Nov. 20 (Bloomberg) -- Investors are wondering just how far Congress will go toward breaking up big banks. The answer may depend on the outcome of the health-care debate.

If they fail to overhaul health care, Democrats will face the 2010 midterm elections with little to show for their time in power other than a high unemployment rate, unpopular stimulus spending and a flub of their biggest legislative priority. Meanwhile, Wall Street will keep earning huge profits thanks in part to rock-bottom interest rates.

That may turn banks into an even juicier political target, especially if financial-reform legislation hasn’t passed by the end of the year.

What better way for Democrats to deflect populist anger than to collect a big-bank scalp, or ratchet up the pressure on Wall Street well beyond legislative proposals now on the table. If they don’t, Republicans will take up the cudgel, figuring the Main Street vs. Wall Street play offers electoral rewards.

Congress is already considering proposals to give regulators new powers to dismantle even healthy financial institutions that pose a risk to the economy. An amendment to this effect was adopted by the House Financial Services Committee Wednesday as it weighed its version of financial reform legislation.

Break the Bank

This puts a bulls eye on members of the too-big-to- fail club such as JPMorgan Chase & Co., Goldman Sachs Group Inc., Bank of America Corp., Citigroup Inc. and possibly Wells Fargo & Co. and Morgan Stanley.

Other proposals have gone even further. Senator Bernard Sanders, a Vermont independent, earlier this month unveiled legislation that would require the Treasury Department to break up too-big-to-fail institutions.

Such talk has clearly rattled the big banks. JPMorgan Chief Executive Officer Jamie Dimon last week penned an opinion piece for the Washington Post arguing that when it comes to banking, big isn’t necessarily bad.

“Ending the era of ‘too big to fail’ does not mean that we must somehow cap the size of financial-services firms,” Dimon wrote. “Global economic growth requires the services of big financial firms.”

Goldman Sachs Chief Executive Officer Lloyd Blankfein struck a similar tone when speaking last week before a banking- industry conference.

Right now, there is little chance that legislation such as that proposed by Sanders would pass. And even the amendment to allow regulators to bust up healthy banks, proposed by Democratic Representative Paul Kanjorski, will face a tough slog in the Senate.

Desperate Democrats

Given the unpredictable course of financial-reform legislation, though, banks can’t rule out anything. Dimon’s message that big isn’t bad may be drowned out if Democrats desperately need to show they support Main Street.

As things now stand, the White House would like to see financial-reform legislation passed by the end of this year. Yet the Senate and House still have to reconcile big differences between approaches advocated in legislation coming from Barney Frank’s Financial Services Committee and a bill unveiled by Senate Banking Committee Chair Christopher Dodd.

Difficulties or delays in resolving those differences, which include tough questions related to the role of the Federal Reserve, might push a vote into early 2010.

Needing a Victory

Meanwhile, the Senate is about to begin a contentious debate about health insurance. If, that is, Senate Majority Leader Harry Reid can wrangle the 60 votes needed to open debate on legislation he proposed Wednesday.

Even if Reid wins those votes, the success or timing of the legislation is far from assured. If the Democrats fail on this priority, or if both reform bills are still up in the air early next year, banks may end up becoming a sacrificial, electoral lamb.

For investors, this means the political calculus needed to evaluate big banks grows more complex. It may also upend assumptions about how quickly banks can return to more-normal, pre-crisis levels of profitability.

At the very least, the too-big-to-fail issue, if not dealt with quickly, could roil bank share prices. “Given the popularity of the issue, we expect significant media coverage generating negative headline risk for the largest institutions,” analysts at FBR Capital Markets wrote in a research note this week.

This may take investors by surprise. Fears related to the government’s massive, new role in markets have waned with the big rally in financial stocks since March lows.

Blunting the Impact

Part of that complacency stems from the fact that banks have so far fought a largely successful rear-guard action to limit possible damage from regulatory reform.

Talk of re-imposing Glass-Steagall-like separations of commercial and investment banking activities, for example, has foundered. The debate about too-big-to-fail firms has focused on how to deal with one that may collapse, rather than how to shrink them in the first place.

Successes like that may be easily undone if there is a big change in the pre-election, political landscape. Banks’ may start hearing ever-more strident calls for the biggest of the bunch to be broken up.

To escape that fate, Dimon and Blankfein may need a health- care victory just as much as Democrats do.

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

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

Last Updated: November 19, 2009 21:00 EST