Global Markets Institute: Effective Regulation - Part 5: Ending "Too Big To Fail"

In the fifth paper in a series on financial-market regulation, the Global Markets Institute discusses how financial reform must effectively eliminate the concept of “too big to fail” if it is to succeed. One of the most promising proposals for this is contingent capital. Structured as debt that converts into common equity when a firm is in financial distress, contingent capital is a form of self-insurance for systemically important firms. Correctly structured, it would force troubled firms to recapitalize early and quickly, and at the expense of shareholders and contingent bondholders -- not taxpayers. Back-tests indicate that contingent capital triggered by a process modeled after the U.S. “stress test” would have allowed the firms that were included in the stress test to recapitalize without taxpayer funds. Proper structuring is essential; done right, contingent capital could be more effective in improving financial firm incentives than a simple increase in regulatory capital requirements would be.


>> Effective Regulation: Part 5 - Ending "Too Big To Fail" December 2009 [PDF, 316 KB]