MacroScope

Too big to exist? Fed’s regulation czar backs limits on bank size

October 11, 2012

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Regional Federal Reserve Bank presidents who oppose quantitative easing have made little way in convincing the central bank’s dovish core. Apparently, not so on the cause célèbre of policymakers like Richard Fisher at the Dallas Fed, who have called for too big to fail banks to be broken up.

In a speech this week, Fed board governor and regulation czar Daniel Tarullo stopped short of calling for outright break-ups. But he did take the unprecedented step of backing size limitations on banks that would be linked to overall U.S. economic output.

In his own words:

In these circumstances, however, with the potentially important consequences of such an upper bound and of the need to balance different interests and social goals, it would be most appropriate for Congress to legislate on the subject. If it chooses to do so, there would be merit in its adopting a simpler policy instrument, rather than relying on indirect, incomplete policy measures such as administrative calculation of potentially complex financial stability footprints.

The idea along these lines that seems to have the most promise would limit the non-deposit liabilities of financial firms to a specified percentage ofU.S.gross domestic product, as calculated on a lagged, averaged basis. In addition to the virtue of simplicity, this approach has the advantage of tying the limitation on growth of financial firms to the growth of the national economy and its capacity to absorb losses, as well as to the extent of a firm’s dependence on funding from sources other than the stable base of deposits. 

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