How Large is the Government Financial Safety Net?

The Richmond Fed estimates that 60 percent of the liabilities of the financial system are subject to explicit or implicit protection from loss by the federal government. This protection distorts the economy may encourage risk taking, making financial crises and bailouts more likely, and results in a competitive advantage to those whose liabilities are protected by the government.

The Bailout Barometer is the Richmond Fed's estimate of the share of financial system liabilities for which the federal government provides protection from losses. In addition to protection from explicit government guarantee programs, the estimate includes implicit protection that people are likely to infer from past government actions and statements. Despite efforts to end ad hoc bailouts, the financial safety net that protects certain firms remains large under current government policies, says the Richmond Fed .

The Richmond Fed notes:

When creditors expect to be protected from losses, they will overfund risky activities, making financial crises and bailouts like those that occurred in 2007-08 more likely. An extensive safety net also creates a need for robust supervision of firms benefitting from perceived protection. Over time, shrinking the financial safety net is essential to restore market discipline and achieve financial stability. Doing so requires credible limits on ad hoc bailouts.

 -RW