WASHINGTON Jan 16 (Reuters) - U.S. authorities should break up the country's largest banks to protect against the risk of institutions that are "too big to fail" and that would saddle ordinary Americans with the cost of a bailout the next time they get into trouble, a senior Federal Reserve official said on Wednesday.
"We recommend that TBTF (too big to fail) financial institutions be restructured into multiple business entities," Richard Fisher, president of the Dallas Federal Reserve Bank, said in remarks prepared for delivery at the National Press Club in Washington.
Lawmakers passed sweeping changes to financial regulation in the aftermath of the 2007-2009 financial crisis in legislation led by Senator Chris Dodd and Congressman Barney Frank.
But critics say Dodd-Frank did not go far enough, including several Fed officials who, like Fisher, want the biggest banks broken up. Fed Governor Daniel Tarullo argued in October that Congress could think about new laws to cap the size of big banks relative to their share of U.S. gross domestic product.
Fisher, blaming such "behemoth" firms for massive bad bets on the U.S. housing market at the root of the crisis and subsequent taxpayer bank bailout, said the Fed should protect their core commercial lending operations -- and nothing else.
He identified 12 "megabanks" with assets of over $250 billion as too big to fail.
"Only the resulting down-sized commercial banking operations, and not shadow banking affiliates or the parent company, would benefit from the safety net of federal deposit insurance and access to the Federal Reserve's discount window," he said.
The discount window is an emergency source of liquidity for qualifying banks unwilling or unable to borrow in the open market. They pay a higher rate of interest for the privilege.
Remaining parts of a bank's business would be excluded from government support, and anyone doing business with them should have to sign an official disclaimer, Fisher said.
Such a health warning would acknowledge that no federal deposit insurance or other public money would come to the rescue if their counterparty hit the rocks.
The 12 "megabanks" Fisher identified together account for 69 percent of all U.S. banking assets, but represent only 0.2 percent of the country's 5,600 banks.
"The 12 institutions ... are candidates to be considered TBTF because of the threat they could pose to the financial system and the economy should one or more of them get into trouble," he said.
He did not name them all, but showed a slide displaying the names of five top U.S. banks: JPMorgan Chase, Bank of America, Goldman Sachs, Citigroup and Morgan Stanley.
By contrast, the country's 5,500 community banks with assets under $10 billion and the 70-or-so larger regional banks, with assets of $10 billion to $250 billion, pose no such threat, and have indeed been shut by regulators in the past when in trouble.
Arguing that firms deemed too big to fail enjoy a "perverse" subsidy because creditors are prepared to lend them money at a lower rate than smaller, better-regulated and less-risky firms, Fisher said the situation has worsened since the crisis.
He acknowledged that big banks - which give generously to U.S. lawmakers of both parties and have well-funded lobby machines in Washington -- would likely not reorganize themselves voluntarily, and he envisaged federal action.
"A subsidy once given is nearly impossible to take away," Fisher said. "Thus, it appears we may need a push, using as little government intervention as possible to realign incentives, re-establish a competitive landscape and level the playing field."