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Economics focus From bail-out to bail-in In a guest article, Paul Calello (pictured left), the head of Credit Suisse’s investment bank, and Wilson Ervin, its former chief risk officer, propose a new process for resolving failing banks Credit Suisse Jan 28th 2010 | From The Economist print edition WHAT should policymakers do when faced with the potential failure of a large bank? In 2008 officials had to choose between taxpayer bail-outs (bad) or systemic financial collapse (probably worse). Various ideas to make finance safer, like contingent capital and living wills, are circulating today. But the central issue of bank resolution, perhaps the most vexing aspect of the financial crisis, has not been clearly addressed. A “bail-in” process for bank resolution is a potentially powerful “third option” that confronts this problem head-on. It would give officials the authority to force banks to recapitalise from within, using private capital, not public money. The concept builds on time-tested procedures that have been used to keep airlines flying and industrial firms going even as their capital structures were being reorganised. It accelerates those procedures to address the unique circumstances of financial firms operating in today’s fast-moving markets. If done correctly it should strengthen market discipline on banks and reduce the potential for systemic risk. The best way to understand the idea is to look at how a bail-in could have changed the outcome for Lehman Brothers over that fateful weekend in September 2008. Despite intensive efforts to find a better alternative, the bankruptcy of Lehman became unavoidable by the end of the weekend. When the two of us left the New York Federal Reserve on Sunday night, we knew that the financial landscape was in for a seismic shock. Sunday, bloody Sunday So it proved. According to market estimates at the time, Lehman’s balance-sheet was under pressure from perhaps $25 billion of unrealised losses on illiquid assets. But bankr