Too Big to Fail: Causes, Consequences, and Policy Responses

Posted: 8 Nov 2013

See all articles by Philip E. Strahan

Philip E. Strahan

Boston College - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: November 2013

Abstract

Governments cannot credibly commit to eschew bailouts of creditors when large financial institutions become distressed. This too-big-to-fail (TBTF) problem distorts how markets price securities issued by TBTF firms, thus encouraging them to borrow too much and take too much risk. TBTF also encourages financial firms to grow, leading to competitive inequity and potential misallocation of credit. This review discusses evidence that such distortions are empirically relevant and also discusses the policy efforts to limit them. In the wake of the Financial Crisis of 2007–2008, it seems increased concentration in the financial industry has worsened the TBTF problem. Nevertheless, markets price the risks of large financial firms more now than before the Financial Crisis.

Suggested Citation

Strahan, Philip E., Too Big to Fail: Causes, Consequences, and Policy Responses (November 2013). Annual Review of Financial Economics, Vol. 5, pp. 43-61, 2013, Available at SSRN: https://ssrn.com/abstract=2351829 or http://dx.doi.org/10.1146/annurev-financial-110112-121025

Philip E. Strahan (Contact Author)

Boston College - Department of Finance ( email )

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