Daniel Tarullo, Fed Board Member, Gives Boost For Bill To Break Up Wall Street Banks

Top Fed Official Endorses Breaking Up 'Too Big To Fail' Banks

But last week, Tarullo told Sen. Sherrod Brown (D-Ohio), who had proposed the plan, that he had changed his mind.

"The ... example embodied in your legislation," Tarullo said. "Speaking personally here, that's the problem we need to address."

In 2008 all of the largest U.S. banks received hefty government bailouts as part of the Trouble Assets Relief Program because politicians and economists believed that letting them fail would cause economic catastrophe.

The Fed is one of a handful of agencies responsible for regulating U.S. banks, and has historically been very close to the industry. Fed officials threw cold water on a host of Wall Street reform efforts that would have clamped down on big banks during the negotiations over the Dodd-Frank financial reform bill, and the agency has weakened the bill's provisions at the regulatory level in response to bank lobbying.

Brown first offered the plan as an amendment to Dodd-Frank. Although Dodd-Frank was approved, Brown's amendment did not make the cut after being voted down 61 to 33.

Brown reintroduced the legislation last year, but Congress has not moved on it. The bill would cap the total non-deposit liabilities of any bank at 2 percent of the total U.S. economy and force all banks to carry at least 10 percent of their total assets on hand as hard equity capital at all times. That's roughly three times the amount of capital required by the new international banking standards approved by the Basel III commission. If the plan were implemented, the six largest U.S. banks -- JPMorgan Chase, Wells Fargo, Citigroup, Bank of America, Morgan Stanley and Goldman Sachs -- would each have to be broken up into two or three smaller banks.

By focusing on total bank liabilities, Brown's bill would prevent banks from taking on huge amounts of debt to grow their operations. During a financial panic, companies can demand that their loans be repaid quickly, which can force a run on that funding and can ultimately cripple the bank -- what Tarullo called "the unaddressed set of issues of large amounts of short-term non-deposit runable funding."

Last fall, Tarullo gave two speeches detailing the merits of a government cap on risky bank borrowing, but did not cite any specific legislative proposals or indicate where he thought the cap should be set. If the cap were very high, it might only cap future bank growth without forcing existing banks to shrink.

At last week's hearing, Tarullo did not explicitly endorse Brown's 2 percent threshold, but said that he is considering a substantive limit on liabilities would be a plan to "break up the banks." Tarullo said breaking up the banks by imposing a new liability cap would be preferable to breaking them up by reinstating the Glass-Steagall barrier between securities dealing and traditional lending.

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