Policymakers in Washington are struggling over what to do about financial institutions that are "too big to fail."

At first they seemed to favor legislation that would establish a new "systemic risk regulator" with the authority to intervene whenever a troubled financial leviathan, or a new product or practice, threatened the safety of the financial system.

After some reflection they recognized the dangers posed by a super-regulator. It is likely to prize stability over innovation; it will discourage other regulators from taking actions, such as enforcement proceedings, that might shake public confidence in too-big-to-fail firms; and over time, as the systemic-risk regulator gains expertise, it will increasingly "crowd out" lesser, specialized regulatory agencies.

Lurking in the background is the unhappy memory of the National Recovery Administration, the ambitious New Deal experiment in super-economic regulation. The New Deal's most ardent admirers now view the NRA as a colossal failure.

Realizing the problems that would be created by a single, all-powerful uber-regulator, policymakers have swung in another direction and are proposing various versions of a council of regulators. Although both the current Senate and House bills would have boards of 11 members, mainly current regulators, they are at polar extremes. The Senate's proposed council would possess the same vast powers as a super-regulator. The House proposal would create a council with no authority beyond making recommendations to Congress and other agencies. The problems in such a committee approach are obvious. It would be consumed by bickering, turf battles, differing regulatory philosophies and ultimately stalemates. As the military maxim warns, "Councils of war don't fight."

Thus, neither the idea of a single, all-powerful systemic-risk regulator nor the concept of a committee holds much promise.

There is an alternative.

In the early part of the last century, Supreme Court Justice Brandeis spoke of "a curse of bigness" and urged the breakup of financial conglomerates. As the New Deal began in 1933, he warned, "Remember, the inevitable ineffectiveness of regulation," and advised that the "curb of bigness is indispensable to true democracy and liberty."

The New Deal took Brandeis' admonitions to heart. The Glass-Steagall Act of 1933 separated commercial and investment banking; the Public Utility Holding Company Act of 1935 imposed a death sentence on giant utility holding companies; and the Revenue Act of 1936 limited mutual funds' ownership of industrial firms. These and other New Deal laws demonstrated that the financial omelet can, in fact, be unscrambled. Some of these reforms have been undone by the recent wave of deregulation, but many remain in place. Indeed, in 1994 Congress used the Brandeis approach when it limited no bank could control more than 10% of the nation's deposits.

Justice Brandeis and his New Deal disciples demonstrated that neither financial behemoths nor smothering regulation is inevitable. Recently, leading experts such as former Federal Reserve Board Chairman Paul Volcker, Bank of England Governor Mervyn King and former Citicorp CEO John Reed called for legislation along the lines of Brandeis' approach. The House Financial Services Committee has made a start by approving legislation that would authorize regulators to break up financial giants. But this approach still relies on action by regulators. The Obama administration and Congress can resist a world where there will be either an omnipotent super-regulator or a toothless council. All that's required is the political will to pursue another, far less risky, route to financial reform — legislation that limits the size and activities of financial firms — so that none are too big to fail.

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