They're Not Too Big to Bust Up

Moves by the British government last week to break up some of the biggest financial institutions in the country are bound to increase pressure on Congress to do the same for giant U.S. banks.

The Brits haven't flinched at the prospect of downsizing a couple of truly historic and world-renowned institutions: the Royal Bank of Scotland and Lloyds Banking Group. Both have received billions of pounds in bailout money in the past year. A third bank, Northern Rock, was one of the first to founder in the financial meltdown and was nationalized last year. Bowing to pressure from European regulators to reduce the threat to the banking system from the "too big to fail" syndrome, the government will force all three institutions to sell off parts of their operations.

U.K. Treasury chief Alistair Darling claims the changes are "better for the taxpayer, better for the banks, and better for the economy. They will mean stronger and safer banks better able to support the recovery," the Associated Press reports.

He's right. The question is: Why aren't U.S. regulators heading in the same direction? So far, the Obama administration remains committed to the super-FDIC model, which means essentially waiting till a big one breaks, and then stepping in to try and fix it. But given the fact that mega-bank failures tend to be more contagious than a bad dose of H1N1, that doesn't do nearly enough to smother the systemic risk. By the time the receivers take over, the damage will have been done.

What's wrong with diffusing the risk by scaling back the bailout beneficiaries? Or insisting on a separation of commercial and investment banking functions, as Paul Volcker suggested earlier this year? What the biggest players would lose in economies of scale, the rest of us would gain in increased competition and, most important, the reduction of moral hazard -- the temptation for the behemoth banks to take ever-greater risks with the assurance that they can always fall back on taxpayers' money.