Yesterday, the president of the Federal Reserve Bank of New York, Bill Dudley, took another take on too big to fail (TBTF). Looks like we now need a new acronym: too big to be good (TBTBG). Apparently based on the belief that big banks will never be anything else but bad, the Dudley plan calls not only for the ever-larger rulebook, but also for mandatory deferral of senior management compensation upon a capital shortfall. Based on the time-honored central-bank mission of taking away the “punch bowl,” the New York Fed head now suggests that regulators also go after the honey pot. Bank regulators are already deferring bonuses in hopes of incentive alignment and clawing back compensation when bad things happen. Going still farther and adding still more grief for being a big cheese at a big bank will work only to make the industry even less efficient as the vital intermediary it’s still supposed to be. What did Mr. Dudley say? The key passage in full follows:

Another [TBTF cure] might be to structure compensation practices to strengthen senior bank managers’ incentives to proactively manage risk. For example, imagine how incentives would change if a significant portion of senior bank management’s compensation each year were deferred to be available to cover future capital losses. I suspect that over time this would meaningfully alter management’s risk tolerance. Also, in addition to the quantity of the deferred compensation, the form it takes could also affect incentives. If most of the deferred compensation were in the form of debt rather than equity, I suspect this would also affect management’s risk tolerance and the appetite to cut dividend payments, reduce share repurchases or raise more capital more promptly when the firm began to become stressed. The terms and the form of deferred compensation are an important tool that could be further developed to generate a better set of incentives consistent with our financial stability objectives.

The passage is long, but its point is direct: the only way to make big-bank managers care enough to do right is to make them creditors. Stripped of its Fedspeak, the Dudley proposal is a radical departure from a fundamental premise of private enterprise – incentives of management and the board are to be aligned with those of the shareholders. Because this fundamental premise can break down when management or the board is inclined to be bad, we back up private enterprise with tough regulation and the panoply of civil and criminal enforcement powers that can also be aimed at miscreant banks and bankers. Can none of these seemingly formidable tools be counted on to cure bad bankers? Mr. Dudley – fan though he is of all of them – says no.

One defense of the Dudley plan is that capital is in the shareholders’ interest because it makes banks less likely to fail. True enough, but how much capital is enough for this and which shortfalls would trigger how much pay from whom? The Dudley concept seems to suggest that any bank that failed its stress test would call on senior management to buck it up, even though the stress test might well deny shareholders the value they seek through capital distributions. Whether the distributions are or aren’t safe is a legitimate question – regulators got this very, very wrong before the crisis in concert with boards. Can they now get it right enough to make required deferred compensation compatible with meaningful capital shortfalls?

If we are going to take senior-management compensation out of the hands of the board and shareholders and at the same time regulate banks to the nth degree, then what are these banks? Private-sector companies regulated to the extent their social benefits (FDIC and FRB discount-window access) warrant or wards of the state because the state has become so dependent on them due to the ill-effect of a bad day at a really big bank? Follow the Dudley line to its conclusion, and big banks become utilities in all but name.

Does that make sense? No. Does it make more sense than this piecemeal process of cutting off every part of a big bank that looks like it might squirm out of a regulator’s hands. Yes, if only because deciding on a utility framework will put big banks out of their misery and redefine the industry once and for all. Shadow banks, fire up your engines.