The Political Economy of Too-Big-To-Fail

25 Pages Posted: 21 Dec 2018

See all articles by J. Atsu Amegashie

J. Atsu Amegashie

University of Guelph - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: December 3, 2018

Abstract

I consider a two-period model in which being "too big" is only a necessary condition for an insolvent firm to receive a government bailout because, in addition to meeting a threshold asset size, the firm must engage in a lobbying contest in order to be bailed out. The firm has a political advantage because its probability of winning the contest is increasing in its size. When the firm experiences an unfavorable price shock, I find that the balance between the size of the requisite bailout and the firm's political advantage of being "too big to fail" determines the firm's probability of getting a bailout. Surprisingly but consistent with the US government's differential treatment of Lehman Brothers and Bear Stearns during the 2008-2010 financial crisis, I find that a smaller firm may receive a bailout while a bigger firm will not, although both firms meet the threshold size of "too big to fail" and a firm's political advantage is increasing in its size.

Keywords: insolvency, bail-out, biased contest, political advantage, too-big-to-fail

JEL Classification: O10, P16, P48

Suggested Citation

Amegashie, J. Atsu, The Political Economy of Too-Big-To-Fail (December 3, 2018). Available at SSRN: https://ssrn.com/abstract=3295132 or http://dx.doi.org/10.2139/ssrn.3295132

J. Atsu Amegashie (Contact Author)

University of Guelph - Department of Economics ( email )

50 Stone Road East
Guelph, Ontario N1G 2W1
Canada
519-824-4120 (Phone)
519-763-8497 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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