Are Bailouts Inevitable?

Abstract

The "too systemically important to fail" problem is one of the most intractable problems of our time. During the financial panic of 2008, governments around the world decided to use taxpayer funds to rescue their most important financial institutions rather than allow them to be liquidated at fire-sale prices. Policymakers have developed measures to make future failures less likely or severe. If failures nevertheless occur, however, regulators will want to resolve systemically important institutions in a way that provides a credible alternative to taxpayer-funded bailouts. This Essay establishes an economic model for testing when a proposed solution is credible. It applies that test to proposals for a new Chapter 14 to the Bankruptcy Code and to the FDIC's new resolution authority, examining especially the FDIC's possible use of this authority to recapitalize the systemically important and viable parts of a failed institution and liquidate the rest without cost to taxpayers.