Editor's note: This is Part 2 of a multipart series. Read Part 1, "6 issues to steer financial reform," and Part 3, "The failure of 'too big to fail.' "The most traumatic and disruptive feature of the recent financial crisis was that the government was forced to rescue firms that had behaved recklessly. These firms were "too big to fail," meaning that the repercussions of their failure could have destabilized the entire system.The best analysis of this problem that I have seen is in "Wind-down Plans as an Alternative to Bailouts: The Cross-Border Challenges," by Richard Herring, a Wharton colleague. I have drawn heavily from his paper. Too-big-to-fail (TBTF) firms in some cases provide services that are critical to the functioning of markets, such as acting as a dealer or providing settlement or escrow services. In some cases, they own many hundreds of affiliates in foreign countries, failure of which become problems for each country's...
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