Consequently, the government has an incentive to step in and bail out these banks in order to prevent a systemic meltdown. Banks that were deemed “too big to fail” therefore operated with implicit government support that was provided free of charge. Such support, however, can induce banks to engage in risky transactions.
If things go well they take the profit, but if things go wrong the taxpayer foots the bill. Obviously, this is a less than optimal situation from any point of view but the banks’. How can we solve this problem? The first step is to reduce the likelihood of a large bank failing.