Academic journal article Economic Inquiry

Banking and Public Policy: Too Big to Fail

Academic journal article Economic Inquiry

Banking and Public Policy: Too Big to Fail

Article excerpt


I have devoted much of my professional career to the study of banking (in the broadest sense to include all channels of financial intermediation operating either in the sunlight or in the shadows), its management, and its interaction with public policy. On the whole, it has been a wonderful and exciting journey. Banking and finance are at the very heart of most industrial economies. As has been vividly reinforced in recent years, what happens in the financial sector may affect not only the remainder of the financial sector but also the real economy, particularly on the downside, and vice versa. What happens in the real sector feeds back on the financial sector.

But, at times, I feel that economists know only little, if any, more about banking and its relationship with the rest of the economy than we did some 50 years earlier. Financial crises have neither been reduced in either magnitude or frequency, no less disappeared (Reinhart and Rogoff 2009). Indeed, in some countries, they have become more frequent and deeper. The recent financial crisis from 2007 to 2010 in the United States and many, but not all, industrial countries, commonly now referred to as the great financial crisis (GFC), may well be the most serious and damaging in U.S. history. It has been a rough and costly ride. This should have humbled most of us.

In this article, I describe what I believe to be one of the, if not the, major public policy issues in banking today--"too big to fail" (TBTF). Although most ideas are taken from my earlier papers, all are not mine. I have borrowed freely and shamelessly from my colleagues. If nothing else, correctly conducted plagiarism can be efficient.

As noted, banking and finance are important in nearly all economies. For the United States, income created by the financial sector accounts for about 8% of GDR Not only are banking and finance important in most countries, but, at least until the GFC, the sector was growing rapidly (Artill, Hou, and Sarkar 2014). This had important collateral benefits and costs. A number of studies have reported that the broader, deeper, and more liquid the financial system is, the greater is the growth rate in real aggregate income in that country (Barth, Caprio, and Levine 2012; Caprio 2013). Some more recent studies, however, found that these results may be sensitive to a number of factors, including the time period examined and the state of a country's economic development (Gambacorta, Yang, and Tsatsaronis 2014; Levine, Loayza, and Beck 2000). Losses in aggregate income from financial problems and crises in any country may be greater than, equal to, or less than the gains in income from greater and more efficient financial activities both before and after the crises. Which it is determines the societal contribution of the financial sector and the success or failure of our policies. Moreover, as observed in recent years, abrupt changes in the health of the financial sector have important societal (income and wealth distribution) and macroeconomic implications. That is, not only aggregate wealth but also the distribution of wealth is importantly affected by banking and financial behavior.

TBTF goes under many different names, such as

* Too big to liquidate;

* Too complex to liquidate;

* Too big to manage;

* Too complex to manage;

* Too big to prosecute; and

* Too big to jail.

Thus, the term means different things to different people. But, by any name, it suggests that the big are getting special treatment that the small are not. Other than those who benefit directly, for reasons discussed later, few like the concept and what it represents and there have been many attempts to kill it. But, like vampires and Moby Dick, TBTF refuses to stay dead for very long and returns to haunt our existence. As a result, TBTF has become one of the most important public policy issues affecting banking and financial markets today. …

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