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Fed Governor Daniel Tarullo: Break Up the Banks

In an announcement that would have really helped two years ago, Federal Reserve Governor Daniel Tarullo called for a size cap on the largest financial firms. Tarullo is the point person at the Fed for bank policy, including consumer protection and regulatory measures. So he’d be in the best position in that organization to know about the necessity of size caps.

In a Philadelphia speech, Fed governor Daniel Tarullo recommended curbing banks’ growth by putting a limit on their nondeposit liabilities, which are sources of funding for operations that go beyond consumer deposits. The idea takes direct aim at the biggest U.S. banks, including J.P. Morgan Chase & Co., Bank of America Corp., Goldman Sachs and Citigroup Inc., all of which rely heavily on such funding. Firms outside of this tier make much greater use of regular deposits […]

Mr. Tarullo’s suggestion would cap banks’ nondeposit liabilities—which are usually some form of debt, such as short-term borrowings—at a fixed percentage of the U.S. economy, a number he didn’t specify.

“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,” he said.

While I don’t expect Congress to return to Washington tomorrow and pass Brown-Kaufman, where this may come into play in the near term is that Tarullo also said that the Fed should block any merger or acquisition by the big banks. Since the financial crisis of 2008, these banks have grown in size and market share by swallowing up their competitors, often at the behest of the US government. So for Tarullo to say that the Fed should use the power granted to it by Dodd-Frank to block all future mergers, specifically to preserve the stability of the financial system, is a big deal. Tarullo said that further expansion would increase the perception that the biggest banks are too big to fail, which implicitly grants that they are already too big to fail as it standas now.

There has been over the past year or so an academic debate about breaking up the banks. Former and current Fed regional bank Presidents on the right, like Richard Fisher and Thomas Hoenig (now of the FDIC), have called for the biggest banks to be broken up. The same figures on the left who promoted Brown-Kaufman, which would have capped bank size in Dodd-Frank, support it as a bulwark against instability in the financial system. Former Citigroup Chair Sandy Weill improbably endorsed the idea. Now you have Tarullo as the highest-ranking regulator to join this chorus. Things move slowly in regulatory circles. But the intellectual underpinnings are being built, which is critical for the opportunity moment to implement this step. Unfortunately, we’re probably going to need another unnecessary financial crisis to get there.

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David Dayen

David Dayen