Question

What do you think is the right policy response to the "too big to fail" problem? What would you do about it if you were a policy maker?

Answer 1

Too big to fail problem arises with the complacency in top management of big companies  that government will come to rescue them as their fall will negatively affect the economy. It brings moral hazard among the management in their decision making process and they think that government will come to save them if problem comes.

In this context, the right policy response will be to bring stringent disclosure laws for the companies under the category of "too big to fail", setting up criminal inquiries if any management or other people found in wrong doing and review of the management decisions by close observation via independent directors. Here, one or few independent directors should be responsible towards the stakeholders such as common investors, and employees. Afterwards, if any organization fails, then the decision to support them, should be on a case to case basis and on the basis of past track record in terms of disclosures, transparency in operations and offering support to the government in reviewing their work.

If I would be there as a policy maker, then I will make it mandatory to put one director that will be from the government or sponsored by the government. On the basis of size of the organization, the disclosure requirements in terms of transactions, flow of funds and other important information should be disclosed to the public or investors. It will increase transparency and management will avoid speculative and moral hazard based decisions. Further, there will be strict rule that financial companies dealing with public's deposit, cannot go into speculative investments. These policy changes will help reduce the scope of moral hazard, agency conflicts and speculative investments that can save the company. Afterwards, if any company faces trouble, then the companies will be evaluated on a case to case basis. If support is forwarded, then management will be controlled by the government authorities.