William C Dudley, president of the NY Federal Reserve, today spoke at length about the dangers of allowing a financial institution become “too-big-to-fail.”
Though he said there is “no one silver bullet” to prevent financial crisis (and, indeed, his speech highlighted the importance of effective macroprudential supervision and increasing the robustness of the financial system), he said that it was “critical that we ensure that no firm is too big to fail.”
The moral hazards with giant institutions were two-fold, he said. First, too-big-to-fail institutions would be able to get cheaper credit, since they’d effectively have an implicit government guarantee. Second, institutions would have an incentive to become large, simply so they could get the government backstop, reguardless of their financial health.
Notably, though, his solutions to the too-big-to-fail problem did not mention actually limiting firms’ size. Read more