What would be actual consequences if banks (or other large companies) weren’t bailed out by the government. Would financial crashes be worse?
In: Economics
>Would financial crashes be worse?
In most cases, yes. Bailouts in the past have been done to restore or maintain confidence on the financial markets. Smaller investment oriented banks have been allowed to crash (e.g. Lehman Brothers) as the fallout has limited impact – people and organisations who have interests in investments are well aware that there are risks involved.
But larger banks, and especially those who deal in retail banking and business loans, can have a significant cascading effect if they are allowed to fail. If word gets out that those banks are likely to fail, then a run on the bank starts (people withdrawing and transferring all liquidity out of their accounts) which reduces liquidity and makes the fall inevitable. In the case of business loans, people stop borrowing money, which then cripples the flow of money from the other direction.
Basically, the whole global financial system is dependant on flow of money. Once that gets squeezed, it collapses.
Edit: that may all be a bit too oversimplified: there are leveraging effects to take into account, which mean that even some small changes can have an outsized impact, as well as concerns for the different types of money supply (M1, M2, M3 etc))
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