Too Big to Fail = Too Big to Exist?

A number of former bank CEOs and bank regulators have said so. Now Federal Reserve governor Daniel Tarullo has joined the ranks of those arguing for a breakup of the biggest U.S. banks.

In a lecture at the University of Pennsylvania Law School, Tarullo pointed out that the top banks enjoy a continued aura of government-guaranteed invulnerability, which gives them a funding advantage and “reinforces the impulse to grow.” To counter this tendency, Congress might consider “specifying an upper bound,” Tarullo said.

The “idea along these lines that seems to have the most promise,” he went on, is a limit on nondeposit liabilities, possibly set at a percentage of U.S. gross domestic product. Such a formula would not only have “the virtue of simplicity,” Tarullo said, but also “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…”

Tarullo’s approach, as the Wall Street Journal’s Victoria McGrane observed, “takes direct aim at the biggest U.S. banks, including J.P. Morgan Chase & Co., Bank of America, Goldman Sachs, and Citigroup, “all of which rely heavily” on the kind of funding that Tarullo would limit.

Tarullo is the Fed governor in charge of bank supervision and regulation. McGrane described him as “the highest-ranking regulatory official to call for limiting the size of banks.”

Senator Sherrod Brown (D-Ohio) has introduced legislation that includes a bank-size cap pegged to GDP, as Tarullo proposed.