The failure of 'too big to fail'

Part 3: Preventing another crisis

TBTF firms are "too big to fail," meaning that their failure to meet their obligations would have such devastating effects on the financial system as a whole that government is forced to protect their creditors. Such rescues are costly to taxpayers, politically disruptive, and (by establishing a rescue precedent) pave the way for even more costly rescues in the future.

For reasons discussed last week, policies designed to convert TBTF firms into firms that are not TBTF are unlikely to be enacted. The alternative to rescuing such firms is to prevent them from getting into trouble in the first place by effectively regulating their risk exposures.