Ex-Merrill CEO favors U.S. bailout fund

NEW YORK (Reuters) - Breaking up the biggest U.S. banks is not a practical solution to addressing the "too big to fail" problem, Merrill Lynch's former chief executive, John Thain, said on Tuesday.

Thain said he favors creating a federal fund that big financial firms would pay into if they had an implicit government guarantee to protect them from failure.

"If a bank essentially has a government subsidy because it's too big to fail, they could pay for that," Thain said at the Reuters Global Finance Summit in New York.

"Just like the (Federal Deposit Insurance Corp) charges for deposit insurance, there could be a charge for being too big to fail, and that charge could grow as both the size of the institution grows or as the riskiness of the institution grows."

The controversial idea to create big bank break-up legislation is attracting interest in Congress and causing alarm on Wall Street.

The goal is to prevent another debacle like last year's, when Lehman Brothers collapsed, triggering a credit crisis, and taxpayers bailed out AIG (AIG.N), Citigroup (C.N) and Bank of America (BAC.N), among others, that were considered "too big to fail."

The break-up power has been championed by Democratic Representative Paul Kanjorski, chairman of the House capital markets subcommittee, and has garnered support from Barney Frank, the powerful chairman of the House Financial Services Committee.

Federal Reserve Chairman Ben Bernanke on Monday signaled support for some form of the idea, saying that bank supervisors must monitor firms' business lines carefully and should be able to require divestiture if those activities pose dangerous risks.

European policymakers have also floated the idea of breaking up big banks, but any formal rulemaking to give governments the power to do so is far from completion or even a certainty.

Thain, whose massive investment bank was dramatically sold off to Bank of America during the credit market meltdown last year, said that simply breaking up big firms would not be a good approach.

"The 'too big to fail' issue is a very important issue, and I don't think we've come up with the answer to it yet," Thain said. "One of the possible answers is this idea of breaking them up. I'm not sure that that's very practical, but that's certainly one answer."

Another solution put forth by the administration is creating economic disincentives that would discourage banks from getting big and risky.

Those could include higher capital requirements, leverage limits, and fees for a "resolution fund" that would only be used to cover the costs of dismantling a failing big firm.

Thain was skeptical that more regulation would be effective. "Of course another answer is much more stringent regulation and much higher capital requirements but I'm not sure that's very practical either," he said.

He acknowledged that it would be difficult for regulators to accurately price the value of firms' government protection from failure, but said such a bailout fee approach is "the most practical one."

"I think that that would be a challenge, but I think it is more likely that they get closer to getting that right than the idea that they're going to break them apart just before they cause a problem."

(Reporting by Karey Wutkowski; Editing by Phil Berlowitz)