"'Too big to fail' is a major problem," Greenspan said at The First Draft of History, a conference in Washington, D.C. "It has a major impact in the way investments are made."
There needs to be a fee or an additional tax, Greenspan said, or some way "to make no institutions too big to fail." Politically, however, he acknowledged that this was very unlikely to happen.
"The problem is when you have institutions too big to fail, it is essentially saying they... cannot compete in the marketplace," he said. "Those institutions' capital... are being financed by national savings. To this extent, it is they and not the more cutting edge technologies getting the capital."
This goes against the very purpose of the financial system, Greenspan said, which is to "direct (the nation's savings) to those physical investments with the greatest promise."
While curbing the existence of institutions that are "too big to fail" may be politically unfeasible, it is not the only idea Greenspan said is necessary but unpalatable to Washington. He repeated his assertion that the United States government will have to raise taxes as the economy comes out of the recession.
"The budget is so badly out of balanced that we've got to do something," he said. "It's got to be both on the spending side and the tax side. I look, for example, at Medicare and just say we've got to significantly increase co-payments as we move up the income scale."
He added that he is not a fan of the value-added tax, but sees it as "the least worse" way to come out of the current economic problem on the tax side.
More from the "First Draft of History" Conference:
Lindsey Graham Hits Glenn Beck and Bill O'Reilly
Geithner: Goal is not to Save People From Mistakes
Petraeus: Afghanistan is not Iraq or Vietnam
Doctor: U.S. Needs to Control "Tsunami of Obesity"
McCain Pushes for More Troops for Afghanistan