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Too Big to Fail: Causes, Consequences, and Policy Responses

Too Big to Fail: Causes, Consequences, and Policy Responses Governments cannot credibly commit to eschew bailouts of creditors when large financial institutions become distressed. This too-big-to-fail (TBTF) problem distorts how markets price securities issued by TBTF firms, thus encouraging them to borrow too much and take too much risk. TBTF also encourages financial firms to grow, leading to competitive inequity and potential misallocation of credit. This review discusses evidence that such distortions are empirically relevant and also discusses the policy efforts to limit them. In the wake of the Financial Crisis of 2007–2008, it seems increased concentration in the financial industry has worsened the TBTF problem. Nevertheless, markets price the risks of large financial firms more now than before the Financial Crisis. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Annual Review of Financial Economics Annual Reviews

Too Big to Fail: Causes, Consequences, and Policy Responses

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References (91)

Publisher
Annual Reviews
Copyright
Copyright © 2013 by Annual Reviews. All rights reserved
ISSN
1941-1367
eISSN
1941-1375
DOI
10.1146/annurev-financial-110112-121025
Publisher site
See Article on Publisher Site

Abstract

Governments cannot credibly commit to eschew bailouts of creditors when large financial institutions become distressed. This too-big-to-fail (TBTF) problem distorts how markets price securities issued by TBTF firms, thus encouraging them to borrow too much and take too much risk. TBTF also encourages financial firms to grow, leading to competitive inequity and potential misallocation of credit. This review discusses evidence that such distortions are empirically relevant and also discusses the policy efforts to limit them. In the wake of the Financial Crisis of 2007–2008, it seems increased concentration in the financial industry has worsened the TBTF problem. Nevertheless, markets price the risks of large financial firms more now than before the Financial Crisis.

Journal

Annual Review of Financial EconomicsAnnual Reviews

Published: Nov 6, 2013

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