Next month, FinServ Chairman Hensarling will head back into too-big-to-fail territory, although whether he plans to just hold more hearings or to actually take up legislation remains to be determined. What I do know is that efforts to scuttle TBTF are coming right as the market has finally figured out that Dodd-Frank is a credible resolution regime. As a result, big banks are in a risky never-never land – subject to stringent rules ensuring that they are readily resolvable, pricing more risk into their debt even as some demand the whole framework be repealed. As a result, big banks are relegated to fail even as the market believes they never can.

How do I know the market is finally waking up to Dodd-Frank’s meaning? Read Moody’s announcement yesterday about pending downgrades for the soundest of the very biggest banks. As Moody’s says, ratings review has been triggered by the “possible reduction in government support assumptions.” This derives from the potential for reduced government support that increases default risk and more orderly work-outs that could limit loss in default. In short, it comes from the build-out of orderly liquidation and all of the new rules demanding more capital, collateral, liquidity, risk management and the like.

One can forgive Moody’s for gobbledy-gook prose because U.S. and global resolution protocols are anything but clear. We did our best for clients this week with three in-depth analyses of the FSB’s proposed framework for insurers, financial-market utilities, and custody banks/prime brokers, but the protocols are a wondrous combination of complexity, uncertainty and tough new requirements designed to bar future taxpayer bail-outs. Moody’s appears to have put faith in the latter aspect of the protocols, faith we think correct, despite the confusion of all of these competing standards and how much in them has yet to be finalized.

One reason Moody’s is feeling perky about an end to TBTF is the FDIC’s build-out of the single-point-of-entry (SPOE) resolution strategy. This will, among other things, require the biggest banks to issue enough long-term, unsecured debt to ensure that debt can quickly be turned into enough equity to fund a bridge entity that keeps systemic operations afloat under acute stress. The more debt a BHC issues, the higher its risk of default, but the sounder the subsidiary bank when this debt is funneled into equity to fund business as usual at the bank. Importantly, Moody’s doesn’t plan to change subsidiary-bank ratings, just those from the holding company from which all this debt would issue forth. If Moody’s does downgrade the biggest BHCs, more will change than the cost of debt. They may become ineligible counterparties for certain customers, needing to post a lot more collateral despite growing shortages of this critical commodity and otherwise operate at much higher costs to themselves, their customers and eventually the shareholder. Thus, big BHCs will come under a costly new resolution rule, plus a lot of market discipline with sharp teeth.

But, this market discipline doesn’t come from recognition of loss upon default, but rather from longstanding prudential criteria (now beefed up) to limit counterparty risk. Under stress, these measures only get the market part of the way out of a crisis – the real cure to collapse is orderly interventions to prevent chaos without providing taxpayer bail-outs. The biggest dilemma posed for big banks, as the end to TBTF comes into view, is not the legal structure governing their resolution, but market disbelief that it will work. This comes not just from the incoherence of some of the resolution protocols, but also from rhetoric from those in Congress and elsewhere that flat-out doubt that regulators will have the nerve to do what they now are empowered to undertake should a behemoth again stumble in a financial crisis.

This leads to the never-never land noted above – big banks are being essentially taxed, through all of the new rules to end TBTF, even as markets anticipate bail-outs that muzzle market discipline. Under stress, big banks won’t be able to ride to the rescue because they will lack the capital or, perhaps, courage to do so again, but markets will run in panic because they still disbelieve that liquidation can indeed be orderly.

In short, big banks are crippled, but markets remain fragile. Sensible financial policy means giving TBTF cures time to take hold; simply repealing the framework will sow the seeds for a 2008 rerun minus the statutory flexibility the Fed and FDIC happily used the last time around.