US regulators should consider breaking up large financial institutions considered "too big to fail", former Federal Reserve chairman Alan Greenspan said yesterday.'
Those banks have an implicit subsidy allowing them to borrow at lower cost because lenders believe the government will always step in to guarantee their obligations. That squeezes out competition and creates a danger to the financial system, Greenspan told the Council on foreign Relations in New Your.
"If they're too big to fail, they're too big," Greenspan said. "In 1911 we broke up Standard Oil - so what happened? The individual parts became more valuable than the whole. Maybe that's what we need to do."
At one point, no bank was considered too big to fail, he said. That changed after the Treasury Department under then-Secrretary Hank Paulson effectively nationalised Fannie Mae and Freddie Mac, and the Treasury and Fed bailed out Bear Stearns and American International Group.
"It's going to be very difficult to repair their credibility on that because when push came to shove, they didn't stand up," Greenspan said.
Fed officials have suggested imposing a tax or requiring higher capital ratios on larger banks to ensure the firms' safety and reduce some of the competitive advantage from the implied subsidy. Greenspan said that would not work.
"I don't think merely raising the fees or capital on large institutions or taxing them is enough," he siad. "I think they'll absorb that, they'll work with that, and it's totally inefficient and they'll still be using the savings."
He said while "just really arbitrarily breaking down organisations into various different sizes" goes against his philosophical leanings, something must be done to solve the too-big-to-fail issue.
"Failure is an integral part, a necessary part of a market system," he said. "If you start focusing on those who should be shrinking, it under mines growing standards of living and can even bring them down."
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