Oct. 29 (Bloomberg) -- President Barack Obama’s proposal to police companies for systemic risk and shift the cost for failure to the financial industry faced opposition as lawmakers said the plan would keep the burden on taxpayers in a crisis.

“The bill we’re considering today will simply institutionalize too-big-to-fail” and lead to “perpetual taxpayer bailouts,” Representative Jeb Hensarling, a Texas Republican, said at a House Financial Services Committee hearing on a draft bill negotiated with the Treasury Department.

Representative Barney Frank, the committee’s chairman, this week unveiled legislation to create a council including the Federal Reserve to monitor firms for risks to the economy. The Federal Deposit Insurance Corp. would get power to take apart systemically risky firms rather than let them fail in bankruptcy. A similar Senate bill hasn’t been proposed.

Frank’s legislation is aimed at preventing companies from becoming so large that government must block a failure that could shake markets. Lawmakers have said a lack of a mechanism for shutting large firms in an orderly way led to ad hoc programs, such as the $700 billion taxpayer bailout used by lenders including Citigroup Inc. and Bank of America Corp.

Lawmakers today took issue with key provisions, including a plan to have U.S. financial companies with more than $10 billion in assets repay costs to unwind a firm after it fails. They also opposed having regulators maintain a confidential list of systemically risky institutions.

‘Ugly Head’

“Most of us don’t die and then buy a life insurance policy,” said Representative Luis Gutierrez, an Illinois Democrat. “The fund should be set up just in case their reckless behavior, their risky behavior, raises its ugly head again.”

Treasury Secretary Timothy Geithner, in testimony, said establishing a fund before a firm collapses “would create expectations that the government would step in to protect shareholders and creditors from losses.”

Frank’s legislation gives the resolution authority to the FDIC, expanding the agency’s existing power to disassemble commercial banks and thrifts.

FDIC Chairman Sheila Bair, breaking with the Obama administration, said firms should be required to prepay into a fund that Congress sets up to cover the costs of future failures, rather than be assessed after a collapse.

“All large firms, not just the survivors, would pay risk- based assessments into the fund,” Bair testified. “This approach would also avoid assessing firms in a crisis.”

Representative Randy Neugebauer, a Texas Republican, and other party members said the resolution authority isn’t necessary and he supported liquidating companies in bankruptcy.

Bankruptcy Role

“In all but the rarest cases, bankruptcy will remain the dominant tool for handling financial failure,” Geithner said, citing the demise of Lehman Brothers Holdings Inc. in September 2008. “As the collapse of Lehman Brothers demonstrates, the bankruptcy code is not an effective tool for resolving the failure of complicated global financial institutions in times of severe stress.”

Federal Reserve Governor Daniel Tarullo, Comptroller of the Currency John Dugan and Office of Thrift Supervision Acting Director John Bowman generally supported the compromise measure.

The legislation is part of the Obama administration’s plan to overhaul U.S. rules governing Wall Street to prevent a repeat of last year’s financial market collapse, leading to more than $1 trillion in U.S. bailout programs.

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

Last Updated: October 29, 2009 14:10 EDT