FDIC's Bair: No bank is too big to fail

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FDIC Chairman Sheila Bair

NEW YORK (CNNMoney.com) -- Federal Deposit Insurance Corp. chief Sheila Bair reiterated calls for creating a system that would allow regulators to dismantle a large financial institution.

Speaking at a luncheon sponsored by the Economic Club of New York Monday, the industry's top regulator said that the lack of such a mechanism has sustained the belief that some financial institutions are just simply "too big to fail" - a notion she said must be done away with.

"We need an effective resolution mechanism, not a get-out-of-jail free card," Bair said, speaking to an audience that included many high-profile members of the financial services community.

"The sooner we modernize our resolution structure, the sooner we can end too big to fail."

Many, including Bair, have argued the lack of such a system has made it difficult to resolve many of the troubles facing the nation's financial services sector. As a result, the government has often been put in the uncomfortable position of picking so-called "winners" and "losers", and leaving taxpayers footing the bill.

Bair cited the turmoil that ensued after regulators decided to let Lehman Brothers declare bankruptcy last fall. Credit markets immediately seized up and the global economy economy came to a screeching halt following the company's collapse.

"The bankruptcy process simply does not work for large, systemically important financial institutions in a way that can preserve stability and avoid disruptions in the financial system," she said.

Bair warned against creating another government agency to handle such large failures though. Instead, she insisted that the FDIC be given that authority, citing the thousands of failed banks the agency has handled since its creation in 1933.

"The FDIC is up to the task, and whether alone or in conjunction with other agencies, the FDIC is central to the solution," she said.

Beyond the topic of "too big to fail," Bair also addressed other key issues facing the nation's banks.

She acknowledged that banks still have a "lot of losses" to work through as a result of ongoing declines in U.S. home prices and as consumers find it increasingly difficult to keep up with loan payments.

Nevertheless, she maintained that regulators were sufficiently equipped to cope with the crisis, even as only $110 billion of the original $700 billion available through the government's Troubled Asset Relief Program, or TARP, remains available.

The highly controversial TARP program has been criticized by many in Congress who maintain that banks are not lending more despite receiving government funding. Conversely, some banks are wary of keeping federal funds because of various restrictions, including on executive compensation, tied to taking the money.

A number of financial institutions though to be more healthy, including Goldman Sachs (GS, Fortune 500) and JPMorgan Chase (JPM, Fortune 500), have said recently they are eager pay back TARP funds as soon as possible.

Those efforts are widely believed to be on hold until the government finalizes its assessment of the health of the nation's 19 largest financial institutions.

Late last week, the Federal Reserve revealed its methodology of the stress-test program announced in late February. The full results of the tests, however, are not expected be made public until May 4. Banks that require additional capital will be required to raise it on their own or accept additional government funds.

Before the Fed made its announcement on Friday, Bair encouraged banks needing additional capital to consider converting some of their existing government preferred shares into common stock to help boost their capital levels first, before seeking additional government support.

But Bair also warned Monday of the risks of allowing banks to pay back the TARP money at will.

Some banks, she said, have a much "rosier view" of their underlying health than may actually be the case. Allowing those institutions to repay taxpayer funds too soon may ultimately lead to less money available for loans.

"If we don't have banks lending, this economic situation is going to get a lot worse," she said.