During the 2007–10 financial crisis, the US government decided that some institutions were too big to fail—and bailed them out.
Now research by Chicago Booth’s Lin William Cong, Stanford University’s Steven Grenadier, and Booth PhD candidate Yunzhi Hu adds to the discussion that among the too-big-to-fail institutions, some may actually be too big to save first. They suggest that when bailouts are being considered, a better sequence of events could involve saving the relatively smaller institutions first.
The researchers model runs on money-market mutual funds and on the financial commercial-paper market, following Lehman Brothers’ failure in 2008. In that case, the Federal Reserve essentially provided unlimited insurance to those investors, which quickly stopped the panic selling. The researchers illustrate how policy makers can utilize an initial intervention to shape the information available before future interventions, thus affecting investor reactions.
The theory suggests that policy makers should consider how interventions in markets with correlated fundamentals relate to one another. In many cases, if an initial intervention is successful, less is needed in subsequent crises to reassure investors that fundamentals are sound and that the central bank can control a market meltdown. But if the first intervention fails, investors will be even more pessimistic, and a second has to be much bigger to avert a run.
One of the research’s findings suggests that, considering the funds to be bailed out, it could be beneficial to target smaller institutions as the first bailout recipients. Successfully rescuing smaller institutions, which are cheaper to save, would in general make a later bailout of a bigger institution less expensive and more likely to succeed. The researchers contend that some funds are “too big to save first” because they would benefit more from broader investor optimism that earlier, less costly bailouts could establish.
The study also considers how one country’s investors learn from the outcomes of another country’s interventions, particularly in interdependent countries such as those in the European Union. Coordinating central-bank interventions, the researchers suggest, would lead to more-effective and less-costly intervention policy for each government.
While consumers are a little hazy about overall inflation, asking them about prices for individual categories yields more realistic forecasts.
People Can Forecast Price Rises—If Asked the Right Questions
The number of workers large companies typically employ in a single place has fallen.
What the Growth of Big Business Means for Jobs
Conventional economic analysis of slavery overlooks the costs imposed upon the people who were enslaved.
Emancipation May Have Generated the Largest Economic Gains in US HistoryYour Privacy
We want to demonstrate our commitment to your privacy. Please review Chicago Booth's privacy notice, which provides information explaining how and why we collect particular information when you visit our website.