siontomakethepassageofTARPmorelikely.ThuswewillneverknowifthemarketdownturnthatfollowedtheLehmanbankruptcyreflectedfearofcontagionfromLehmantotherealeconomyorfearofthedepthsofexistingproblemsintherealeconomythatwerehighlightedsodramaticallybyregulators.Inthispaperweanalyzethemechanismsbywhichsuchriskcouldcauseaneconomy-widecol-lapse.Wefocusontwotypesofcontagionthatmightleadtosystemicriskproblems:(1)informationcontagion,monriskfactors;or(2)counterpartycontagion,whereoneimportantfinancialinstitution’scollapseleadsdirectlytotroublesatothercred-itorfirmswhosetroublessnowballanddriveotherfirmsintodistress.TheefficacyofTBTFpoliciesdependscruciallyonwhichofthesetwotypesofsystemicriskmechanismsdominates.Counterpartycontagionmaywarrantinterventioninindividualbankfailureswhileinformationcontagiondoesnot.
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