legal framework. the growth of large institutions has distorted the framework of the financial system in ways other than just tbtf. larger and more complex institutions have become more difficult to regulate and supervise. in some cases, regulators did not have the resources or authority to keep up with a growing and innovative financial system, particularly during a period when some regulatory rules were being replaced with a risk - focused supervisory system. it has been very difficult for examiners to get large banks to tighten their operations, especially when the banks were generating tremendous profits. these large institutions wield considerable influence. an obvious example of this is the way that fannie mae and freddie mac were both able to game the political system after their accounting problems and avoid tighter regulation and more realistic leverage constraints. looking back, one sees that the crisis was inevitable, if for no other reason than that these tbtf firms would push the boundaries until there was a crisis. in a 1999 speech on financial megamergers, i concluded that “ to the extent these institutions become “ too big to fail, ” and … uninsured depositors and other creditors are protected by implicit government guarantees, the consequences can be quite serious. indeed, the result may be a less stable and a less efficient financial system. ” more than a decade later, the only thing i can change about this statement is that the government guarantees are no longer just implicit. actions during the financial crisis have made this protection quite explicit. the results so, what does this protection mean? tbtf status provides a direct cost advantage to these firms. without the fear of loss to creditors, these large firms can use higher leverage, which allows them to fund more assets with lower cost debt instead of more expensive equity. as of year - end, the top 20 banking firms held tier 1 common equity equal to only 5. 1 percent of their assets. in contrast, other banking institutions held 6. 7 percent equity. if the top 20 firms held the same equity capital levels as other smaller banking institutions, they would require $ 210 billion in new equity or reduced assets of over $ 3 trillion, or some combination of both. ( see attached charts. ) stated another way, almost one - quarter of the assets held by these large institutions are supported by less equity capital. furthermore, tbtf reduces the cost of the debt that these firms issue. due to their implied government support, ratings agencies explicitly increase the debt ratings of the largest banking organizations above the intrinsic rating that would be assigned based on the bank

given that primary dealers could no longer be affiliated with commercial banks, would this inhibit market - making in securities, including treasuries, and therefore interfere with the conduct of monetary policy? the answer is “ no. ” it is not necessary that primary dealers be affiliated with banks. it is only necessary that they be institutions that deal in u. s. treasuries and participate in auctions of u. s. government debt. prior to the 1990s merger boom among investment banks and the gramm - leach - bliley act, it was typical that half or more of the primary dealers were not affiliated with commercial banks. therefore, the fact that primary dealers are not commercial banks would have little effect on the federal reserve ’ s ability to conduct monetary policy. i would add that although commercial banks could not be primary dealers, they could remain a key part of the monetary policy mechanism. recently, the federal reserve gained experience in using the term auction facility ( taf ). the taf might very successfully be used in conjunction with primary dealer operations to conduct policy well into the future. as you may recall, during the financial crisis, the taf was an important component of monetary policy. for example, the taf was introduced in december 2007 with an initial auction of $ 20 billion. the facility was then ramped up to almost $ 500 billion by march 2009 – about one - fourth of the assets on the federal reserve ’ s balance sheet. the maturity of taf loans was generally 28 days or 84 days. by broadening the federal reserve ’ s monetary tools to include the taf to provide term funds through the banking system in parallel with the primary dealers, we could greatly expand the number of counterparties used in the conduct of monetary policy. thus, the taf and primary dealers would provide deep markets for the term portion of policy ; primary dealers and traditional open - market operations would continue as the means for managing day - to - day operations and for maintaining the federal funds rate close to the target. with more counterparties, we enhance competition and enable nearly all banks to play a role in the conduct of monetary policy. this would make the largest banks less “ si ” and more “ fi. ” conclusion the financial system has become far less competitive and far more volatile with the onset of systemically important institutions. though large firms remain a critical part of our economic system in the united states, they should not become so dominant that they become unaccountable to our capitalist