Ending "Too Big to Fail": Government Promises vs. Investor Perceptions

56 Pages Posted: 22 Oct 2011 Last revised: 1 Nov 2011

See all articles by Todd A. Gormley

Todd A. Gormley

Washington University in St. Louis

Simon Johnson

Massachusetts Institute of Technology (MIT) - Entrepreneurship Center; National Bureau of Economic Research (NBER)

Changyong Rhee

Asian Development Bank

Date Written: October 2011

Abstract

Can a government credibly promise not to bailout firms whose failure would have major negative systemic consequences? Our analysis of Korea's 1997-99 crisis, suggests an answer: No. Despite a general "no bailout" policy during the crisis, the largest Korean corporate groups (chaebol) - facing severe financial and governance problems - could still borrow heavily from households through issuing bonds at prices implying very low expected default risk. The evidence suggests "too big to fail" beliefs were not eliminated by government promises, presumably because investors believed that this policy was not time consistent. Subsequent government handling of potential and actual defaults by Daewoo and Hyundai confirmed the market view that creditors would be protected.

Suggested Citation

Gormley, Todd A. and Johnson, Simon and Rhee, Changyong, Ending "Too Big to Fail": Government Promises vs. Investor Perceptions (October 2011). NBER Working Paper No. w17518. Available at SSRN: https://ssrn.com/abstract=1947175

Todd A. Gormley (Contact Author)

Washington University in St. Louis ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
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(314) 935-7171 (Phone)

HOME PAGE: http://www.gormley.info

Simon Johnson

Massachusetts Institute of Technology (MIT) - Entrepreneurship Center ( email )

United States
617-253-8412 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Changyong Rhee

Asian Development Bank ( email )

6 ADB Avenue, Mandaluyong City 1550
Metro Manila
Philippines

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