MIT Professor Simon Johnson recently argued that Bill Daley’s appointment as Obama’s Chief of Staff signals that “too big to fail,” as it relates to our largest financial institutions, is here to stay. Personally I never thought it was in doubt. With Geithner at Treasury and Dodd-Frank further codifiying “too big to fail,” its been clear for some time that the bailout net is larger than it’s ever been, and is not being pulled back.

That said, Professor Johnson’s focus on Daley distracts from the real issue, which is changing our bank regulatory structure to end bailouts. The focus on Daley has the potential to lead us down that path of “if we just had the right people in government…” We shouldn’t be designing our regulatory structures with the “right” people in mind, but rather with the rule of law in mind. In fact, one of the benefits of the Obama administration is that it serves as a great test of the “right people” hypothesis of government. One is unlikely to see a more left-leaning White House than this one, so if this one gets captured by special interests, including Wall Street, than it’s a safe bet that any future administration will as well.

Since I believe most of us actually want to end “too big to fail,” the real question is how to do it. It strikes me that we have three options: regulate the largest institutions to death (or competitive disadvantage), break them up, or credibly impose losses on their creditors. Ultimately I think the regulation approach is bound to fail, if for no other reason than regulatory capture. (Even Elizabeth Warren seems to get this: “Regulations, over time, fail. I want to see Congress focus more on a credible system for liquidating the banks that are considered too big to fail.”) Breaking them up might sound attractive in theory, but I have a hard time seeing how it truly works in practice. After all, few in Washington viewed Bear Stearns as “too big to fail.” Accordingly, I believe the best approach would be to force creditors to take losses or be converted into equity. To make this credible, we must bind the hands of the regulators. As long as the Fed, Treasury, or the FDIC can inject money, then bailouts are always on the table. 

Sadly, what the Daley appointment reminds us is that any attempt to end “too big to fail” will likely have to wait until the next administration. Not only is this one wed to bailouts, the President would likely veto any bill that really tied the hands of the Fed.