Credible Resolution: What It Takes to End Too Big to Fail

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Make Markets Be Markets


The market system depends upon the discipline of failure.

This is the basis of dynamic evolution of the economy and is essential to the legitimacy of the market system.  When failure occurs, corporate finance has well-developed principles and procedures for bankruptcy and the restructuring of failing firms.  We have all seen these procedures in action in the failure of airlines, auto companies, the bankruptcy of non-financial businesses both small and large, like Kmart, Texaco, and Converse, Inc.  We have seen them in the failure of venture capital start-ups, and even with smaller financial institutions.  Well-known individuals - from P.T. Barnum to Walt Disney to Donald Trump - have gone through bankruptcy. 

But the discipline of bankruptcy and restructuring has not been applied to the large complex financial institutions (LCFIs) in the recent financial crisis.  The inability to apply market discipline to LCFIs is not only unsound; it has forced the citizens of the United States to support them with a great deal of money via bailouts and guarantees.  When LCFIs are not penalized for failure, it sets a terrible precedent for their future behavior - creating an unhealthy dynamic in which bailouts are assumed and risky behavior is underwritten.  Worse still, when society perceives a distance between how individuals and businesses are disciplined, anger and demoralization flourish.  The resulting distrust in government makes it even more difficult to fix a broken regulatory system.

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Robert Johnson is Senior Fellow and Director of the Project on Global Finance at the Roosevelt Institute; he also serves on the United Nations Commission of Experts on Finance and International Monetary Reform.  Previously, Dr. Johnson was a managing director at Soros Fund Management and a managing director at the Bankers Trust Company.  He has served as chief economist of the U.S. Senate Banking Committee and was senior economist of the U.S. Senate Banking Committee.

The views expressed in this paper are those of the author and do not necessarily reflect the positions of the Roosevelt institute, its officers, or its directors.