Do we really believe that in the middle of economic distress when the public is looking for safety that the government will start imposing losses on debt holders, potentially increasing fear and panic among investors? Policymakers didn’t do that in 2008. There is no evidence that their response in a future crisis will be any different. When I heard experts describe the TLAC approach during our symposium, it sounded like a plan that requires everything to work out perfectly when we know that in a crisis, that simply does not happen.

A policy analyst recently asked me if we really could resolve a large bank during a crisis. I responded by asking him if he thought we could dismantle an aircraft carrier in the middle of a hurricane. It’s not a perfect analogy, but he got my point.

I’ve mentioned this before, but when I first went to Treasury in 2006, Treasury Secretary Henry Paulson directed his staff (including me) to work with financial regulators to look for what might trigger the next crisis. We looked at a number of scenarios, including an individual large bank running into trouble or a hedge fund suffering large losses, among others. We didn’t consider a nationwide housing downturn. It seems so obvious now, but we didn’t see it, and we were looking. We should design our regulatory framework to assume that, as in 2008, regulators won’t have better insights than market participants. We must assume they won’t see a future crisis coming until it is too late.

“I have not reached any conclusion that a particular bank needs to be broken up or anything like that,” Mr. Powell said at a banking conference. The point is to “raise capital requirements to the point at which it becomes a question that banks have to ask themselves.”

As I listened to the wide range of views on the merits and costs of higher capital, it struck me that we could increase capital requirements in a straightforward way to address TBTF. As we saw in my earlier comments about the behavior of legal structures in a crisis, there is a strong argument that simpler solutions are more likely to be effective than complex ones, so I see virtue in focusing on increasing common equity to assets, which seems the simplest and potentially the most powerful in terms of safety and soundness.

More capital has another advantage. We have seen extraordinary structural changes in our financial system over the past several decades. We have to be prepared for more change. More capital will absorb losses even from activities we cannot anticipate today.

Thinking back to my earlier comments about risk spreading between banks in the 2008 crisis, I realize that capital by itself is not a direct firewall to contain risk, but at a minimum, it does not intensify the spreading of risk from bank to bank. If all of the largest banks had enough capital that investors were confident in their strength, even during an economic shock, such concerns about shared risks could be substantially reduced.

Cleveland Fed President Loretta Mester, asked about her colleague Neel Kashkari's push at the Minneapolis Fed to possibly break up risky banks before they again imperil the economy, said his effort aims to bring more analysis to the lingering issue.

But the 2010 Dodd-Frank reforms have not yet been fully implemented and should be given some "time to work" before "going in a whole new direction," she said.

I think too big to fail is something we need to watch, but I think we have made excellent progress over the last seven or eight years in deleveraging the banks, making them more liquid and reducing the interconnectedness..I think the market might, over the next few years, take its own actions with companies to make these banks smaller, but I think, of the issues I see out there that are systemic, breaking up the big banks is not high on my list.

While "I certainly share President Kashkari’s concern” about the possibility some banks are still too large to be allowed to fail by the government, “I feel more positive on the progress we have made” with improvements to financial oversight because of the Dodd-Frank law, she said.

More than anything, I just don't want the American people to have a false sense of security that we've addressed too big to fail, that this can't happen again. I think some of those risks remain and we need to consider more transformational solutions to deal with this problem once and for all.

Tausche: So do you think the system really would be more secure if you broke up the banks and gave the Fed and the U.S. economy three or more new pure play investment banks that they would have to hold capital against and would still have inherent risk in the business model but not cushioned by other business units? Would that really be the ideal outcome for you for the economy?

Kashkari: Well, we haven't decided what the ideal structure looks like. What I’m saying is and what we in Minneapolis are saying is a bunch of these transformational solutions were taken off the table in 2010. It was too – they are too bold coming out of the crisis. I'm saying now is the time to reflect on the last seven or eight years. What have we learned, what progress has been made, what gaps remain? Breaking up the banks is one of the options that we looked at yesterday, Professor Johnson at MIT talked about it. Professor Admati from Stanford talked about increasing the capital requirements so banks are so strong they virtually can't fail. You can never eliminate all risk and I don't think we would want to, but I think we can go further than we've gone today. And it's all about cost benefit analysis. Where's the optimal safety versus cost versus risk for the economy and for the country?

Much of Mr. Kashkari’s remarks Tuesday were devoted to reiterating his commitment to addressing the too-big-to-fail problem that still surrounds the banking system. He said that “we need to be humble about our ability to forecast crises.” Because trouble often comes from unexpected places, it is that much more important to strengthen the resiliency of the financial system to deal with shocks, he said.

While significant progress has been made to strengthen our financial system, I believe the Act did not go far enough. I believe the biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy.

I believe we need to complete the important work that my colleagues are doing so that, at a minimum, we are as prepared as we can be to deal with an individual large bank failure. But given the enormous costs that would be associated with another financial crisis and the lack of certainty about whether these new tools would be effective in dealing with one, I believe we must seriously consider bolder, transformational options. Some other Federal Reserve policymakers have noted the potential benefits to considering more transformational measures.6 I believe we must begin this work now and give serious consideration to a range of options, including the following:

• Breaking up large banks into smaller, less connected, less important entities.
  
  
• Turning large banks into public utilities by forcing them to hold so much capital that they virtually can’t fail (with regulation akin to that of a nuclear power plant).
  
  
• Taxing leverage throughout the financial system to reduce systemic risks wherever they lie.

BROWN: One more: Does an aggressive thorough living-will process answer the question of "too big to fail"?

YELLEN: It certainly helps. We have also put in place requirements for adequate, or so-called TLAC rules, for adequate loss absorbancy. We certainly are requiring that firms have workable plans for how they would be resolved under bankruptcy and Dodd-Frank.

So we want to make sure that there is a way that they could be resolvable under bankruptcy, and that the resources are there so that the taxpayer would not be at risk. And Dodd-Frank provided -- is a backup authority, Title 2, which would be, if it's necessary, an additional tool that we can use. So I think premature to say we have solved "too big to fail," but I do think we've made very substantial strides toward dealing with it, toward addressing it.

Significant progress has been made in eliminating too big to fail and the possibility that taxpayers in the United States would need to bail out the domestic [Global Systemically Important Bank Holding Companies] to preserve the financial system’s functioning. But it is important to remember that significant work still remains. Some of the proposals need to be finalized, some of the regulations are only in the process of being phased in, and more work needs to be done on resolution plans to insure that GSIBs can be resolved in an orderly fashion.

Nonetheless, capital ratios at the GSIBs have been steadily increasing, with the goal of reducing the chances that a GSIB will fail. In the event that one does fail, the new total loss-absorbing capacity proposal and resolution plans intend to reduce the potential costs to taxpayers of such a failure and make it less likely that there would be a need for any financial support from taxpayers to preserve financial system functioning.

Steve Liesman: I just have one question about all of this stuff Is it the policy of the Federal Reserve to force large banks to be smaller?

Dan Tarullo: It's not the policy to force them to be smaller. But I think it is the policy of our bank regulatory system as embodied in congressional legislation to make sure that large institutions of systemic importance do internalize the potential risks to the broader economy from their size and interconnectedness. So in essence, a firm has a choice which is that it can either maintain substantially higher capital levels or it can make a judgement that some forms of business or certain size of that business may not be worth the higher capital charge that takes account of those negative externalities. It really is up to the institution to make that evaluation but what we've tried to do it in a context that forces them to internalize costs.