By Colin Barr
September 2, 2010

Did this summer’s regulatory overhaul really kill too big to fail?

Count the chairman of the Financial Crisis Inquiry Commission, Phil Angelides, as a skeptic.

Angelides asked Federal Deposit Insurance Corp. Chairman Sheila Bair (right) Thursday whether the Dodd Frank Act, enacted last month, will actually help regulators whip the financial system into shape – and keep them from propping up deeply troubled institutions such as Wachovia.

“There has been a pattern of institutions growing like a weed,” Angelides said. “What Wall Street needs is not a series of bailouts but a financial intervention. How do you break the pattern?”

Bair said she believes an important departure for the new regulations from previous law is that the Dodd Frank rules prevent regulators from assisting institutions on a so-called open bank basis – that is, without sacking management and imposing haircuts on creditors.

She said that rule will prevent a recurrence of the debacle at Wachovia, which ultimately was sold to Wells Fargo

at the tail end of the September 2008 meltdown.

Wachovia was a top 10 bank when it suffered a deposit run following the collapse of another aggressive bubble-era mortgage lender, Washington Mutual. After a frantic weekend weighing the merits of a government rescue against a shutdown of the bank, regulators decided to invoke the so-called systemic risk exception of banking laws and offer federal funds to Wachovia on an open bank basis.

The decision allowed regulators to keep Wachovia open for the sake of arranging a merger with Citi

that was ultimately scotched when Wells made an offer to buy Wachovia without government assistance (though it did get a nice tax break).

Bair said she wasn’t doing cartwheels over the Wachovia bailout, which was arranged in conjunction with other top policymakers, but signed off on the move because “our worst nightmare was bank depositors would start losing confidence in the system.”

By specifying that special aid can be offered only on a marketwide basis, rather than to individual institutions, the Dodd Frank Act should help regulators enlist the help of the market to discipline bank managers and investors. Without execs and investors facing the threat of firing or job loss, Bair said, there is no way to dissuade them from gambling with funds that are ultimately backed by the federal deposit insurance fund.

“The statute specifically prohibits open assistance,” Bair said. “Regulators have no authority to do bailouts anymore.”

Of course, that’s not saying it’s going to be easy to take down bankers who will claim they’re being treated unfairly and will warn of the larger economic ramifications of a decision to close them down. Ultimately, regulators will have to show much stronger stomachs than they have in the past.

“It’s up to us,” Bair said.

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