Shelby Criticizes Reform Bill, Saying It Won’t End ‘Too Big to Fail’ Problem

WASHINGTON — The Democratic bill to overhaul the nation’s financial system would not end the “too big to fail” phenomenon or adequately protect taxpayers from having to bail out large companies, a leading Republican senator said on Thursday.

The senator, Richard C. Shelby, is the top Republican on the Banking Committee, and his objections, laid out in a letter to the Treasury secretary, Timothy F. Geithner, suggested the line of criticism that his party will pursue when the Senate takes up the bill, possibly as early as next month.

Lawmakers from both parties have said that a major aim, perhaps the foremost aim, in rewriting financial regulations is to prevent the government from having to bail out systemically important financial companies, as it did in 2008.

But economists and lawyers have disagreed about how to create a workable “resolution authority.” In general, Republicans have sought to rely as much as possible on existing bankruptcy law, while Democrats support an approach like the one the Federal Deposit Insurance Corporation uses to seize and dismantle failing banks.

Sole reliance on bankruptcy courts is seen as unfeasible. After the Bush administration allowed Lehman Brothers to fail in September 2008, markets went into a panic and the government was forced to bail out the American International Group and other companies.

On Monday, the Banking Committee approved, on a party-line vote, a bill introduced by its Democratic chairman, Senator Christopher J. Dodd of Connecticut.

Mr. Shelby outlined four objections to the Dodd bill’s handling of the “too big to fail” problem.

He said that the bill would leave the Federal Reserve with emergency lending powers that could be abused, and that the bill would give the F.D.I.C. and the Treasury Department the ability to provide broad debt guarantees.

“A resolution regime can be credible only if the government does not have the authority to bail out failing firms,” he wrote.

The Dodd proposal contains a provision that would require large financial companies to contribute to a $50 billion fund that could be used to help dismantle a systemically important company.

Mr. Shelby called it a slush fund and said, “The mere existence of this fund will make it all too easy to choose a bailout over bankruptcy.” (The Obama administration has indicated that it does not support such a fund.)

Finally, Mr. Shelby said that giving the Fed oversight over the largest and most interconnected financial companies would tarnish those firms by singling them out for scrutiny.

“The market will view these firms as being identified by the Federal Reserve as ‘too big to fail’ and implicitly backed by the government,” he wrote.

Democrats have called for Republicans to come forward with alternative proposals instead of trying to block the legislation altogether.