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Schwarcz, Steven L. --- "Too Big to Fail? Recasting the Financial Safety Net" [2010] ELECD 693; in Mitchell, E. Lawrence; Wilmarth, Jr, E. Arthur (eds), "The Panic of 2008" (Edward Elgar Publishing, 2010)

Book Title: The Panic of 2008

Editor(s): Mitchell, E. Lawrence; Wilmarth, Jr, E. Arthur

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9781849802611

Section: Chapter 4

Section Title: Too Big to Fail? Recasting the Financial Safety Net

Author(s): Schwarcz, Steven L.

Number of pages: 22

Extract:

4. Too big to fail?: recasting the
financial safety net1
Steven L. Schwarcz2

Government safety nets in the United States and abroad focus anachronisti-
cally 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 encour-
ages 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 ...