The Too Big For Fail Policy Essay example

1309 Words Nov 2nd, 2016 6 Pages
Over the past decade, the “too-big-to-fail policy” has caused a slow deterioration of the US financial system in many ways. This term was coined after the financial crisis of 2008, and is more formally known as the “problem in which regulators are reluctant to close down large financial institutions because doing so might precipitate a financial crisis (Mishkin p.218).” In this situation, the government issues guarantees of settlements of uninsured creditors to large financial institutions. The government does this so that neither the depositor nor the creditor incurs a loss. The transaction is done by the FDIC (Federal Deposit Insurance Corporation) and is completed through the purchase and assumption method. This phenomenon brings up many problems, most notably increasing the amount of moral hazard incentives for large banks. The long-term issue is that this may cause larger financial institutions to take on greater risks, which could lead to a spike in the amount of bank failures. One instance in which the “too-big-to-fail policy” has been used goes in part with AIG Insurance Company. The problem that AIG ran into involved their business with credit default swaps. Originally, AIG mostly did business with traditional insurance products; however, after getting involved with credit default swaps the company incurred a lot more risk as well as to the institutions that bought the swaps. The swaps AIG invested in had to do with subprime mortgages. The problem that arose was…

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