More taxpayer bailouts or increase markets' regulatory uncertainty? That may be the trade-off from legislation dealing with financials deemed "too big to fail."

The House Financial Services Committee voted 38-29 last week to expand federal power over Tier 1 firms, which face more scrutiny because they pose a systemic risk. It was an amendment by Rep. Paul Kanjorski, D-Penn., to the Financial Stability Improvement Act.

"(The) Kanjorski amendment would empower federal regulators to rein in and dismantle financial firms that are so large, inter-connected, or risky that their collapse would put at risk the entire American economic system, even if those firms currently appear to be well-capitalized and healthy," Kanjorski said in a press release. "Therefore, American taxpayers should no longer be on the hook for bailouts, as financial companies would not be able to become 'too big to fail.'"

Critics say investors will be wary of putting money into activities of companies when regulators can later order those firms to discontinue those activities.

"These firms may be held back from profitable ventures their non-Tier 1 competitors can enter," said John Berlau, director of the Center for Investors and Entrepreneurs at the free-market Competitive Enterprise Institute. "Investors will take into account that these firms may receive greater harm from regulators than their competitors."

But Berlau also noted that Tier 1 firms might benefit from the implicit guarantee that the federal government will not let them fail.

That's what Kanjorski has said he wants to avoid. His amendment would let regulators deem a Tier 1 firm to be engaged in risky activity even if it's well capitalized. Regulators could impose stricter standards, order it to end particular activities, force it to divest assets and restrict its ability to offer financial products or buy a rival company.

Last fall, Lehman Bros.' failure and AIG's (NYSE:AIG - News) near-collapse threatened the entire U.S. financial system. Regulators had limited authority to stop the firms' ultimately fatal activities. Rather, they had to rely on government bailout and rescue from other financial firms.

Some analysts argue that the Kanjorski amendment is a good way to avoid future taxpayer bailouts.

"The incentives of bankers in Tier 1 companies will be to maximize risk because they don't have to bear the consequences -- taxpayers do," said David Min, associate director for financial markets policy at the liberal Center for American Progress. "Allowing the regulators to say, even though you are meeting numerical requirements, we think you are still risky -- that's a fair way to go."

Just Don't Do It?

"The only way to end taxpayer bailouts is to end taxpayer bailouts," said Jeb Hensarling, R-Texas, and a member of the Financial Services Committee.

Hensarling says the Kanjorski amendment would create more political uncertainty in markets.

"It is completely irrational to believe that substituting the arbitrary actions of unelected federal bureaucrats for the judgments of well-informed market participants will reduce the government's moral hazard for the impact of its actions on shareholders, creditors, counterparties and others," he said.

But, after the massive Wall Street bailouts over the past year, saying the government won't engage in future rescues may not be credible.

Before deciding a firm is engaged in risky activity, Kanjorski would require regulators to consider factors such as a firm's leverage, its ties with other companies, its role as a lender to households, businesses and governments, and the size and nature of a firm's liabilities.

"The idea of being too big, of posing systemic risk, that is defined somehow by some bureaucrat," said Don Luskin, chief investment officer of Trend Macrolytics, and a libertarian. "It will become inherently capricious like antitrust law. No one knows when they will run afoul of the law."

A Kanjorski spokesperson said as antitrust laws have evolved they have increased certainty and pointed out that few companies violate them because they know what's acceptable. Kanjorski expects a similar outcome with his amendment.

But antitrust enforcement changes with every administration.

Still, others also see benefits in giving regulators such authority.

"Reducing the size and complexity of these firms outweighs the uncertainty," said Nomi Prins, former managing director at Goldman Sachs (NYSE:GS - News) and now a senior fellow at the liberal think tank Demos. "Kanjorski should have gone further by setting the constraints and restrictions for these firms in advance and then let regulators enforce them."

The House Financial Services panel will continue work on the overall regulatory reform after Thanksgiving. A full House vote is expected in December.

Gerard Blanchard, a partner at Bryan Cave, sees positives and negatives in the House legislation.

"The bill creates a clearinghouse for derivatives like credit default swaps -- that's going to increase transparency," he said. "But I question the ability of the government to adequately judge risk. Over time, regulators may put so many boxes around companies, investors may say that it's not worth the hassle."