U.S. watchdog: Need way to unwind troubled firms

By Rachelle Younglai

WASHINGTON (Reuters) - The United States needs a credible way to dismantle large troubled financial institutions to squash a belief that some firms will always be rescued, a top U.S. government watchdog said on Friday.

"We live in a 'They won't fail' world right now," said Elizabeth Warren, who is in charge of overseeing the U.S. government's $700 billion financial bailout program.

The government is using tens of billions of dollars in taxpayer funds to prop up firms that were considered a risk to the financial system such as insurer AIG (AIG.N) and Bank of America (BAC.N).

As a result, there is a market perception the government will always step in to prop up large financial firms whose global reach has the potential to destabilize markets.

"I am really pushing hard on the importance of resolution authority," Warren told reporters on the sidelines of a Bloomberg Summit in Washington.

"In my view resolution authority is what terminates the implicit guarantee (that the government will always backstop certain firms,)" she said.

There are bills in the U.S. Congress that would give regulators a way to resolve large troubled firms and ensure shareholders and creditors would absorb some of the losses.

Some policymakers believe that the government should have the authority to break up firms before they become too large to pose a risk to the economy. Warren said resolution authority would help mitigate this risk.

"If we have a credible way to liquidate them, then the need to break them up is substantially less because they are in effect no longer too big to fail," she told reporters.

The chief executive of JPMorgan Chase & Co (JPM.N), the second-biggest U.S. bank by assets, also said there should be a system in place to ensure that the biggest banks could fail.

In an opinion piece in the Washington Post newspaper, Jamie Dimon said regulators deserve authority to manage failures of large financial institutions, including the ability to replace management, sell assets, and wipe out shareholders and even unsecured creditors.

He argued against caps on banks' size, saying increased scale can benefit customers, shareholders and the economy by permitting better products to be delivered fast and cheaply.

WARREN PRAISES SENATE BILL

Separately, Warren praised a Senate financial reform bill that would create a single bank super-regulator and strip the Federal Reserve of its supervisory powers.

"There is reason to question the current governance of the Federal Reserve," she said.