Too Big To Fail

The phrase "too big to fail" was actually coined in 1984 during the Continental Illinois bank failure, where, during hearings a senior government official let slip that probably the top 11 banks in America were "too big to fail." Continental Illinois was the 7th largest bank at the time. Shareholders basically wiped out, but bond-holders were bailed out.

The author of the book Too Big to Fail (written in 2004!) made the following comment (paraphrased)

Bondholders can assume that they will be paid in full by the government. So, they stop caring whether the bank they are lending to will be prudent. Thus, risk is under-priced and when something is priced too low, you consume more of it than you might normally, .e.g. the bank actually takes larger risks.

I guess this logic also applies to small creditors like depositors who can rely on FDIC.

So, the perverse incentives for banks would be to be very big, and also have a lot of interconnections, counter-parties, etc. to make sure you are a major systemic risk.

.......

How about restaurants? Do you ever consider going in a restaurant but then have second thoughts based on cleanliness, lack of other customers, chef coughing over my food, etc.? I do.

But I never worry about what the hell my bank is up to behind the scenes. Are they lending my money to goat turd entrepreneurs or itinerant patent trolls? Don't care.

Is this a poor analogy?