Greenspan Says U.S. Should Consider Breaking Up Large Banks

Bloomberg.com:

Oct. 15 (Bloomberg) -- U.S. regulators should consider breaking up large financial institutions considered “too big to fail,” former Federal Reserve Chairman Alan Greenspan said.

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 York.

“If they’re too big to fail, they’re too big,” Greenspan said today. “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.”

I don't know how the government is supposed to break up the banks again. Greenspan probably could have prevented a lot of the mergers that created the superbanks, but now I think there is a more elegant way. When there is an externality, it can be corrected with a Pigouvian tax. The oversized banks impose an external cost on society and so they should be taxed at a higher rate than smaller banks. And if the tax is high enough, then the big banks will divide up of their own accord. If they have enough economies of scale, then they can stay big, but at least they will be paying back some of their dues to society.