How to allow large banks to fail

Use credit default swaps to determine their solvency.

This requires making CDS more transparent, by trading them on an open exchange.

When the CDS prices fall enough, and a “stress test” confirms the bank has taken on unjustifiable levels of risk, it goes into receivership. Shareholders are out of luck. Creditors take a hair cut. It would be, in effect, a mild form of bankruptcy. But the bank would not end up taking everyone else down with it.

Incidentally, [i]National Affairs[/i] has some of the best policy essays available (mostly) free online that I’ve seen in a while.