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In the wake of the 2008 financial crisis, many economists have come to the stark realization that banks are, in fact, designed to fail — and they do so with disastrous effects.
In 2008, a series of interrelated financial events caused the collapse of major banks and financial institutions, leading to soaring unemployment and a dramatic downturn in the global economy. In the decade since, the overwhelming consensus has been that there was systemic failure amidst banks and financial regulators who allowed for the kinds of risky investments that set the stage for the financial collapse.
Central to the discussion on financial regulation is the idea that banks are, essentially, ‘too big to fail’. This notion is rooted in the assumption that if large banks, such as those implicated in the financial crisis, fail, the consequences would be so severe that the government would have to step in and provide a bailout— essentially imposing the costs of their failure onto taxpayers.
However, regulations designed to mitigate the risk of such a collapse are often inadequate. This is in part because of political pressure to deregulate banks, allowing them to take on more risk to in pursuit of short-term profits. Additionally, compensation schemes tied to short-term profits create incentives for individuals to take on risky investments with the possibility of short-term reward. Finally, obscene levels of complexity in the banking system make it nearly impossible to wind down a major bank in an orderly fashion.
In light of this, it appears that banks are indeed designed to fail — and failure is inevitable, if the pattern of recent decades is any indication. It is only through robust regulation, enforced without political pressures, which will allow for the financial sector to become more reliable and stable. Until then, the fear of major banking collapse will continue to weigh abundantly on the minds of citizens and regulators alike.