful history, with roots woven through different languages and cultures. Linguists trace it to the Greek rhiza, a hazard for sailors navigating rocky coasts; to the Latin risicum; and to the Arabic rizq, meaning chance or fortune. These are only a few of its many paths. From the beginning, risk oscillated between threat and opportunity: the chance of wreckage, but also the hope of discovery.

With modernity, risk underwent a profound transformation. Max Weber described this as the “disenchantment of the world.” Fate was replaced by calculation. Mathematics and probability seemed to promise control. If we could assign numbers to hazards, perhaps we could tame them.

But that promise was deceptive. Many dangers resist quantification—especially systemic risks. Financial crises do not unfold like dice rolls. They emerge from feedback loops, hidden interdependencies, and sudden shifts in trust. Models may produce neat figures, but beneath them lies radical uncertainty.

Even in the sciences, the concept of risk is fragmented. Some use it to mean the probability of an event, others the cause of harm, the expected value of possible outcomes, or the decision situation under uncertainty. This plurality shows how elusive the idea remains.

Still, three features are central:

• Goal orientation: risk always refers to deviations from a target, positive or negative.
• Normativity: whether a deviation counts as “opportunity” or “danger” depends on values. A rising interest rate may be good news for savers, bad news for debtors.
• Epistemicity: risk embodies incomplete knowledge. One must know something about not-knowing.

Think of it this way: buying a lottery ticket is a risk in the narrow sense—you know the odds. Buying a mortgage-backed security in 2006 was different: models pretended to know the odds, but the variables themselves were uncertain. Systemic risks nearly always fall into this second category.

Two Interpretations of Too Big to Fail

The meaning of too big to fail has shifted over time.

• Before 2008: the illusion of certainty. In the decades of deregulation, too big to fail was seen almost as a fact of life. Certain banks were considered simply too large and too powerful to collapse. Their survival seemed automatic, even natural. The doctrine was descriptive: “too big to go bankrupt.”
• After 2008: the critical reading. Lehman Brothers’ bankruptcy shattered that belief. It proved that even giants can fail—and that their failure can spread panic worldwide. From then on, too big to fail came to mean “too large to be allowed to fail.” The state must intervene, not out of preference but out of necessity.

This shift turned the doctrine from wishful thinking into a political and ethical problem. It now raises questions about moral hazard, distorted competition, and the legitimacy of implicit guarantees.

The Birth of a Doctrine: Continental Illinois, 1984

The story begins with Continental Illinois, the seventh‑largest bank in the United States by 1984. Its exposure was largely due to risky oil and gas loans—particularly through bad loan participations acquired from the failed Penn Square Bank, which had collapsed in 1982. Rumors spread, depositors panicked, and capital fled.

The government intervened—and not only were ordinary depositors shielded, but also bondholders and large creditors, marking an unprecedented broad rescue. During the congressional hearings, Congressman Stewart McKinney famously declared:

“We have a new kind of bank. It is called ‘too big to fail.’ TBTF, and it is a wonderful bank.”

The implications were clear:

• Size itself had become a form of privilege.
• Big banks gained cheaper refinancing, reinforcing their growth.
• A self-reinforcing cycle began: the larger the bank, the stronger the expectation of rescue—and the greater the incentive to expand further.

Continental Illinois was more than a bailout—it was the birth of a doctrine that would shape global finance for decades.

Expansion and Normalization

From that moment, the logic of protection deepened. Several forces drove it:

• Structural change: mergers and acquisitions concentrated financial power, creating “megabanks.”
• Implicit guarantees: investors assumed large institutions would be rescued, granting them cheaper credit.
• Political pragmatism: governments weighed the short-term chaos of collapse against the long-term costs of bailouts—and nearly always chose rescue.
• Financial innovation: derivatives, securitization, and global trading networks increased opacity. Regulators faced a new refrain: “We cannot let this bank fail, because the consequences are unknowable.”

Each crisis confirmed the pattern. In 1998, the near-collapse of Long-Term Capital Management—technically a hedge fund, not a bank—provoked a Federal Reserve–brokered rescue. The message widened: too big to fail was not limited to banks, but to any institution enmeshed deeply enough in the system.

By the early 2000s, protection was no longer exceptional. It was part of the fabric of finance.

Lehman Brothers and the Erratic Turn

Then came 2008. Lehman Brothers, a 158-year-old investment bank, was allowed to fail. The result was chaos: global credit markets froze, stock exchanges plunged, and trust evaporated. The experiment of letting a giant collapse ended in catastrophe.

From that moment, the critical reading of too big to fail dominated. Governments around the world poured trillions into stabilizing banks. In the Eurozone, massive bailouts followed for institutions in Ireland, Spain, and beyond. In Switzerland, the 2023 rescue of Credit Suisse showed that the doctrine remains alive: once again, a government stepped in to prevent a systemic shock.

The lesson was not lost on markets. If anything, expectations of rescue became stronger. Investors understood: the political costs of letting a giant fall are simply too high.

The Moral Hazard of Too Big to Fail

Here lies the ethical dilemma. Too big to fail severs the link between risk and responsibility. Large institutions can take on systemic risks while expecting the state to absorb the fallout. Losses are socialized—through taxpayer bailouts, austerity, or lost growth—while profits remain private.

The system rewards precisely the behaviors that worsen fragility: unsustainable growth, complexity, aggressive risk-taking. For an individual bank, expanding under the umbrella of implicit protection makes sense. For society, it is perilous.

This imbalance is what economists call moral hazard—a dynamic where the very expectation of rescue encourages risk.

The Political Economy of Power

There is another layer: power. Too big to fail is not only a market distortion; it is also a political fact.

Governments, fearing collapse, hesitate to discipline large banks. The banks, in turn, use their position to influence regulation. They lobby, argue for exceptions, and fend off stricter oversight. Some critics speak of “too big to jail”: the idea that size confers not only protection from bankruptcy but also from accountability.

The result is an asymmetry of responsibility. Households face foreclosure when they default on loans. Small firms go bankrupt if they miscalculate. But global banks, shielded by systemic relevance, play by different rules.

The Normative Dilemma

The too big to fail doctrine embodies a double bind:

• On one side, uncontrolled bank failures can cause devastating economic and social costs.
• On the other, repeated bailouts entrench moral hazard, distort markets, and undermine democratic trust.

The challenge is to secure stability without institutionalizing irresponsibility. That is easier said than done. Resolution regimes, capital buffers, and bail-in rules have been introduced since 2008. Yet as Credit Suisse showed, when panic looms, the path of least resistance is still rescue.

Conclusion: A Precarious Pact

The story of too big to fail is more than financial history. It is the tale of how societies try to control risk—and how that control creates new vulnerabilities. What began with the rescue of a single bank in 1984 has grown into a global doctrine: one that fuses economics with politics, uncertainty with power.

The next crisis will not ask whether too big to fail exists. It will only remind us of its costs. The real challenge is whether we resign ourselves to this precarious pact—or whether we can find a better way to confront too big to fail as the essential systemic risk of global financial markets, reconnecting risk with responsibility.

Before we can rethink systemic risk, we must confront how it was misunderstood. Chapter 2 uncovers the blind spots of pre-crisis economics, where dazzling complexity disguised fragility, and the very models designed to measure risk ignored it. Opacity and mathematical complexity disguised speculation, while faith in market ‘discipline’ concealed neglect—the stage was set for collapse.

This article series presents the main ideas of my book in digestible form. For a complete and detailed treatment, see Risikoethik der Banken (The Risk Ethics of Banks), published by Mohr Siebeck and freely available in Open Access. Feel free to use it in teaching, seminars, and academic discussions.