'Too Big to Live'

The crisis is a result of at least eight distinct but related failures:

·Too-big-to-fail banks have perverse incentives; if they gamble and win, they walk off with the proceeds; if they fail, taxpayers pick up the tab.

·Financial institutions are too intertwined to fail; the part of AIG that cost America’s taxpayers $180 billion was relatively small.

·Even if individual banks are small, if they engage in correlated behavior – using the same models – their behavior can fuel systemic risk;

.Incentive structures within banks are designed to encourage short-sighted behavior and excessive risk taking.

·In assessing their own risk, banks do not look at the externalities that they (or their failure) would impose on others, which is one reason why we need regulation in the first place.

·Banks have done a bad job in risk assessment – the models they were using were deeply flawed.

·Investors, seemingly even less informed about the risk of excessive leverage than banks, put enormous pressure on banks to undertake excessive risk.

...banks that are too big to fail are too big to exist. If they continue to exist, they must exist in what is sometimes called a “utility” model, meaning that they are heavily regulated.

Joseph E. Stiglitz, Project-Syndicate, Dec-2009