Let's speculate a bit more. There are two possible outcomes to letting a large bank/financial institution fail:
1. Financial institutions cannot transfer funds between each other as usual and they cannot accurately predict who might fail next, so they pull back credit access. Spreads blow up as money supply decreases, causing a sharp decline in equipment investment and a big rise in consumer interest rates. Shit gets worse from there.
2. Banks die and, in conflict with everything we know about liquidity, money continues to flow perfectly. Banks are not afraid of failure so credit flows freely.
What do you see as more likely? Can you sum it up in a one-word answer?
You're probably right - if they'd just been allowed to collapse we'd be in serious trouble.
However we're still in serious trouble because of the moral hazard created. Banks have been given the greenlight to take similar risks again because they know they'll be bailed out in future.
Frankly, without also taking steps to force banks back into smaller entities that we can afford to let fail, all we've done is compound the problem and delay it until later when it will be worse.
Is it better to force banks into smaller entities, exerting government control over the marketplace, or let their investors lose their pants when the banks take stupid risks, allowing the marketplace to correct itself?
Well personally, I'd prefer the latter, but if it really was going to crash the economy completely, then the former might be necessary. But the only point in forcing them into smaller entities would be so that in future they would be allowed to fail.
1. Financial institutions cannot transfer funds between each other as usual and they cannot accurately predict who might fail next, so they pull back credit access. Spreads blow up as money supply decreases, causing a sharp decline in equipment investment and a big rise in consumer interest rates. Shit gets worse from there.
2. Banks die and, in conflict with everything we know about liquidity, money continues to flow perfectly. Banks are not afraid of failure so credit flows freely.
What do you see as more likely? Can you sum it up in a one-word answer?