Too Big To Fail: The Hazards of Bank Bailouts »

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.

The potential failure of a large bank presents vexing questions for policymakers. 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 important new 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 losses 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.

Foreword Paul A. Volcker vii

Preface to the Paperback Edition xi

Preface to the First Edition xix

1 Introduction: Our Message and Methods 1

1 Warnings 9

2 What Is the Problem? 11

3 Why Protection Is Costly 23

4 How Pervasive is TBTF? 29

5 Why Protect TBTF Creditors? 43

6 The Growth of TBTF Protection 60

7 Testing Our Thesis: The Cases of Not Too Big to Fail 80

2 Options 87

8 Can the Problem Be Addressed? 89

9 Creating the Necessary Foundation 98

10 Reducing Policymakers' Uncertainty 111

11 Limiting Creditor Losses 124

12 Restricting Payment System Spillovers 132

13 Alternatives for Managing Too Big to Fail 141

14 Summary: Talking Points on Too Big to Fail 146

Appendixes

A FDICIA: An Incomplete Fix 149

B Penalizing Policymakers 159

C Supervision and Regulation 168

D Increasing Market Discipline 179

References 197

Index 223