As the memories of the cataclysmic events of the fall of 2008 recede, we run the risk of failing to apply their lessons. Many things went wrong, mistakes were made, and important lessons must be learned. One lesson is that we must master the art of dealing with large failing nonbanking institutions.
We have a safety net (maintained by the Federal Reserve and Federal Deposit Insurance Corp.) and an extensive regulatory regime wrapped around depository institutions. But over the past quarter century, much of our financial system moved from regulated banks and thrifts into a relatively unregulated "shadow" banking system. Bankruptcies and bailouts were tried for these large nonbank firms during 2008, and both were found severely lacking. Is this Hobson's choice inevitable when large nonbank financial firms stumble?