Echoes of 2008 Crisis Met with Dull Bailout Tools

* Dodd-Frank limits ability to help individual firms

* Still skepticism "too big to fail" is over

By Dave Clarke

WASHINGTON (Reuters) - Extreme market volatility has sparked comparisons to the 2008 global credit crisis, but Washington's ability to help out weak financial firms is dramatically different.

The 2010 Dodd-Frank financial oversight law purposefully limits regulators' ability to prop up firms caught in the cross-hairs of a market crisis of confidence.

The idea, meanwhile, that Congress would approve any special assistance is remote, with both liberals and conservatives still holding their noses from the public stink raised by bank bailouts during the financial crisis.

"I think it's unimaginable," said Phillip Swagel, who served in the Treasury Department under President George W. Bush.

Markets' fear factor has been sky high recently as worries about the global economy escalate after an embarrassing downgrade of U.S. debt. In addition, fears remain that European efforts to put a safety net under heavily indebted Italy and Spain might not suffice to avert wider credit market disruptions.

U.S. bank shares have fallen by almost 20 percent from an early July peak, as measured by the KBW Bank Index. Bank of America Corp, in particular, has taken a hit, falling by about 31 percent over that time frame.

Bank stocks did rebound Tuesday with the KBW index closing up 7 percent, but questions remain about the ability of banks to deal with their mortgage exposures and what might happen if market volatility evolves into a credit crisis.

Dodd-Frank restrains regulators from aiding individual firms, and instead pushes the government to seize and liquidate in an orderly fashion a large, failing financial firm.

For instance, it ends the Fed's ability to extend emergency loans under its so-called "13(3)" powers.

It also prevents the Federal Deposit Insurance Corp from providing "open bank" assistance directly to an individual institution, as it did for Citigroup Inc in November 2008, to help keep it in business.

Regardless of the restrictions the law places on banking agencies, several analysts and industry lawyers said the creativity of regulators should not be underestimated if they decide quick action is needed.

"I would bet that regulators would figure out what to do and find a way to do it," said Thomas Vartanian, a bank regulatory attorney with Dechert in Washington.

The law, for instance, does allow both the Fed and the FDIC to create programs intended to deal with liquidity problems that would be considered financial industry-wide.

Several analysts said it is unclear how this would work in practice. But they said regulators might have some wiggle room that could allow them to help one or only a few banks without violating the law.

Despite the troubles facing bank stocks, there is little evidence right now that any large institution is at a stage where the need for a bailout needs to be considered, experts said.

"I think we're very far away from that being an issue, our big banks are in much better shape today," Swagel said.

The issue for banks will be if worries over their health leads to problems raising funds, analysts said.

If this were to occur, banks could fend off troubles for a while by borrowing from the Fed through its discount window.

"If someone needs liquidity in the short run, they go to the Fed," said Ernest Patrikis, a partner at law firm White & Case and a former general counsel at the New York Fed. "I don't know why in this market a bank could not get liquidity." (Editing by Andre Grenon)