The Panic of 2008
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The Panic of 2008

Causes, Consequences and Implications for Reform

Edited by Lawrence E. Mitchell and Arthur E. Wilmarth, Jr

The Panic of 2008 brings together scholars from a variety of disciplines to examine the causes and consequences of the global credit crisis, the subsequent collapse of the financial markets, and the following recession. The book evaluates the crisis in historical context, explores its various legal, economic, and financial dimensions, and considers various possibilities for reform. The Panic of 2008 is one of the first in-depth efforts to study the crisis as it was in the very earliest stage of resolution, and establishes a foundation for thinking about and evaluating current reform efforts and the likelihood of recurrence.
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Chapter 4: Too Big to Fail? Recasting the Financial Safety Net

Steven L. Schwarcz


4. Too big to fail?: recasting the financial safety net1 Steven L. Schwarcz2 Government safety nets in the United States and abroad focus anachronistically on problems of banks and other financial institutions, largely ignoring financial markets which have become major credit sources for consumers and companies. Besides failing to protect these markets, this narrow focus encourages morally hazardous behavior by large institutions, like AIG and Citigroup, that are ‘too big to fail’. This chapter examines how a safety net should be recast to protect financial markets and also explains why that safety net would mitigate moral hazard and help resolve the too-big-to-fail dilemma. The real economy relies critically on the supply of liquidity in the form of credit.3 The subprime financial crisis, which has now devolved into a larger global financial crisis (collectively the ‘subprime crisis’), ‘began in the credit markets, and eventually . . . will end there’.4 Diminished credit harms the real economy because firms need credit to operate and grow and individuals need credit to buy homes and cars and to finance other expensive purchases. Many think that the story of the credit crunch fundamentally is a banking story.5 Although there is now a severe lack of confidence in banks, the credit crunch predated and contributed to this lack of confidence; although the lack of confidence, in turn, is now making the credit crunch worse. SECURITIZATION AND CREDIT The credit crunch started with the breakdown of securitization and other financial markets for debt. Securitization is a process whereby consumer financial...

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