How to Bail out Good Banks and Let Bad Banks Fail
Nobody wants to bail out bad banks, but to save a financial system from collapse requires preventing all banks from failing at the same time. A novel approach to supporting the whole but not the parts would be for a country’s central bank to put a floor under the value of the banking system by committing to buy shares in an index fund of bank stocks at a predetermined price.
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LOS ANGELES – How should large-scale systemic failures of a country’s financial system be addressed? Nobody wants to bail out banks that make bad decisions. But to save a financial system from collapse requires preventing all banks from failing at the same time. We need a way to bail out good banks but allow bad banks to fail. But how can we distinguish good banks from bad?