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BlogGames at Work: Too Big To Fail

Games at Work: Too Big To Fail

Too_big_to_failBy Phil Read

One of the institutional games that has come into the spotlight over the last year or more is the game of "too big to fail". This is the game where a large financial institution takes on excessive risk.

The payoff is that if that risk taking yields high rewards that profit will be privately held (and distributed partly to shareholders, partly in the form of bonuses to senior staff); if it yields large losses which might threaten the viability of the institution the government will intervene to prevent this and so the losses will be publicly guaranteed through loans, financial injections etc. This is also called "moral hazard". The Treasury Secretary has been struggling with how to mitigate against this game through regulation (eg. requiring higher capital holdings for institutions that might be tempted to play this game).

In addition to these considerations, what is important I believe in minimising the likelihood of this game being played is:
- understanding whether allowing the size and market share of these larger financial institutions themselves is something which should be challenged
- understanding the web of incentivation for excessive risk taking versus the downsides for risk failure - not just at an institutional level, but also at an individual level (especially for senior management and the traders making the big bets)
 

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