Policymakers say 'too big to fail' strategy must end; see new financial 'resolution' authority

Giving the government new powers to seize big troubled companies on Thursday became the new focus of debate in Congress as lawmakers and the administration begin efforts to overhaul the U.S. financial rule book.

The head of the Federal Deposit Insurance Corp. said the government's strategy in the financial crisis of bailing out huge institutions deemed "too big to fail" must be replaced by a new model.

FDIC Chairman Sheila Bair called for a new system of supervision that prevents institutions from taking on excessive risk and becoming so large their failure would threaten the financial system. A mechanism is needed to resolve troubled financial institutions similar to what the FDIC does with federally insured banks and thrifts, she said.

Testifying at a packed Senate Banking Committee hearing, Bair said simply creating a so-called systemic risk regulator — a central idea in the discussion of overhauling the U.S. financial rules — "is not a panacea."

The committee's chairman, Sen. Christopher Dodd, said possibly the most important lesson to take from the financial crisis gripping the U.S. and the global economies is that "no institution should ever be 'too big to fail.'"

Dodd suggested it could make sense to give the FDIC, which has the expertise in that area, the authority to take over and resolve big institutions whose collapse would threaten the financial system.

President Barack Obama said Wednesday his administration soon will propose new financial industry oversight that includes a "resolution authority" with powers similar to those of the FDIC, which can seize control of banks, take over their bad assets and sell the good ones to competitors.

The proposal would give the Treasury secretary the power, after consulting with officials at the Federal Reserve, to take control of a major financial institution and run it. The Treasury chief is an official of the administration, unlike the FDIC, which is an independent regulatory agency.

Bair appeared with top regulators from the Fed, Treasury and other agencies to lay out views on revamping oversight of the nation's financial institutions.

The government's rescue of insurance giant American International Group Inc., its pumping of tens of billions of dollars into Citigroup Inc. and Bank of America Corp. in more than one instance, and other actions in the crisis have put a "too big to fail" stamp on U.S. policy.

Also looming in the debate is deep congressional and public outrage over millions in bonuses paid to employees by embattled AIG, which has received $182 billion in federal bailout money. In the House Thursday, Democrats rushed a bill to the floor to levy a 90 percent tax on bonuses paid to employees with family incomes above $250,0000 at all companies that have received at least $5 billion in government rescue money.

If an agency with resolution authority had been operating, it would have been able to block the bonus payments by AIG, regulators said at the Senate hearing.

Rep. Barney Frank, chairman of the House Financial Services Committee, and other lawmakers have proposed the Fed assume the role of systemic regulator to monitor against the kinds of risks that plunged markets worldwide into distress last year.

At the same time, the Fed — as well as Treasury Department regulators — has been blamed for lax oversight of the banking industry that was considered a factor in worsening the subprime mortgage crisis that touched off global financial and economic distress.

"Whether or not those vast powers will reside at the Fed remains an open question," Dodd said at the hearing. He referred to "the obvious mistakes the Fed made in the run-up to the current crisis."

Fed Gov. Daniel Tarullo testified that "effectively identifying and addressing systemic risks would seem to require some involvement of the Federal Reserve."

The extent to which the new responsibility for systemic risk should fall to the central bank "depends a great deal on precisely how the Congress defines the role and responsibilities of the authority," Tarullo said.