"TOO BIG TO FAIL": RATIONALE, CONSEQUENCES, AND ALTERNATIVES


      The "Too Big to Fail" (TBTF) doctrine was formalized in light of the liquidity crisis at Continental Illinois Bank in 1984 The objective of this policy is to preserve public confidence in banking institutions and thereby avoid the systemic problems associated with large bank failures. This article reviews the history of the TBTF policy, critically appraises its rationale and success, and discusses the serious economic consequences associated with TBTF. The moral hazard problems arising from the combination of TBTF, lax capital standards and a flat rate system of deposit insurance are examined. Alternatives to TBTF are suggested.
    IN THE WAKE of the Continental Illinois bank liquidity crisis, the Comptroller of the Currency testified to Congress on September 19, 1984, that some banks were just "too big to fail" (TBTF), and in these cases total deposit insurance protection would be provided, rather than enforcing the statutory $100,000 per account limit. In his testimony, the Comptroller admitted that banks included in the TBTF policy were the eleven largest. The next day, the Wall Street Journal identified these banks as BankAmerica, Bankers Trust, Chase Manhattan, Chemical Bank, Citibank, Continental Illinois, First Chicago, J. P. Morgan, Manufacturers Hanover Trust, Security Pacific, and Wells Fargo.(n1)