November 16, 2012

In a dinner speech, New York Fed President William Dudley took on those who would simply break up big banks and abandon the more measured approach taken in the 2010 Dodd-Frank financial reform bill, which aims to reduce the likelihood of banks failing and lessen the cost to society if they do.

The wide-ranging law was the U.S. response to the 2007-2009 financial crisis, in which the Fed and other regulators orchestrated a government bailout of major firms that were interconnected in a financial web that put the global system at risk.

So-called too-big-to-fail banks are those perceived to have an implicit government backstop.

"Too big to fail is an unacceptable regime," Dudley told a dinner gathering of financial professionals. "The good news is there are many efforts underway to address this problem. The bad news is that some of these efforts are just in their nascent stages."

Some, including Dallas Federal Reserve Bank President Richard Fisher, have advocated breaking up too-big banks. Fisher has repeatedly argued that the five biggest U.S. banks should be sliced up to protect the economy from another crisis.

Without naming any backers of this plan, Dudley said such a move would be a "complicated business," and warned that limiting banks' size cold sacrifice socially useful benefits that come with operating globally.

Dudley said it would be helpful if advocates of breaking up big banks "put a bit more flesh on the bones and develop detailed proposals that address essential questions of how such downsizing or functional separation would be accomplished, and what benefits and costs could be expected."

He listed seven questions that would need to be answered around the break-up process, adding he was "open-minded."

While breaking up too-big-to-fail banks "could yet prove necessary," he added, "it is premature to give up on the current approach: changing the incentives facing large and complex firms, forcing them to become more resilient, and making the financial system more robust to their failure."

Dudley's comments suggest that regulators are still keenly worried that massive and complex banks can threaten the financial system, four years after the worst of the crisis.

Illustrating the range of approaches within the Fed alone, Fed Governor Daniel Tarullo recently surprised Wall Street when he called on Congress to legislate "an upper bound point of reference" for banks based on their percentage of U.S. gross domestic product.

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