You're hearing this term a lot, so it's worth making a quick point: The move towards extreme levels of leveraging has made a lot of small institutions "too big to fail," because if they fail, then their unpaid debts bring down a bunch of other smaller institutions, and if too many of them fail, then their unpaid debts bring down big institutions. Essentially, everyone made so many bets with each other, and entered into so many deals with each other, that they're hardly autonomous players anymore. As counter example: Freddie Mae and Fanny Mac were too big to fail on their own terms. They were fairly isolated players who controlled a market. They were not investment banks, and they were not dealing in subprime mortgages. Everyone else is too interconnected to fail. Thinking of these institutions as self-contained structures is the wrong way to understand the crisis. Take the case of AIG. They were a central player in the credit default market that's worth at least $60 trillion. Credit default swaps are an insurance contract where one party pays another party to protect it from the risk that yet another party will default on their debt (this should give you an idea of how complicated this has all become). If AIG went down, its hundreds of billions of dollars in bad assets would have to be sold, which would depress values for all these assets further, which would mean that fewer institutions could sell their assets to pay off their debts, so they'd collapse, which would mean that their lenders couldn't collect, and since AIG is now gone, their lenders would also be deprived of the insurance they'd taken out for that eventuality, and so they'd collapse, too. Insofar as AIG was too big to fail, that was why: "Big" is no longer a simple measure of the size of one institution, but a judgment on how dependent all the other players are on that institution.
