I am a Capitalist Pig, and proud of it. thus you would not expect me to support government interference and more strenuous regulation of financial institutions. After all, free markets and tight regulation don't mix well. Well, at the risk of being kicked out of the Capitalistic Pig Party, I am in support of tighter regulation of too-big-to-fail (TBTF) institutions-the likes of which include Citigroup, JPMorgan, Bank of America and Goldman Sachs.

Lack of tight regulation in the TBTF space leads to the worst economic system of all: asymmetric socialism. The enormous gains are reaped by employees and shareholders, but losses are socialized and paid by taxpayers. That is simply immoral.

Letting companies fail is at the core of capitalism's DNA, and I stand by that. However, what we've discovered over the past few years is that if we let TBTF banks go bankrupt, their failure may take down other healthy financial institutions and derail the real economy. Lehman Brothers' bankruptcy could have caused massive withdrawals of funds from money markets and a shutdown of the commercial paper market. This in turn would have cut off healthy companies from essential short-term funding for daily operations.

BIGGER, NOT BETTER

Our financial system operates on the assumption of continuity: We assume tomorrow will arrive and that we'll be able to get our money out of the banks if we want to. A failure of large financial institutions is akin to an earthquake in New York, but with aftershocks rippling throughout the country that leaves everyone in ruin. So we end up with an imperfect world in which big banks will not be allowed to fail.

This leads us to two realistic solutions:

* Severely restricting the activities of TBTF institutions by creating incredibly strenuous regulations that will require much higher equity-to-debt ratios than for smaller banks. Basically, they would be turned into regulated utilities like your local gas and water companies. Limit their work to only very transparent traditional banking activities, so they cannot fail. In other words, bring back a more sophisticated version of the Glass-Steagall Act, and separate investment and commercial banking.

* Break them up, either by making their lives unbearable through the strenuous regulation described in the first option or simply by legislating them, as was done with AT&T in the 1980s. I personally believe regulation of complex systems often fails, as Wall Street always figures out how to game the system. Breaking them up into small enough pieces so that their failure becomes a non-event for the economy as a whole is what makes the most sense to me. That way, failure will not be socialized, but borne by those who were reaping the rewards.

PRESERVING CAPITALISM

Intense regulation of TBTF institutions will slow economic growth, but to its natural, sustainable level. As we have learned, the other type of growth, though fun for a while, has a price tag that only increases with time. Regulation may also stifle innovation, but our economy would have been better off over the last decade if Wall Street was less "innovative" and employed fewer mathematicians with PhDs.

Critics will argue that smaller banks will be less efficient and thus borrowing costs will be higher for consumers and corporations. This would be true if TBTF banks did not already come with million-dollar executive offices, fleets of corporate jets, and $100 million compensation packages. The bottom line, if you compare the financial metrics, is that smaller banks are not any less efficient than larger ones.

A greater government involvement in the financial sector is not something I thought I'd ever ask for, but it has turned into a necessity in order to preserve-not destroy-capitalism.

Vitaliy Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver. He is the author of Active Value Investing: Making Money in Range-Bound Markets.