Bailing out financial institutions viewed as "too big too fail" is the greatest threat to the free market and the economic future of the U.S., former Federal Reserve Chairman Alan Greenspan said Wednesday.

Greenspan lamented the growth in size of banks and other financial institutions in a speech at the conservative American Enterprise Institute (AEI) think-tank, suggesting the formation of new, less risky banks to replace the existing financial services infrastructure.

"Government guarantees of the liabilities of institutions viewed as too big to fail thwarts the competitive process that produces capital efficiency," Greenspan said in his prepared remarks. "Of all the regulatory challenges that have emerged out of this crisis, I view the ["too big to fail"} problem and the...precedents, now fresh in everyone's mind, as the most threatening to market efficiency and our economic future."

The bailouts "impairs creative destruction," he added, with the government misdirecting funds to economically wasteful companies.

The former Fed chief also said he was "puzzled" that there hasn't been a rush to create new banks free of toxic assets, which he said could be profitable and contribute significantly to an economic recovery.

Greenspan also said the Obama administration faced a dilemma in creating new regulations for banks and financial institutions and allowing those firms to compete on a worldwide playing field.