Table of Contents

Research Handbook on Crisis Management in the Banking Sector

Research Handbook on Crisis Management in the Banking Sector

Research Handbooks in Financial Law series

Edited by Matthias Haentjens and Bob Wessels

In this timely Handbook, over 30 prominent academics, practitioners and regulators from across the globe provide in-depth insights into an area of law that the recent global financial crisis has placed in the spotlight: bank insolvency law.

Chapter 1: Too big to fail: A policy’s beginning, middle and end (?)

Thomas F. Huertas

Subjects: economics and finance, financial economics and regulation, money and banking, law - academic, company and insolvency law, finance and banking law

Extract

Too big to fail is too costly to continue. It destroys the public finances, undermines competition and promotes risk taking. Indeed, it may even sow the seeds of the next crisis. So ending too big to fail has top priority on the regulatory agenda, and Mark Carney, Chairman of the Financial Stability Board (FSB) has declared that 2014 is ‘the year to complete the job’. But how did such a policy come about, and why has it persisted? Briefly put, it originated as the lesser and less immediate of two evils. More moral hazard in the future seemed preferable to instant financial instability. Across the developed world authorities intervened in the case of large failing banks, such as Continental Illinois, Credit Lyonnais and various Japanese banks, to protect all creditors. Bail out appeared to become the norm, and rating agencies raised banks’ overall rating to reflect this implicit government support. On 15 September 2008 things changed abruptly. Instead of saving Lehmans as the market had expected, the US authorities forced Lehmans into bankruptcy. That in turn caused investors to reappraise risk and return. They flew to strong banks and ran from the weak, causing the latter to fail, markets to collapse and the real economy to contract. Financial instability was indeed the instant result of letting a big bank fail. So, as the world teetered on the verge of financial meltdown, policymakers reversed course.