Too Big to Fail as a Game of Chicken with the State: What Insolvency Law Theory Has to Say About TBTF and Vice Versa

Governments have bailed out banks that were considered too big to fail (TBTF). In an attempt to end these bail-outs, the European Commission has presented a proposal for a Directive for a European framework for the recovery and resolution of credit institutions and investment firms. This article analyses what insolvency law theory has to say about TBTF and vice versa. The dominant insolvency law them), the creditors' bargain theory (CBT), does not do well in explaining the problems presented by TBTF. The CBT frames insolvency law as a set of rules to overcome common pool problems, most notably to prevent a destructive race to the assets by individual creditors. The problems TBTF presents, however, do not primarily relate to a race to the assets. In order to understand the TBTF problem and key elements of the Directive's response (capital write-down and bail-in), the CBT needs to be supplemented with the property law theory of anticommons and its explanation of hold-out behaviour. Common pool problems and anticommons problems have different game-theoretical companions. Whereas common pool problems can be explained by the prisoners' dilemma, anticommons can trigger a game of chicken. In the case of TBTF, shareholders and creditors can engage in this game of chicken with the state. The Directive sends out the message that states will no longer be drawn into playing this game.