The Need For Failure
BY Thomas F. Cooley
If a firm is ”too big to fail,” it is … too big.
There has been constant chatter about the fact that our regulatory institutions don’t really know how to deal with firms that are deemed “too big to fail” but may be insolvent. Throughout 2008, policymakers improvised a solution for each case that came along–Bear Stearns, Fannie and Freddie, Lehman Brothers, AIG. But improvisation is not a policy, and the weakness of that approach has become increasingly apparent as we drag through 2009.
First, the very notion of “too big to fail” is dangerous. It suggests that there is an insurance policy that says, no matter how risky your behavior, we will make sure you stay in business. It encourages banks to get bigger (or more interconnected), and it subsidizes risky behavior.
Second, it leaves ambiguous the important issue of who gets protected in the event of insolvency–the equity holders, creditors, subordinated debt holders, etc. It seems fair to say that the solutions that have developed on the fly have done severe damage to the notion that there is a well-ordered capital structure that means something.
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