(1) It finally allows underwater borrowers to exercise an option that investors knew existed when they purchased mortgage backed securities--the prepayment option. Right now, the fact that borrowers are underwater allows investors to earn a windfall by collecting a premium on what is effectively a callable bond.
(2) It imposes a Pigou tax on large banks. When a small bank fails, the negative externality is small to non-existent. When a TBTF bank fails, the negative externality can be catastrophic. Taxes on large banks help internalize the externality.
(2) It imposes a Pigou tax on large banks. When a small bank fails, the negative externality is small to non-existent. When a TBTF bank fails, the negative externality can be catastrophic. Taxes on large banks help internalize the externality.
