Fed's Hoenig: Taking on "too big to fail" is key

NEW YORK (Reuters) - Policy-makers must focus on how to treat systemically important firms that are seen as too big to fail, Thomas Hoenig, president of the Kansas City Federal Reserve Bank, said on Tuesday.

The process needs to operate decisively, fairly and free from political influence, or it could merely encourage new risky behavior, Hoenig said in a speech to the New York University Stern School of Business.

Hoenig said the Treasury Department's plan for financial regulatory reform and its resolution regime for failing banks and other financial holding companies "is only a start," and needs to be complemented by a commitment to tackling the notion of a company being too big to fail.

"It will not be realistic for any authority in any regulatory structure to oversee a system where incentives remain to take on excessive risk," Hoenig said.

Management should be replaced at failed firms without exception, he said: "When failure occurs, certainly new management must be required as part of any resolution process."

Moreover, a firm's chief executive and board "are hardly in a position to be angry with any government-imposed restrictions on compensation when they neglected their responsibility to manage a sound company," Hoenig added.

The policy-maker decried as unacceptable a "dereliction of duty" among the top management of some companies in the lead-up to the financial crisis that helped to trigger a severe global recession.

"Far too few senior executives in these largest organizations believed it was their responsibility to understand the financial products their company was buying and trading in quantities of billions and trillions of dollars," Hoenig said.

Hoenig, who is not a voting member of the policy-setting Federal Open Market Committee in 2009 but will vote in 2010, did not address the economic or the monetary policy outlook.

Returning to the subject of a series of speeches made this year, Hoenig called for a strong, rules-based approach to financial regulation, including simple leverage standards for setting capital requirements.

"While no system is perfect, clear and firm rules are easier to understand and enforce. Principles-based oversight is an exercise in philosophy, not a supervisory framework," he said.

(Writing by Ros Krasny; Editing by James Dalgleish)