The need to bailout Bear Stearns & Cos. earlier this year, and to provide a government backstop to ailing mortgage finance giants Fannie Mae (FNM) and Freddie Mac (FRE) may possibly have been avoided with a more flexible bankruptcy system, according to comments by Yale professor Robert Shiller, half of the namesake behind the ubiquitous Case-Shiller home price indices. In an op-ed published Saturday by the New York Times, Shiller suggested that systemic risk is the largest threat our financial systems now face, and one reason why the current housing mess has had such an over-reaching effect on the broader financial system. "The government has already felt it necessary to take measures to bail out Fannie Mae and Freddie Mac," he wrote. "What if the next case is worse? No one in government seems to feel a responsibility for warning about such possibilities and formulating a detailed policy for dealing with them." Instead, he suggests that an overhaul of the U.S. bankruptcy code could alleviate problems associated with what Federal Reserve chief Ben Bernanke has called a "complex and interconnected financial system." The last such major overhaul took place with the Bankruptcy Reform Act of 2005, which was targeted primarily towards consumer bankruptcies (we won't delve into BAPCPA here for the sake of brevity). "Current bankruptcy law was not written with the perspective of systemic risk in mind," Shiller argued. "There is a big problem -- a discontinuity in macroeconomic outcomes -- when large financial institutions are at the margin between solvency and insolvency." What Shiller suggests, along with some legal specialists in the academic community, is reforming the bankruptcy code to support what he called a "subsidized system of triage," meaning that in times of crisis, some ill-fated companies may continue to operate until it becomes feasible to shut them down or transfer ownership. His take on the "too big to fail" issue reaches well beyond the GSEs and investment banks, however, and into that huge uncharted world we like to call private equity and hedge funds (otherwise known as "real money"). "Hedge funds, for example, do not need to disclose much about what they are doing, yet they are starting to play a role in our economy that resembles that of 19th-century banks," Shiller noted in his column. "WHAT would happen to the economy if hedge funds had to liquidate, one after another, in a financial crisis?" His remarks on hedge funds as banks are prescient, given news today that large private-equity firms are lately doing much more than just investing in equity. Disclosure: The author was long FRE and held no positions in FNM when this story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.