Although "too big to fail" (TBTF) has been a perennial policy
issue, it was highlighted by the near-collapse of several large
financial firms in 2008. Financial firms are said to be TBTF when
policymakers judge that their failure would cause unacceptable
disruptions to the overall financial system, and they can be TBTF
because of their size or interconnectedness. In addition to
fairness issues, economic theory suggests that expectations that a
firm will not be allowed to fail creates moral hazard-if the
creditors and counterparties of a TBTF firm believe that the
government will protect them from losses, they have less incentive
to monitor the firm's riskiness because they are shielded from the
negative consequences of those risks.
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