Tuesday, March 9, 2010

Too Big to Bail

Just imagine. Suppose the government were to announce that, henceforth, once a firm got sufficiently large, it was on its own -- no government bailouts would ever, ever be forthcoming. "Too big to bail" as opposed to current policy. What would happen?

The market itself would discipline a firm that was "too big to bail." Bondholders would be leery of providing the funding for excessively poor behavior. Higher interest rates would be required for bondholders and management would take heed that the market would not endorse their foolishness. The market itself would rein in firms that are "too big to bail."

Compare this to "too big to fail." Here the market is irrelevant. If a firm is too big to fail, then it can easily finance absurd behavior at low rates. Why not? If the government is there as a backstop, why should management and bondholders not indulge themselves at taxpayers' expense. It's heads I win tails you lose.

I prefer "too big to bail."

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