Published: Thursday, 29 Oct 2009 | 12:11 PM ET

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A top U.S. bank regulator said Thursday a government mechanism to dismantle troubled giant financial companies should be pre-funded, a departure from the administration's draft legislation on the subject.

AP Treasury Secretary Timothy Geithner said the Fed should be able to act as an emergency lender, but only with Treasury consent.

Sheila Bair, chairman of the Federal Deposit Insurance Corp, said that Congress should establish a Financial Company Resolution Fund (FCRF) that is pre-funded by assessments on financial companies with assets of at least $10 billion.

"We believe that a pre-funded FCRF has significant advantages over an ex-post funded system," Bair said in prepared testimony for a House Financial Services Committee hearing on how to fix the idea that some financial companies are too big to fail.

"It allows all large firms to pay risk-based assessments into the FCRF, not just the survivors after any resolution, and it avoids the pro-cyclical nature of requiring repayment after a systemic crisis."

The House Financial Services Committee and the Treasury Department released draft legislation earlier this week that would call for resolution costs to be repaid by a broad range of financial companies after a failure.

Treasury Secretary Timothy Geithner said a funding mechanism that assesses fees after a failure has several advantages over a pre-funded mechanism.

"Most notably, it would generate less moral hazard because a standing fund would create expectations that the government would step in to protect shareholders and creditors from losses," Geithner said in remarks prepared for the same hearing. "In essence, a standing fund would be viewed as a form of insurance for those stakeholders."

Under the draft legislation, the FDIC would be given the power to unwind large, complex financial companies that fail. The model would be similar to the FDIC's current power to act as receiver for failed depository banks.

The legislation says that costs to resolve a failing firm would be repaid first from the assets of the firm at the expense of shareholders and creditors. Any remaining costs would be recouped through spread-out assessments on all large financial companies with assets of $10 billion or more.

Bair's break from the administration's views on funding was not echoed by other regulators.

Comptroller of the Currency John Dugan said in its preliminary review, his agency supports the administration's approach to funding.

But some lawmakers were more sympathetic to Bair's views. Republican Representative Judy Biggert said a post-funded mechanism "could create perverse incentives" because only the survivors would have to pay for the costs of a failed firm.

Representative Luis Gutierrez, a Democrat, said a pre-funded mechanism like the FDIC's current deposit insurance fund makes sense and would not likely encourage financial firms to take on excessive risks.

"I don't see banks racing to the precipice of destruction," Gutierrez told Geithner during his appearance before the committee.

Geithner countered that the FDIC's deposit insurance fund is different because it is explicit insurance for customers' bank accounts.

"We don't want to provide explicit insurance for creditors," he said.

Bair also said that failures of some less-complex bank holding companies should be resolved through the bankruptcy process, not through the government's enhanced resolution powers.

She said the FDIC should be able to "opt out" from being the resolution authority for a failing holding company if a bankruptcy process would be cheaper for the industry and the government.

Geithner also said The Federal Reserve should lose its authority to bail out big, failing financial firms like AIG and Bear Stearns under proposed reforms aimed at limiting the collateral damage from such failures.

He said the Fed should keep its ability to act as an emergency lender of last resort, but only to solvent firms in times of severe stress in financial markets — with Treasury consent.

"Any firm that puts itself in a position where it cannot survive without special assistance from the government must faces the consequences of failure," Geithner said. "The proposed resolution authority would not authorize the government to provide open-bank assistance to any failing firm."

• Video: Geithner on Systemic Regulation

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