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Fed governor wants banks to shrink

By Claes Bell, CFA · Bankrate.com
Sunday, October 14, 2012
Posted: 6 am ET

One of the biggest criticisms of the Dodd-Frank financial reform law is that it doesn't do enough to protect the U.S. from the threat of a megabank like Citigroup or Bank of America failing and bringing the whole financial system crashing down with it.

Lately, financial notables from Chairman Sheila Bair, former chairman of the Federal Deposit Insurance Corp., to former Citi CEO Sandy Weill have suggested it might be time to cut the big banks down to size.

This week, Federal Reserve Gov. Daniel Tarullo joined the conversation, seeming to endorse the idea that regulators should set a firm limit on the size of U.S. banks in a speech at the University of Pennsylvania:

The idea along these lines that seems to have the most promise would limit the nondeposit liabilities of financial firms to a specified percentage of U.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.

Basically, Tarullo wants to trim banks' nondeposit liabilities down to a percentage of the U.S. economy small enough that if a megabank does fail, it wouldn't bring us all down with it.

With a seat on the rate-setting Federal Open Market Committee, Tarullo is a powerful man and his proposal seems less radical than other calls to split megabanks down the middle into consumer banks and investment banks. But as he acknowledged in his speech, it would take an act of Congress and a significant paring down of the banks to make it happen and that seems unlikely, considering the amount of sway that megabanks have on Capitol Hill these days.

Still, the fact that the biggest banks are being attacked from two sides at this point is definitely interesting. On one side, you have regulators and scholars who think they present a clear danger to the economy that's unabated by measures in Dodd-Frank. On the other side, you have business folks and analysts who criticize big banks for their poor returns to stockholders.

So, depending on the outcome of the election, we could see the idea get some traction in Congress, especially if there's another big disruption in the banking system in the near future.

What do you think? Should the big banks be reduced in size?

Follow me on Twitter: @ClaesBell.

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2 Comments
Mark F. Lapham
October 14, 2012 at 1:48 pm

Every major growth period of modern economic history has commenced with a surge in residential construction. With mortgage rates at historic lows and far more bank credit available than the banks can lend, why is our housing recovery anemic, insufficient to accelerate economic growth? It’s because the community-based institutions which historically funded housing booms have been forced by deregulation into unequal competition and a negative spiral of speculative lending contrary to their natural purpose.

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