Sept. 30 (Bloomberg) -- It was surprising to hear JPMorgan Chase & Co. Chief Executive Jamie Dimon say, “It would be a very bad long-term policy error to have banks that are too big to fail.”

Dimon, after all, runs one of the biggest members of the too-big-to-fail club. Things became clearer when he quickly added, “By that I don’t mean make the banks smaller. We’re large because we have a reason to be large.”

What Dimon was trying to say while speaking last week at the Clinton Global Initiative conference in New York was that the government needs to figure out how to handle a too-big-to- fail firm that runs into trouble. He wasn’t espousing government action that would break up the largest banks or curtail what they do when alive, especially if they are minting profits.

Yet that’s one reason why efforts to overhaul financial regulation are taking so long to produce results. The emphasis on what Congressman Barney Frank last week called “death panels” for systemically risky firms is getting in the way of finding smarter ways to deal with these firms as they are today.

The Obama administration needs to change that. Otherwise, reform efforts may drag on until the next crisis erupts. In the meantime, too-big-to-fail firms will have grown more entrenched and harder than ever to handle.

Imposing Restrictions

How can the administration sharpen the regulatory reform focus? The White House should take concrete steps to restrict the way the biggest firms live, even as it lets Congress wrestle with the issue of how to manage these entities when they are dying.

One approach is to adopt some Treasury Department proposals for changing how banks operate and apply them in a sort of pilot program to only the biggest banks. The changes would include increased capital requirements; caps on the amount of borrowed money these firms may use; and a closer examination of the kinds of funding they use to operate.

The administration would be able to make these changes through the regulatory process, ahead of any legislation and adoption by all banks. Doing so would have multiple benefits.

It would start to bring the biggest institutions such as JPMorgan, Bank of America Corp.,Citigroup Inc.,Wells Fargo & Co.,Goldman Sachs Group Inc. and Morgan Stanley to heel. That may cause them to weigh the benefits of being a systemically important firm.

This sort of pilot program would also sidestep some international squabbles over the minutiae of financial reform, at least as it relates to the wider banking system. That process, at best, will be long and drawn out.

Needing Years

In principles laid out following their meeting last week in Pittsburgh, leaders of the Group of 20 nations talked about changes for bank capital requirements in terms of years, not months.

The process may take even longer given bankers’ strong desire to maintain the status quo. The G-20 leaders had barely ended their meetings before European and U.S. financial-industry groups were calling for restraint.

In the U.S., the Securities Industry and Financial Markets Association said that before the G-20 recommendations are put into place, “It is critical that we understand their aggregate impact on global economic growth.”

When it comes to systemically risky firms, we don’t have the luxury of taking time to do more studies while they continue to grow bigger and more powerful.

Delays Are Dangerous

The same danger of delay lurks on Capitol Hill where Congress is trying to craft sweeping financial-overhaul legislation. Although legislators want to finish a reform bill by the end of the year, chances of that happening are slim.

Congress is no closer to figuring out what to do about too- big-to-fail firms than it was a dozen or so hearings ago. Questions over how best to structure regulatory oversight to prevent systemic risks are another big sticking point, as is the issue of a consumer financial protection agency.

Those contentious issues aside, the legislation is voluminous and will require time to make its way through Congress. During testimony last week, Treasury Secretary Timothy Geithner noted that his staff had already sent 600 pages of legislative language to Congress.

Given this, it is better for Obama’s team to take some more direct action and apply them to the biggest institutions. The Treasury’s proposals are a good starting point.

Volker’s Testimony

The administration may also want to limit some non-banking activities, such as proprietary trading, done by big firms. Former Federal Reserve Chairman Paul Volcker noted during congressional testimony last week that bank regulators already have “the authority to arrange capital requirements that could be increasingly severe as the trading activity increased.”

None of this would be received well by the biggest banks. As JPMorgan’s Dimon said, he doesn’t want to see his bank shrink. Neither do his peers.

That is exactly why the process of figuring out what to do about them can’t be dragged out. And it’s why the focus needs to be on how we live with these behemoths, not just their possible funeral arrangements.

(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: David Reilly at dreilly14@bloomberg.net

Last Updated: September 29, 2009 21:00 EDT