In their recent article "It's Time to End Too Big to Fail," fellow Fools Ilan Moscovitz and Morgan Housel advocate breaking up big banks, and reintroducing the Glass-Steagall Act's separation of investment and commercial banking. The "too big to fail" policy is indeed an invitation to disaster, and the authors make some strong points. But ultimately, the proposed solution would not fix what ails our financial system -- it would only impose large additional costs.

Bank market share isn't unduly concentrated
The authors lead off with perhaps their weakest argument: The banking system has become unduly concentrated. They point out that the "Big Four" banks -- JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C), Bank of America (NYSE:BAC), and Wells Fargo (NYSE:WFC) -- control nearly 40% of the nation's deposits, and that these four plus Goldman Sachs (NYSE:GS) hold 97% of the banking system's derivatives exposure by notional value, as though these are self-evidently outrageous figures.

In fact, there is nothing to suggest that four competitors holding 40% of a market is any impediment to competition. In the U.S., Dell and Hewlett-Packard alone hold 52% of the PC market; Google (NASDAQ:GOOG) holds more than 70% of Web search market share; and McDonald's (NYSE:MCD) holds 46.8% of the fast-food hamburger market. Should we break up McDonald's into a cohort of "Baby Burgers?"

While five competitors holding 97% of derivatives exposure is indeed a high level of concentration, I submit that it's entirely reasonable, given the concentration of expertise needed to operate in derivatives markets. The largest exposure by far is at JPMorgan Chase, which has been a pillar of stability throughout the financial crisis. Who believes the banking system would be safer if JPMorgan Chase's exposure were spread out among a bunch of community banks?

Size and scope in banking are indeed overrated ...
I agree with the authors that Jamie Dimon's justifications for gigantism are self-serving. And I believe consolidation in the banking industry has been driven less by competitive forces, and more by the correlation they cite between balance sheet size and CEO compensation.

But they're not the real problem
However, Glass-Steagall 2.0 would have done precisely nothing to ameliorate the current financial crisis. Bear Stearns and Lehman Brothers didn't fail because of any commercial banking activities, nor did Wachovia or Washington Mutual fail because of investment banking.

Indeed, the repeal of Glass-Steagall arguably prevented Merrill Lynch from failing, by allowing Bank of America to acquire it.

The justification for Glass-Steagall is it protects commercial bank deposits. Yet failing investment banks have imposed no great costs on the FDIC in this cycle; the FDIC is broke because of commercial bank failures.

Breaking up is costly to do
Moreover, barring institutions from using stable deposit funding heightens the risk of failure. This crisis has shown that stable deposit funding is a bulwark against the liquidity squeezes that can cause otherwise solvent institutions to fail. This isn't a new lesson; the FDIC's own postmortem on the failure of Continental Illinois also highlighted that bank's inability to build a stable deposit base, as a result of Illinois' laws at the time.

Breakups would also entail lots of redundant costs; each broken-up part would require its own CEO, its own underwriting processes, its own branding, and so on. Meanwhile, bargaining power with suppliers would diminish along with size. Just because economies of scale in banking don't fall to the bottom line doesn't mean they don't exist. The cost of eliminating them would inevitably fall to customers.

And while eight individual Baby Wells wouldn't individually be too big to fail, they'd likely be highly correlated. Should they all arrive at death's door at the same time for the same reasons in the same crisis, they might very well still be collectively deemed too big to fail.

Would national banks be broken up, AT&T-style, into geographically discrete franchises? If so, then each would suffer from dramatically increased geographic concentration in their credit portfolios. This would also rob customers of the convenience of having access to their bank's branch and ATM network from coast to coast.

A modest proposal: the free market
So if Glass-Steagall 2.0 is such a dead end, how should we address "too big to fail?"

Allow me to make a modest proposal: the free market. Enshrine in law that henceforth, shareholders and creditors are on their own. No more privatized gains and socialized losses; their profits are theirs to keep, as are their risks and losses. The sun still rose after Lehman Brothers declared bankruptcy; it would have a day later, had AIG been forced to do likewise.

Pleasant? Not really. But sometimes life forces us to choose the least bad option. Compared to "too big to fail" and "Glass-Steagall 2.0," the pain (and discipline) of the free market isn't so bad after all.

Do you side with me on "too big to fail" and "Glass-Steagall 2.0" or are you with Ilan and Morgan? Let us know in the comments section below.

Fool contributor Sean Ryan does not own any of the stocks referenced in this article. Google is a Motley Fool Rule Breakers recommendation. Dell is a Motley Fool Inside Value pick. The Fool's disclosure policy can be found here.