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John Marshall Global Markets Law Journal

Abstract

The 2008 financial crisis led to controversial government bailouts of institutions that were deemed “too big to fail” (TBTF). Critics propose that systemic risk and TBTF were the main causes of the financial collapse of Bear Stearns and Lehman Brothers—two of the institutions that were at the center of the bailout controversy. These bailouts have been criticized as creating moral hazard which, for financial institutions, means that decision makers, counterparties, creditors, and shareholders will take fewer precautions and take on more risk since the government will bail them out. However, whether various market participants in fact take fewer precautions and incur more risk because of the possibility of a bailout is not proven; other factors exist which may dictate the decisions of a TBTF firm. This Article goes beyond the mere supposed direct causal link between bailouts and moral hazard, to examine the other possibilities which increase risk in a TBTF firm. Such factors include the effect of the executive compensation and the Investment Bank Business Model. This Article also considers the general nature of the asset manager relationship as promoting moral hazard insofar as the risk of personal loss is by nature minimal—there is no “skin in the game.” This Article examines these factors in light of the actions of Bear Stearns and Lehman Brothers before their respective meltdowns, and in view of the firms’ actions which were seemingly influenced by other factors rather than the possibility of a bailout. In view of these factors and the actions taken by such TBTF institutions, this Article suggests that a firm’s TBTF status and the possibility of a bailout may not actually effectuate the excessive risks that give way to failure. At most, the moral hazard encountered as a result of these considerations likely carries only minimal influence over decision makers when compared to the myriad of other factors they face.

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