The cronyism in the financial sector that led to "too big to fail" must be dealt with. The Dallas Fed recommends (and I agree) that banks must instead be "too small to save".
If commercial banking and investment banking could be kept separate within the same corporate shell, that would probably be okay. But when risk-taking in investment banking is implicitly subsidized by deposit insurance on the commercial banking side of the business, then bankers and investors have strong incentives to take on too much risk, knowling that the taxpayers will eventually bail them out.
The Dallas Fed recommends incorporating more market discipline into investment banking and making sure that deposit insurance does not subsidize risk-taking.
To address this situation, we have proposed confining access to the federal safety net—the Federal Reserve’s discount window and federal deposit insurance protection—to traditional commercial banks. Further, we advocate that customers and creditors of companies affiliated with commercial banks sign a disclaimer acknowledging their understanding that there is no federal guarantee underpinning their relationship with these nonbank units or with the parent of any banking company. We believe these two steps would reduce the perverse incentives stemming from the implicit—but widely recognized—creditor protection offered to TBTF [Too Big To Fail] institutions. These two changes would help realign incentives to better resemble those faced by customers of smaller banks whose unsecured creditors and equity shareholders are exposed to losses. In short, our proposal would revive the inhibited forces of market discipline. [Emphasis added]
The piece cited here is a bit short on details of how to implement the transition, but it is clearly on the right track.
Addendum: My former classmate from Iowa State (and KC Fed Prez for years), Tom Hoenig had this to say about the failure of "too big to fail". His position (too briefly summarized) is that banks should be allowed to fail and that priority rules in bankruptcy must be observed. But be sure to read the last few pages at this link; they spell things out in greater detail. Tom is now a director of the FDIC.