The Real Reason Some Major Banks Are Deemed Too Big to Fail

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What is the real reason some major banks are deemed “too big to fail”? There are a number of possible reasons, from lack of regulatory oversight to moral hazard. Let’s examine these factors one by one. Ultimately, the answer will depend on the specific situation and the financial institutions. Despite the risks, too many large institutions are still too big to fail.

Large size

There are two interconnected problems in the so-called “too big to fail” problem. First, the failure of a large firm creates high negative consequences, which create an uneven playing field. Second, interventions in the market for large financial firms increase their complexity, increasing systemic risk. In other words, too big to fail institutions have an incentive to become even larger. But what exactly is too big to fail?

Lack of regulatory oversight

The term “too big to fail” was coined in 1984 by Rep. Stewart McKinney to refer to the Federal Deposit Insurance Corporation’s intervention in a bank in Continental Illinois. The term had been used earlier in 1975, in reference to the government’s bailout of Lockheed Corp., but only became popular after the 2008 financial crisis and subsequent financial sector reform.

Cost of bailouts

The Congressional Budget Office has published a report on the cost of bailouts for the big banks. It says the $700 billion taxpayer bailout actually cost $21 billion, which is considerably less than initially thought. lån med sikkerhet i bolig This figure includes GM and insurance giant AIG. The report also says that the cost of bailouts for the major banks will amount to “almost nothing.” Politico puts the word “bailout” in quotation marks, highlighting that the bailouts did not benefit working families.

Moral hazard

Moral hazard occurs when someone takes a risk knowing that they can be bailed out. The banking system encourages moral hazard by providing government funds for bank bailouts. The crisis in 2008 taught the financial industry that a bank’s role as a lender encourages reckless behavior. If the IMF does not rein in the behavior of banks, it will create a system of moral hazard that will eventually lead to bankruptcy.

Incentives for risky behavior

Incentives for risky behavior at major financial institutions have come under increasing scrutiny in the wake of the global financial crisis. While much of the focus has focused on executive compensation, non-equity incentives for lower-level employees may share some of the blame. For example, volume incentives for mortgage brokers rewarded risky lending. The research suggests that such incentives may have contributed to the risky behavior at the time of the crisis.

Regulation of risky activities

In addition to the current economic crisis, there is also a risk that too big to fail institutions will affect the incentives of bank creditors. For instance, if a bank is too big, creditors are not likely to price the risk fully, creating moral hazard. Furthermore, banks may not internalize the social costs associated with their size, leading to diminished market discipline and inefficient capital allocation. At the same time, too big to fail institutions may also be in a competitive advantage over smaller competitors.

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