Bailouts of Systemically Relevant Banks Do Not Create Moral Hazard

Many economists and policy-makers believe that bailouts of systemically important financial institutions (SIFIs), though unavoidable ex post, are inefficient ex ante: The expectation of such bailouts is said to lead to moral hazard in the form of excessive risk taking. We argue that this view may be true for non-systemically relevant banks, but misleading for SIFIs. To the degree that an institution neglects the systemic damage of its potential failure it will take excessive risk even under laissez-faire, i.e., in the absence of a state and hence of bailouts. Bailouts of such institutions, even if anticipated ex ante, are likely to reduce moral hazard