WASHINGTON -(Dow Jones)- Instead of funneling taxpayer money into large, faltering firms, it is time for the government to take the radical step of breaking them up into smaller, more transparent companies, top economists told U.S. lawmakers Tuesday.

“We have little to lose, and much to gain, by breaking up these behemoths, which are not just too big to fail, but also too big to save and too big to manage,” said 2001 Nobel Prize recipient and Columbia University professor Joseph Stiglitz, one of the witnesses testifying before the Joint Economic Committee of the U.S. Congress Tuesday morning.

He argued that the U.S. financial sector is simply too large, and gigantic institutions are more likely to take excessive risks that backfire on taxpayers and distort markets. Stiglitz also criticized the Treasury Department’s $700 billion financial-rescue program for propping up large firms with subsidies while allowing smaller, community-based banks to collapse.

“In short, our bailouts run the risk of transferring large amounts of money, often in non-transparent ways, to those banks that did the worse job in risk management – hardly principles on which normal market economics is based,” said Stiglitz.

Similarly, Massachusetts Institute of Technology Professor and Peterson Institute for International Economics Fellow Simon Johnson argued that policymakers need to overhaul antitrust laws to prevent the development of financial firms that are too large. Banks should be sold to new private-equity owners and broken up, Johnson said, adding that banks could be sold in medium- sized pieces and divided regionally or by type of business to avoid a concentration of power.

“This may seem like a crude and arbitrary step, but it is the most direct way to limit the power of individual institutions, especially in a sector that, the last year as taught us, is even more critical to the economy as a whole than anyone had imagined,” said Johnson. He also called for caps on executive pay for all banks that receive government aid – including those that benefit from Federal Reserve programs. Additionally, he said Treasury’s Public-Private Investment Program to address toxic assets that sit at the heart of the current crisis is riddled with problems and unlikely to work.

Also on the panel was Federal Reserve Bank of Kansas City President Thomas Hoenig, who criticized the federal government’s response to the financial crisis, saying the measures have focused too heavily on propping up large companies such as American International Group Inc. (AIG).

“Our actions so far risk prolonging the crisis while increasing the cost and raising serious questions about how we eventually unwind these programs without creating another financial crisis as bad or worse than the one we currently face,” Hoenig told the Joint Economic Committee.

He argued that large ailing banks should be allowed to collapse. They could be temporarily operated as a conservatorship and then reprivatized, he said, adding, “We cannot simply add more capital without a change in the firm’s ownership and management and expect different outcomes in the future.”

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