In surprisingly blunt criticism of both the government and his colleagues, Federal Reserve Bank of Kansas City chief Thomas Hoenig argued that “insolvent firms must be allowed to fail regardless of their size, market position or the complexity of operations.” His Congressional testimony Tuesday morning to the Joint Economic Committee provided some of the strongest criticism of the government bailout yet by any major figure within the Federal Reserve. “The United States currently faces economic turmoil related directly to a loss of confidence in our largest financial institutions because policymakers accepted the idea that some firms are just ‘too big to fail.'” he said. “I do not.” “With the crisis continuing and hundreds of thousands of Americans losing their jobs every month, it remains tempting to pour additional funds into large firms in hopes of a turnaround. However, actions that strive to protect our largest institutions from failure risk prolonging the crisis and increasing its cost. Of particular concern to me is the fact that the financial support provided to firms considered ‘too big to fail’ provides them a competitive advantage over other firms and subsidizes their growth and profit with taxpayer funds.” The sentiment from Hoenig echoes some of the sentiments among smaller bankers and even consumers that HousingWire has corresponded with, who have wondered aloud: if a large bank were to fail, wouldn’t another bank, ostensibly one that didn’t take undue risks, rise to take its place? Hoenig suggests a two-step resolution problem for troubled banks in his testimony: first, triage viable firms (defined as those that are well-capitalized) and either raise capital or receive assistance from the government. Second, allow non-viable banks to fail and be placed into conservatorship. Doing anything less, he suggests, risks pulling the U.S. into a lost decade of its own, similar to the Japanese experience that has been discussed ad nauseum by commentators and economists alike. Treasury secretary Geithner suggested in testimony Tuesday that no banks would fail the government’s current “stress tests,” an outcome Hoenig clearly feels would be a mistake. “These ‘too big to fail’ institutions are not only too big, they are too complex and too politically influential to supervise on a sustained basis without a clear set of rules constraining their actions,” he said. Read the full testimony. Write to Paul Jackson at paul.jackson@housingwire.com.