TBTF: Where Do We Stand?

Abstract

There is only one (society-wide or economy-wide) perceived (or alleged) benefit that can be gained from bailing out financial institutions deemed too big to fail: avoiding a systemic collapse. However, the claim that the failure of one financial institution can cause systemic failure and significant economic destruction cannot be substantiated by resorting to history, economics or simple intuition. Corporate failure is an integral part of the so-called “creative destruction”, which is a feature of capitalism that the TBTF doctrine is inconsistent with. Avoiding systemic failure is a perceived benefit only because regulators and the managers of failed institutions use the language of fear to warn that failure to bailout the underlying institution will cause misery for millions of people. It is all nonsense because humans are resilient. If people can outlive an earthquake or a tsunami, they can surely survive and flourish in the aftermath of the collapse of a bank, an insurance company or a hedge fund.