It was kind of a big deal coming from the Federal Reserve Bank of New York’s influential president William Dudley. The former Goldman Sachs partner and chief economist has offered a fig leaf to those who say the problem of banks considered too-big-to-fail must be dealt with more aggressively. Some regional Fed presidents have advocated breaking up these institutions. But Dudley and other powerful figures at the central bank have maintained recent financial reforms have already laid the groundwork for resolving the issue.
At a gathering of financial executives in New York last week, Dudley said he prefers the existing approach of making it costlier for firms to become big in the first place. Still, he left open the possibility of tackling the mega-bank problem more directly:
Should society tolerate a financial system in which certain financial institutions are deemed to be too big to fail? And, if not, then what should we do about it?
The answer to the first question is clearly ‘no.’ We cannot tolerate a financial system in which some firms are too big to fail—at least not ones that operate in any form other than that of a very tightly regulated utility.
The second question is the more interesting one. Is the current approach of the official sector to ending too-big-to-fail the right one? I’d characterize this approach as reducing the incentives for firms to operate with a large systemic footprint, reducing the likelihood of them failing, and lowering the cost to society when they do fail. Or would it be better to take the more direct, but less nuanced approach advocated by some and simply break up the most systemically important firms into smaller or simpler pieces in the hope that what emerges is no longer systemic and too big to fail?