“Too Big To Fail.” We saw it with Countrywide Financial. We saw it with Bear Stearns. As the controversy expanded, there were more than a few smarties defending the need to save big financials because of the systemic danger their failure would inflict upon the world’s intertwined and complex financial structure. Chairman Bernanke suggested he really didn’t want to do what he did with Bear Stearns….only did it because of stuff associated with the “too big to fail” phenomenon….and doesn’t ever want to do it again. Personally, I doubt that Bear Stearns will be the only test of “too big to fail” before this mess is all over.

When I went through the charts this past weekend, I was struck by how many regional banks and S&L’s suddenly looked weak after some attempts at recent stabilization since mid-March. It caused me to think heavily about the other side of “too big to fail.” If the government is committed to only bailing out banks that would cause systemic national and international distress, then there is an inevitable concept coming that I call “Too Small To NOT Fail.” Okay, so National City got about $1 billion of pseudo Private Equity money from JP Morgan Corsair. Washington Mutual got $7 billion from TPG et al. There are rumors about other PE firms circling the S&L’s and regionals looking for opportunities. But the reality is there are thousands of these small financial firms and I suspect many of them are in big trouble. Their reserves for losses are insufficient. They need capital and some will get it. But there is not enough capital to cover it all and some of these banks will just not be appealing enough for new investors to put up the money.

In the early stages of the failures that will likely result, there won’t be a government bailout entity like we had with the S&L crisis. Instead, there will be a tough love stage where the banks will be allowed to fail. And then the politicos will start complaining why we could bail out the big guys on Wall Street at Bear Stearns (Too Big To Fail) and not the little guys on Main Street in small town America (Too Small To NOT Fail). Eventually, as the banks that could not obtain new capital topple, it will be tough to avoid small bank runs and then I expect that we will learn that even something small can lead to something big.