If you think the way to deal with too big/interconnected to fail/manage is by breaking up the megabanks, you have three basic options: 1) cap their size, 2) restructure them, 3) make them raise gobs of equity capital.
In a Q&A after a speech today, Federal Reserve Chairman Ben Bernanke addressed the issue of TBTF and breaking up the megabanks. First of all, while Bernake said he believed TBTF still existed, he also wanted to see Dodd-Frank rule making and Basel 3 play out before taking additional steps. Second, if additional steps did need to be taken, raising more capital might be the way to go rather than size caps, a belief keeping in line with what colleagues like Federal Reserve Governor Daniel Tarullo have been saying. Tarullo has suggested banks with large amounts of short-term wholesale funding should have to hold more capital. American Banker:
During a question and answer session, Bernanke once again addressed the persistent view by critics that “too big to fail” continues to exist, suggesting that policymakers should wait until the rules are completed to see if further reforms are necessary.
He argued that regulatory reform efforts under the Dodd-Frank Act and Basel III “constitute important steps” in addressing the “too big to fail” problem.
“We will see if we are comfortable when that is all done, if ‘too big to fail’ is solved,” said Bernanke.
The Fed chairman suggested that one way to solve the issue — if it remains — is by raising capital requirements even higher rather than attempting to place a size cap on the largest institutions. A capital increase could help reduce their funding advantage, he said.
Banking analyst Jaret Seiberg of Guggenheim Washington Research Group:
Bernanke’s comments reinforce our view that regulators will go beyond Basel 3 to impose additional capital requirements on the biggest banks. We continue to believe the regulators will use a combination of a more restrictive leverage limit, a capital surcharge based on reliance on short-term debt, and a long-term debt requirement.
Regulatory steps to further address Too Big to Fail could drain the momentum from legislative options, almost all of which are more onerous for the mega banks as well as for the regional banks.
Our view remains that the regulatory and legislative environment is favoring the regional banks over the mega banks as the regional banks will enjoy better capital treatment and more M&A freedom.
Important: While Bernanke did not say he thought megabanks should be broken up, dramatically higher capital levels could cause such an outcome. Yet I would doubt the Fed would go that far without Congress coming along for the ride. Seiberg makes an interesting point about further Fed action draining momentum from the break-up-the-big-banks movement on Capitol Hill. But the Fed policy may move slower than what politics demands.