Question

Why are federal prosecutors reluctant to bring major charges against large financial firms? What was the main regulatory action of the Glass-Steagall law? Why might having many smaller financial firms be more stable than having fewer larger firms? What argument can be made for the possibility that larger financial firms might be more stable than smaller financial firms?

Short answer

The federal prosecutors are reluctant to bring major charges against large financial firms since these are interconnected, and if collapsed, it will bring the entire financial system down with them.

The Glass-Steagall law restricted commercial banks to lower-risk lending activities.

The smaller financial firms are more stable as it is easy to control over them compared to larger ones that have a large market share.

The economies of scale and higher profits are why larger financial firms are considered more stable than smaller ones.

Step-by-step solution

Step 1. The reluctance of prosecutors to bring charges against large financial firms

The big firms become too powerful and interconnected, and the federal prosecutors do not feel free to put major charges on them since the entire financial system depends upon these firms. Therefore, it is believed that it is better to have stable small firms since they will not end up bringing the entire financial system down with them.

Step 2. The Glass-Steagall Law

The Glass-Steagall law was passed in 1933, and it defined the US financial system. The law restricted commercial banks to low-risk activities such as issuing home-mortgage and small-business loans. The high-risk lending activities were left to for an entirely different set of firms to handle.

Step 3. Reason why smaller financial firms are more stable

The smaller financial firms are easy to manage. The larger firms decide the fate of the banking system. The power due to larger market share can disrupt the whole market. The fall of one firm such firm can create a significant effect over the entire banking system. Thus, smaller firms provide more stability.

 Step 4. Reason why larger financial firms are more stable

The big financial firms are so powerfully rooted and connected that it is tough for such firms to collapse; therefore, this serves as a good argument for the possibility that larger financial firms might be more stable than smaller financial firms. The economies of scale provide them with the advantage of producing higher services at a cheaper cost. The increased profits enable them to cover their losses at the time of crisis and continue with their services.