Professor Edward Kane:

I should have said how bonds and insurance contracts are priced. People try to get a measure of the probability of default, or the probability of some event if it is an insurance contract, and the contingent loss given that event and put them together. It is much richer when we look at options. It should be priced as the difference between the put option, for the institution to be able to put losses on the taxpayer, and the call option, for the taxpayer to be able to take over the firm. In the case of banks that are too big to fail, the call option is never exercised. Not looking at that as a put option and using the bond or insurance approach misses how important is forbearance. I do not remember seeing how the particular calculation is made but some co-authors and I put the figure 2 into the statement. We figured out what it was worth as a quarterly dividend to have guarantees across the banking system. It surged in late 2008 and early 2009 and has come down since. It will never go away and the value will be there until we change the incentives.