Should the federal government have broad authority to seize private financial institutions on the verge of collapse to keep them from harming the economy? President Obama and his treasury secretary, Timothy Geithner, are arguing just that – saying that such power would have eased problems associated with recent bailouts. “(It) is precisely because of the lack of this authority that the AIG situation has gotten worse,” Obama said in a press conference on Tuesday.

They do have a point. In any sector of the economy, failure should be an option. That means we need effective and workable ways to wind down institutions in an orderly way, without unnecessary collateral damage to the economy. And it’s not clear that current bankruptcy laws or other existing mechanisms do that.

The Administration has seized on seizure as the answer. The Obama proposal – released this morning by the Treasury Department — provides for the seizure of failing financial institutions by the Federal Deposit Insurance Corporation (FDIC), as authorized under an elaborate process involving the Federal Reserve, Treasury Department, the FDIC itself and other financial regulators. The system is meant to parallel the existing authority of the FDIC to seize institutions that it insures. But the proposal raises a raft of dangers. For instance:

– Seizure power would extend to a broad array of financial companies, apparently including private hedge funds as well as bank holding companies.
– Seizure could be ordered whenever an institution is “in danger of becoming insolvent” and the failure would have “serious adverse effects on financial stability or economic conditions in the United States.” But how is “serious adverse effects” to be defined? Are we talking a financial collapse? Substantial job losses? Stock market losses?
– Specific authorization is made for financial assistance to the seized companies, indicating that rather than provide a way to avoid future bailouts, the proposal will facilitate them.
– Appeal to the courts is limited, as the legislation provides: “no court may take any action to restrain or affect the exercise of powers or functions of the conservator or receiver hereunder” (although the initial seizure decision may be appealed).

Any legislation allowing the government to seize private property is inherently dangerous – even more so when done in a rushed manner and under the banner of “emergency.” Certainly, policymakers need to address problems in current law that may be making it too difficult to close down failed institutions. But they should do so deliberatively and cautiously, building on the bankruptcy process to the extent possible. A hurried and dangerous grant of seizure power to Washington is not the answer.