Vermont Senator Bernie Sanders, the left-leaning Independent who caucuses with the Democrats, today introduced legislation that would give the government the power to identify and break up financial firms that are "too big to fail."

The story from Reuters:

An independent U.S. senator on Friday introduced a bill that would give the government the power to identify and break up financial firms that are "too big to fail," an idea that is catching on.

"If an institution is too big to fail, it is too big to exist," said Senator Bernie Sanders in a statement.

"We should break them up so they are no longer in a position to bring down the entire economy," he said.

Sanders is an independent outside the U.S. political mainstream. But he is not the only one looking at break-ups.

Representative Paul Kanjorski, the Democratic chairman of the capital markets subcommittee in the U.S. House of Representatives, is working on a break-up power amendment.

It would give a new government systemic risk council break-up power, with clearance from the president.

"It's the natural action of capital to grow and exceed. Now we're going to contain it," Kanjorski told CNBC television.

He said large banks oppose his amendment because it would threaten them. But, he said, mid-sized and smaller financial institutions would be helped by it because they would be better able to compete if mega-firms were downsized.

"When the people's money is being used to bail out these large companies ... We certainly have to have someone to tell them what to do in order to save them," he said.

House Financial Services Committee Chairman Barney Frank said earlier on CNBC that a bill he is working on, which Kanjorski wants to toughen, would let a systemic risk regulator "break up" risky financial firms.

The Obama Administration has proposed regulating large firms' risk-taking much more tightly to prevent them from failing, while setting up new protocols for managing failure if things go wrong. Senator Sander's approach, however, would be to prevent the firms from getting so big in the first place.

The legislation introduced by Senator Sanders would give Treasury Secretary Timothy Geithner 90 days to list commercial banks, investment banks, hedge funds and insurers that he deems too big to fail.

The bill defines that as "any entity that has grown so large that its failure would have a catastrophic effect on the stability of either the financial system or the United States economy without substantial government assistance."

A few quick thoughts. One, I think it important to separate investment banks from commercial banks. Two, exotic derivative products need to be regulated. At times it is difficult to tell the difference between Wall Street and the Vegas Strip. Three, don't allow commercial banks to grow via acquisition. Make them grow organically. That's part of the Canadian banking model and the Canadian banking model is worth studying closely. From an April 2009 Brookings Institution report:

In Canada, over-leveraging is discouraged. The ceiling on leverage ratios (assets to capital) for Canada's financial institutions is capped well below the U.S. norm (an average of 18:1 compared to over 25:1, respectively).

Second, the requirements for mortgage loans are relatively stringent. Down payments of at least 20 percent are ordinarily required, unless the bank obtains mortgage insurance through the Canada Mortgage and Housing Corporation (CMHC). The CMHC exerts a prudential influence over mortgage underwriting. Banks rely extensively on it for default insurance, which is conditioned on comparatively strict criteria for creditworthiness.

The Canada Mortgage and Housing Corporation transparently plays a role in circumscribing residential mortgage securitization. The great bulk of all lending in Canada takes place within the banking system itself, not through a largely unsupervised secondary market for bundles of loans and securities supposedly backed by other bundles of loans and securities--the "shadow banking system" - hedge funds and buy out firms - that has burgeoned in the United States.

Senator Sanders Unfiltered: Break 'Em Up!