As policymakers debate how the regulatory system should be reworked, Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, said Monday that breaking up large banking companies should be an option.

"While a carefully constructed safety net and a better resolution procedure for large institutions are critical, we also need to think about how to prevent such institutions from holding us hostage in the future," he said Monday. "This may require breaking them up, limiting the activities or size, increasing capital requirements or taking other steps to limit the systemic risks they impose on the financial system."

Hoenig has been stumping in recent weeks for a proposal that would require any firm seeking government assistance to put taxpayers ahead of all shareholders. The impact on managers and directors would depend on whether the firm would be viable. If it could not continue operating, it would fail, and bad assets would be liquidated, while the remaining pieces would be reprivatized under new management.

Regardless of how regulation is restructured, Hoenig said policymakers run the risk of waiting too long. "I fear that if we pour in enough public funds to see us through the current crisis, we will then breathe a sigh of relief and back off from implementing any comprehensive solutions to controlling the use of government guarantees and to addressing the problems posed by systemically important institutions," he said.

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