“I suppose we should talk about the Financial Stability Board's new global anti-too-big-to-fail proposal? Here it is. The basic theory makes sense. You have a bank. A bank is a collection of probabilities. You can estimate how much its assets are worth. But the assets may be worth much more, or much less, than you think.1
People have claims on the bank's assets. If the assets are worth less than you think, then those claims are worth less than you think. Some of those claims are Important: It would be Bad, for the world, for some definition of the world, if those claims were worth less than you think. Bank deposits are, classically, Important; so are other bank liabilities that are necessary for the functioning of markets and the monetary system. There are various ways to guarantee against those claims being impaired when the bank loses money. One is, if the Important claims are impaired, the government will just step in and make the Important claimants whole. This is called a "bailout," more or less, and is widely perceived as Bad.”
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