Banks May 6, 2009, 6:12PM EST

Too Big to Fail: Still an Issue

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The 1999 repeal of the law permitted great risk to be concentrated in a handful of mammoth banks. Charles Geisst, a finance professor at Manhattan College and a noted Wall Street historian, says the repeal opened the door for an explosion in risk-taking with derivatives, not just in the U.S. but around the globe. "The original Glass-Steagall wasn't just a banking law; it was also a very good form of antitrust law," laments Geisst.

But beyond the formidable political hurdles to forcing healthy institutions to split up, critics argue that trust-busting might not even solve the problem. Many small institutions, for example, could fail just like the big boys did. "It sounds very easy and appealing; it won't be," says Ron J. Feldman, senior vice-president for supervision, regulation, and credit at the Federal Reserve Bank of Minneapolis. Trust-busting would also mean reversing actions taken during the heat of the crisis, such as allowing JPMorgan Chase (JPM), Bank of America, and Barclays (BCS) to grow even bigger by picking up assets from the sinking Bear Stearns, Merrill Lynch, and Lehman.

Another response to the problem would be to staff up the regulators and crack down on the firms' risky dealings by monitoring trades and the like. It's tempting, but it won't work, said Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia, in a recent speech. Try to imagine regulators getting it just right—preventing catastrophic failures without stifling innovation, protecting poor performers, or leaving loopholes like those that contributed to the current crisis. "Failures are an inevitable consequence of a dynamic financial system," said Plosser.

Preparing for the End

Then there's what might be called the "living will" approach. Big institutions would be required to plan for their own orderly demise, much like many terminally ill people do. They would prepare to unwind derivatives, move assets to healthy institutions, and settle up their estates. If regulators knew such plans were in place, they could better judge the risk of a failure and then, perhaps, let some giants fall. Says Richard J. Herring, professor at the University of Pennsylvania: "You've got to make global companies think about how they can gracefully leave the scene if the worst should happen."

Francis is a correspondent in BusinessWeek's Washington bureau. Henry is a senior writer at BusinessWeek. Goldstein is a senior writer at BusinessWeek.