There-in is part of the problem, that nutshell is missing a very important part. It is better put that they are too large and critically interconnected within the economy to fail and be dismantled safely
with the current legal system to do so.
We (the royal we
) have already faced “too big to fail” at wide scale, a prime example being back in the late 1920’s and early 1930’s. The response, after the initial laissez-faire (with a very poor outcome), was in part to institute the FDIC for banks. There was already bankruptcy laws on the books but they proved insufficient for the banking industry, as the economy had evolved and progressed in using them. The problem had to do with both speed at which the bankruptcy was executed (so assets could be divided and dispersed) and the level of insolvency that the banks could reach (thus shortage of assets to pass out to creditors), coupled with their tight ties though out the economy. It was not a matter of ensuring a bank would never fail, it was a matter of having a better chainsaw (and authority to use the chainsaw) to chop it up and move on quickly coupled with triggers and boundaries to keep the job at a size that the chainsaw could handle.
And it worked [well], and continues to work, for 80+ years
for the institutions that it was targeted at.
What has happened is that AIG, and others such as Citibank, blurred the lines with the banking industry (and partially due to particular dismantling of key aforementioned boundaries were allowed to blur the lines) and also became similarly key, widely interconnected components of the economy. But we did not build the chainsaw for them, as they exist. Citibank is only
partially a bank. AIG never was a bank (although there were insurer rules that they sort of colored outside the lines on). Why AIG was/is so critical has to do with the role of insurance in our economy, and the level of marketshare that AIG had. If those policies, Trillions of dollars worth, fall our economy grinds to a halt. Maybe you do not understand this but it is the case, and I will save time by not going into it.
So now we need a bigger chainsaw (and accompanying rules of operation to keep the chainsaw relevant, maybe requiring some partial dismantling of existing problem children). Thus we can within a few days shutdown, chop up, and move on from say Citibank or AIG failing in the same way that we do 100’s of times a year with banks like Joe Sawbuck’s First National Bank of Duluth.
Presto, no more “too big to fail” without removing the [critical] scenario of failing.