“Daniel Tarullo, a governor of the Federal Reserve System, spoke for the first time last week about potentially imposing a size cap on the largest U.S. banks. His language, naturally, was that of a central banker.
“To the extent that a growing systemic footprint increases perceptions of at least some residual too-big-to-fail quality in such a firm, notwithstanding the panoply of measures in Dodd- Frank and our regulations, there may be funding advantages for the firm, which reinforces the impulse to grow,” he said in a speech at the University of Pennsylvania Law School. “There is, then, a case to be made for specifying an upper bound.”
His point was simple and clear. Creditors to very large financial institutions believe they receive downside protection from the government — primarily through measures that the Fed would put in place in the event of financial distress. This gives large bank holding companies and other financial enterprises the ability and incentive to become even larger, which in turn increases the perceived subsidy and further lowers their funding costs.”
Read Simon Johnson’s full article here