Too Big to Fail : The Hazards of Bank Bailouts

The potential failure of a large bank presents vexing questions for policy-makers. It poses significant risks to other financial institutions; to the financial system as a whole; and possibly to the economic and social order. Because of such fears; policymakers in many countries - developed and less developed, democratic and autocratic - respond by protecting bank creditors from all or some of the losses they otherwise would face. Failing banks are labeled "too big to fail" (or TBTF). This book examines the issues surrounding TBTF, explaining why it is a problem and discussing ways of dealing with it more effectively. Gary Stern and Ron Feldman, officers with the Federal Reserve, warn that not enough has been done to reduce creditors' expectations of TBTF protection. Many of the existing pledges and policies meant to convince creditors that they will bear market loses when large banks fail are not credible, resulting in significant net costs to the economy. The authors recommend that policymakers enact a series of reforms to reduce expectations of bailouts when large banks fail. The potential failure of a large bank presents vexing questions for policymakers. It poses significant risks to other financial institutions, to the financial system as a whole, and possibly to the economic and social order. The threat is psychological as well as financial. Because of such fears, policymakers in many countries -- developed and less developed, democratic and autocratic -- respond by protecting bank creditors from all or some of the losses they otherwise would face. Failing banks are often labeled "too big to fail" (or TBTF), and the government steps in to help shore up such financial institutions. This important new book examines the issues surrounding the TBTF phenomenon, explaining why it is a problem and discussing ways of dealing with it more effectively. Gary Stern and Ron Feldman, officers with the Federal Reserve Bank of Minneapolis, warn that too little has been done to reduce creditors' expectations of TBTF protection. To a large degree, the problem is a question of moral hazard, wherein anticipation of a safety net reduces a creditor or bank's incentive to act prudently. Many of the existing pledges and policies meant to convince creditors that they will bear market losses when large banks fail are not credible. The unfortunate results are significant net costs to the economy. The authors recommend that policymakers enact a series of reforms to reduce expectations of bailouts when large banks fail. " The potential failure of a large bank presents vexing questions for policymakers. It poses significant risks to other financial institutions, to the financial system as a whole, and possibly to the economic and social order. Because of such fears, policymakers in many countriesdeveloped and less developed, democratic and autocraticrespond by protecting bank creditors from all or some of the losses they otherwise would face. Failing banks are labeled ""too big to fail"" (or TBTF). This important new book examines the issues surrounding TBTF, explaining why it is a problem and discussing ways of dealing with it more effectively. Gary Stern and Ron Feldman, officers with the Federal Reserve, warn that not enough has been done to reduce creditors' expectations of TBTF protection. Many of the existing pledges and policies meant to convince creditors that they will bear market losses when large banks fail are not credible, resulting in significant net costs to the economy. The authors recommend that policymakers enact a series of reforms to reduce expectations of bailouts when large banks fail. " In this clearly prophetic book, Gary H. Stern and Ron J. Feldman examine the "too big to fail" doctrine, and show how policymakers made the financial system riskier by implicitly promising to bail out the biggest banking institutions. In the wake of the global financial crisis in which several major institutions failed in 2008, getAbstract welcomes this reissued, lucid assessment of one of the most perplexing, perverse policies in financial regulation, the idea that some institutions are too big to fail. Former Federal Reserve Chairman Paul A. Volcker's foreword helps sharpen the book's focus, and the authors' advocacy for an end to bailouts is quite persuasive. This book is recommended reading for anyone seriously interested in understanding the calculus of financial policymakers, financial system risk, and the tilted playing field that benefits huge, risky banks and their shareholders Introduction : Our Message And Methods -- What Is The Problem? -- Why Protection Is Costly -- How Pervasive Is Tbtf? -- Why Protect Tbtf Creditors? -- The Growth Of Tbtf Protection -- Testing Our Thesis : The Cases Of Not Too Big To Fail -- Can The Problem Be Addressed? -- Creating The Necessary Foundation -- Reducing Policymakers' Uncertainty -- Limiting Creditor Losses -- Restricting Payment System Spillovers -- Alternatives For Managing Too Big To Fail -- Summary : Talking Points On Too Big To Fail. Gary H. Stern, Ron J. Feldman. Includes Bibliographical References (p. 197-222) And Index. Summarizing the warnings and options of this book requires a little background for the uninitiated.