Big U.S. banks should become smaller to make any failure more manageable, a senior Federal Reserve official said on Thursday, supporting a suggestion that the size of banks be limited to a specific percentage of U.S. gross domestic product.
"I'm very much of a view that 'too-big-to-fail' remains alive and well and the only way to really make progress on this issue is to get firms down to a smaller size where you'd feel comfortable letting them fail if the situation arose," St. Louis Federal Reserve President James Bullard told reporters.
Bullard was referring to a situation in which a bank gets so big that it is too costly to let it fail if it gets into trouble. This is a competitive advantage a big bank can exploit through access to cheaper capital, which allows it to grow even larger compared with their rivals.
Some Fed officials advocate simply breaking apart the biggest banks and Bullard has aligned himself with that camp.
"I do not think that we need firms that are so large and complicated in order to have a healthy intermediation sector in the U.S.," he said. "We would be better served by a setup that had smaller firms in a competitive landscape across the sector."
Fed Board Governor Daniel Tarullo suggested in a speech on Wednesday that Congress might want to think about new laws to cap the size of banks relative to the size of the U.S. economy. He argued this would tie their growth to the county's own growth and consequent ability to absorb the shock if they got into trouble. Bullard said that the suggestion had merit.
"Scaling by GDP (gross domestic product)... in general terms, would make sense," he said. "Of course, the devil is in the details of exactly how you would do that. But over time, as the economy continues to grow, you would have to think about what constitutes big and what constitutes small."
Big U.S. banks have been sharply critical of parts of the Dodd-Frank financial reform legislation that contains limits on financial sector concentration as too complex. Bullard said he would prefer "multidimensional" measures of what too big meant and then ask firms to stay beneath those thresholds.
Bullard is not a voting member of the Fed's policy-setting committee this year but will be in 2013.
However, he has spoken out against the additional action taken in September by the U.S. central bank to spur growth, when it announced a third round of quantitative easing and promised to hold rates near zero until mid-2015.
Bullard said he was encouraged by the weekly jobs data, released earlier on Thursday, that showed a surprise 30,000 drop in initial claims for unemployment benefit last week to 339,000.
He also said the more closely watched four-week moving average, which smoothes out week-to-week volatility, pointed at continued progress in bringing down the rate of unemployment from current levels of 7.8 percent, which came down last month, but remains high by historic U.S. standards.
"I think we'll continue to tick down over the rest of the year. I think a good benchmark is a tenth of a (percentage) point (reduction) every other month...so long as the economy stays in an expansion."
He expects U.S. growth to stay around 2 percent on an annual basis over the second half of 2012, before picking up to a plus 3 percent pace next year.
But he has pushed out his estimate for when the Fed should begin raising interest rates until mid-2014, from late-2013 under previous forecasts, because the economy had been weaker than he anticipated.
Fed officials next meet on Oct. 23-24 to review policy and Bullard said the picture they would consider remains mixed.
"You've got some sectors, like housing, that seem to be doing somewhat better... but you've got other parts that are little more ominous. Europe seems to be a little deeper in recession than what we've seen earlier this year," he said.
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