The administration’s original legislation would give the Federal Reserve authority to regulate and supervise all large nonbank financial institutions and, if they are in danger of failing, take control of them and resolve their problems outside the bankruptcy system. The underlying notion is that the failure of one of these companies—which include bank holding companies, securities firms, insurance companies, finance companies, hedge funds and possibly others—could cause a systemic collapse.

Although the administration likes to give the impression that its proposal is limited to exceptional cases and the largest financial institutions, its draft legislation, and the Frank and Dodd bills, use very broad language to describe the triggering event for either enhanced supervision or a subsequent bailout…

Putting it bluntly, the administration’s proposal, and the House and Senate draft bills, would establish too big to fail as national policy. Whether the companies are regulated by the Fed or by a new agency, they will still have been marked as threats to economic well-being—and thus seen by creditors and investors as specially protected by the government. This will give them the same advantages enjoyed in the mortgage business by Fannie Mae and Freddie Mac, with the same result for competitors and taxpayers.