Legal and Political Toolkits to Rescue Major Financial Institutions

This chapter delves into the array of legal and political strategies for bailing out major financial institutions. The realm of possibilities has continued to expand since the global financial crisis (GFC) of 2008. Specifically, it is argued that a great deal of the concerns revolves around the lessons drawn from the collapse of Lehman Brothers in 2008. Supposedly, the failure to rescue Lehman Brothers was intended to maintain constructive ambiguity within the system, thereby reducing moral hazard. However, this strategy backfired, resulting in a cascade of financial institution bailouts to avert systemic collapse. The subsequent bailout of numerous entities is argued to have eventually exacerbated moral hazard. Financial crises or bailouts can impose heavy costs and exacerbate the public debt problem. Therefore, it is important to address the sovereign risk and “too-big-to-fail” (TBTF) issues. This chapter examines the tools available to rescue major financial institutions. The choice of the tool depends on the desired objective. Initially, the focus was laid on curbing moral hazard and minimizing state intervention. In particular, the bail-in mechanism developed as a response to the shortcomings of the bailouts is aligned with the idea of having losses absorbed by investors and creditors rather than taxpayers. However, subsequent mechanisms imply more state involvement. In particular, the temporary public ownership (TPO) regime reinforces the public–private interdependence. Another possibility consists of establishing a bridge bank. A combination of tools is frequently employed, tailored to specific circumstances. In 2023, in the case of Credit Suisse, authorities opted for emergency laws rather than utilizing available recovery and resolution mechanisms under Swiss legislation. The growing emphasis on preventing stigma (i.e., the risk that a systemic bank may be identified as a user of an urgent lending facility or a recipient of extraordinary public support, which would be perceived as a signal that the bank is weak) leads to the development of early assistance mechanisms. However, this shift nurtures moral hazard, strengthens the public–private nexus, and weakens the credit position of the government acting as a lender of last resort (LOLR).