Nov. 4 (Bloomberg) -- A U.S. House Democrat will propose letting the federal government break up large financial firms whose failure could threaten the economy by adding a provision to legislation that would end taxpayer-funded bailouts.

Representative Paul Kanjorski said today regulators should get authority to dismantle firms, preventing them from getting so big their collapse would harm the financial system. He said he is coordinating with the European Union, which is forcing asset sales by state-aided banks to limit their advantage.

“Nowhere in the world in the future will there be gigantic tsunamis coming out of nowhere and striking the entire world’s economy,” Kanjorski, a Pennsylvania Democrat, said as the House Financial Services Committee took up the legislation.

The committee today began considering a bill, proposed last week by Chairman Barney Frank, that would let the Federal Reserve limit company size by forcing the sale and transfer of assets and off-balance-sheet items at firms whose collapse would pose a risk to the economy. The Fed would have power to stop some activities by institutions.

“That’s a very limited power,” Kanjorski said of Frank’s plan. “It’s not clearly defined. We’re going to be very evident as to how.”

Frank’s provision on the Fed only applies to holding companies, while Kanjorski said his proposal will apply to all U.S. financial institutions.

European Actions

In Europe, Royal Bank of Scotland Plc and Lloyds Banking Group Plc, the two biggest U.K. banks to get aid, said yesterday they would sell branches and divisions to win EU approval for their bailouts. ING Groep NV, the biggest Dutch financial services company, last month said it would sell its insurance units to secure approval for its rescue.

Fed Governor Daniel Tarullo said Oct. 21 the idea of breaking up large institutions is impractical, calling it “more a provocative idea than a proposal.” Instead, he said any firm that may pose a risk should be subject to stricter oversight. Former Fed Chairman Alan Greenspan on Oct. 15 said regulators should consider breaking up systemically risky firms.

“The answer to fixing too big to fail shouldn’t be breaking up the big institutions,” Stephen Cutler, JPMorgan Chase & Co. general counsel, said today at a law conference in New York. “Big banks do serve a purpose.”

Regulator Council

The Frank measure also creates a council to monitor firms for systemic risk and gives the Federal Deposit Insurance Corp. power to liquidate firms that would disrupt the economy if allowed to collapse in bankruptcy. Kanjorski plans to offer his amendment to the Frank bill.

Kanjorski said the power to restructure a company could go to the systemic-risk council and involve the Treasury secretary, with a final decision made by the president.

Industry “would have to be scared” of the proposal, Kanjorski said. “We’re not trying to scare them. We’re trying to face the reality.”

The U.S. has about 15 or 20 financial organizations “that are so large that everybody knows we can’t allow them to fail and that’s why we’re putting this bill together,” he said.

Senator Richard Shelby, the top Republican on the Senate Banking Committee, said today he liked the idea.

“I don’t think anything is too-big-to-fail,” said Shelby, of Alabama. “We ought to be looking at legislation to deal with a bank beforehand if we can, or an institution that would cause systemic risk, to make it stronger, or make it smaller.”

To contact the reporter on this story: Alison Vekshin in Washington at avekshin@bloomberg.net.

Last Updated: November 4, 2009 14:46 EST