The potential failure of a large bank presents vexing questions for policy-makers. It poses significant risks to other financial institutions; to the financial system as a whole; and possibly to the economic and social order. Because of such fears; policymakers in many countries - developed and less developed, democratic and autocratic - respond by protecting bank creditors from all or some of the losses they otherwise would face. Failing banks are labeled "too big to fail" (or TBTF).

This book examines the issues surrounding TBTF, explaining why it is a problem and discussing ways of dealing with it more effectively. Gary Stern and Ron Feldman, officers with the Federal Reserve, warn that not enough has been done to reduce creditors' expectations of TBTF protection. Many of the existing pledges and policies meant to convince creditors that they will bear market loses when large banks fail are not credible, resulting in significant net costs to the economy.

The authors recommend that policymakers enact a series of reforms to reduce expectations of bailouts when large banks fail.

About the Author
Gary H. Stern is president and chief executive officer of the Federal Reserve Bank of Minneapolis. He also serves as chairman of the board of directors of both the National Council on Economic Education and the Northwest Area Foundation.

Ron J. Feldman is assistant vice-president at the Federal Reserve Bank of Minneapolis. His recent articles include Mortgage Rates, Homeownership Rates, and Government-Sponsored Enterprises (The Region, 2002).

Read an Excerpt from Too Big to Fail: The Hazards of Bank Bailouts

Hardcover: 240 pages
Authors: Gary H. Stern, Ron J. Feldman
Publisher: Brookings Institution Press (March 2004)
Language: English
ISBN-10: 0815781520
ISBN-13: 978-0815781523

Introduction: Our Message and Methods

Summarizing the warnings and options of this book requires a little background for the uninitiated. We start with the trivial observation that banks fail. Some banks fail without notice. Other failing banks capture the attention of policymakers, often because of the bank's large size and significant role in the financial system.

Determining the appropriate policy response to an important failing bank has long been a vexing public policy issue. The failure of a large banking organization is seen as posing significant risks to other financial institutions, to the financial system as a whole, and possibly to the economic and social order. Because of such fears, policymakers in many countries—developed and less developed, democratic and autocratic—respond by protecting uninsured creditors of banks from all or some of the losses they otherwise would face.

These banks have assumed the title of "too big to fail" (TBTF), a term describing the receipt of discretionary government support by a bank's uninsured creditors who are not automatically entitled to government support (for simplicity we use creditors and uninsured creditors synonymously from here on). ...

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