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Who's really too big to fail?

Let some troubled financial firms fail, U.S. regulators tell Congress. Fannie Mae and Freddie Mac are exceptions.

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America's top financial policymakers have a message about the government's role in times of turbulence: Bailouts not necessarily included.

"Allowed to fail." That's the way Treasury Secretary Henry Paulson, in a congressional hearing Thursday, said financial companies should generally be treated.

"Orderly liquidation," said Federal Reserve Chairman Ben Bernanke at the same hearing, outlining a possible response if a prominent securities firm faced bankruptcy.

Their words don't mean that the government is withdrawing from its backstop role in financial markets. In fact, the importance of that role was underscored this week as mortgage giants Fannie Mae and Freddie Mac saw their share prices plunge to levels not seen since the early 1990s. The two companies are so central to the home-loan industry that in a crisis regulators would have to step in.

Still, after cooperating to arrange the March rescue of securities dealer Bear Stearns, Mr. Paulson and Mr. Bernanke are reminding investors that government support has its limits.

Congress is considering how to reconfigure the nation's bank regulations after a year of turmoil and a decade of rapid change in financial markets.

Both the Treasury secretary and the Fed chairman say that such legislation is needed – including new regulatory powers to ensure the safety of the financial system on which Americans rely.

But in the hearing, they took care to stress that such moves will not be successful if investors and firms perceive themselves as shielded from often-harsh discipline of the marketplace.

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