Obama readies tougher "too big to fail" strategy

Financial chief executives wait to speak to the media at the White House after a meeting about the economy with President Obama in Washington, March 27, 2009.

WASHINGTON (Reuters) - The Obama administration on Monday was moving to toughen its strategy on financial firms seen as "too big to fail," with a new proposal expected in days to restrict bailouts and shut down large distressed firms.

An administration official said the new proposal to Congress would let the government seize control, force shareholders to bear losses, remove management, and restructure debts at non-bank financial firms whose failure could threaten the banking system and economy.

It will attack a market perception -- reinforced by last year's massive Bush administration bailouts of banks and Wall Street firms -- that some financial groups are so large and interconnected the government will never let them fail.

"We need to end 'too big to fail,' " said Federal Deposit Insurance Corp (FDIC) Chairman Sheila Bair at the American Bankers Association annual convention on Monday.

The administration's new strategy was still being hammered out late on Monday by Treasury Department officials and staffers for the House of Representatives Financial Services Committee, the likely conduit for its release within days.

It comes in a week when more incremental progress is expected in Congress for President Barack Obama's broader push to tighten bank and capital market regulation in the aftermath of the worst financial crisis in decades.

The regulatory reform push is facing stiff resistance from an army of lobbyists for banks and Wall Street, but it taps an upswell in public anger over a return to enormous bonuses for executives at firms bailed out by taxpayers just months ago.

The House Financial Services Committee on Tuesday and Wednesday will debate bills to require hedge funds to register with the government, and to crack down on credit rating agencies like Moody's (MCO.N) and Standard and Poor's (MHP.N).

The full House also this week, possibly on Thursday, was expected to vote on advancing by almost three months to December 1 the effective date for new credit card industry rules, a swipe at card issuers such as Citigroup (C.N), Bank of America (BAC.N), American Express (AXP.N) and Capital One (COF.N).

Senate Banking Committee Chairman Christopher Dodd on Monday introduced legislation calling for a temporary freeze on credit card interest rates on existing balances.

Dodd, a Democrat, accused card issuers of jacking up rates and fees to maximize their revenues before the effective date of new limits signed into law in May.

'TOO BIG TO FAIL' SEEN AS CENTRAL

But the credit card bills and other measures before Congress were less crucial to reguatory reform than tackling the "too big to fail" issue, said analysts and lawyers.

More than a year since governments worldwide intervened to rescue the global financial system at huge cost to taxpayers, no coherent approach to resolving troubled firms has emerged that is somewhere between bailout and bankruptcy.

"We now have gone through several decades knowing that the 'too big to fail' problem was looming, but we have been unwilling to come to grips with it," said Walter Moeling, a partner and banking lawyer at the law firm of Bryan Cave.

"The most critical part is to have a resolution and to have a plan in place so we do not enter the next downturn as unprepared as we were last October," Moeling said.

Obama wants to avoid another episode like the confused scramble of last year, when Wall Street giant Lehman Brothers was allowed to collapse, other firms were bailed out, such as former insurance giant American International Group (AIG.N), and still others were merged in government-engineered deals.

The president's new strategy was expected to build on a proposal he sent to Congress months ago, possibly by dropping language that would allow for temporary government bailouts.

"In the coming days, the president will send a letter to Chairman Dodd and Chairman Frank setting out principles to guide the process," the administration official said, referring to Dodd and House of Representatives Financial Services Committee Chairman Barney Frank. Both are Democrats.

The new proposal needs to "make it far more likely that equity holders and creditors sustain losses" in cases where the government intervenes to deal with a failing firm, said U.S. Comptroller of the Currency John Dugan on Monday.

The government already has an established method for resolving troubled banks: the FDIC routinely steps in to take over and dismantle them. It has shut down more than 100 banks so far in 2009 alone.

"There appears to be broad consensus among the Treasury, Federal Reserve and Congress to move forward on legislation that requires higher capital standards and an FDIC-like mechanism for winding down large insolvent financial institutions," said Michael Darda, chief economist at institutional equity trading and research firm MKM Partners.

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(Additional reporting by Patricia Zengerle, Rachelle Younglai and Emily Kaiser, with Karey Wutkowski in Chicago)