Be more specific, please

Crazy Megan! Why doesn't she understand that we need more financial regulation?

I'm not against the idea of financial regulation per se; I like 10-Ks just fine. But I'm still trying to figure out what sort of financial regulation would have prevented this. Not every regulation is an improvement. Raising capital requirements for financial institutions is a good idea, but I don't think that's exactly what the "Bury Bear" crowd has in mind.

It's no good to demand a "tougher" regulator, because it's not clear that anyone did anything wrong. They didn't scam the public; they got caught out by bad investments. Stupid investments. Lunatic, even. As did the many hedge funds that have already vaporized the capital of their rich investors.

I'm all for regulation that increases transparency, but the very problem is that no one has any very good idea how to price all these exotic financial instruments. Should we outlaw them? That would prevent the sort of trouble we've just witnessed, but it would also make it harder for firms to do desirable things like hedge risk.

As I see it, we are currently beset by three problems:

1) Diversifying risks reduced the number of local failures, but made larger, rarer events possible. It also made it harder to accurately assess risk, or renegotiate deals gone bad.

2) Bankers thought that they were smarter than they were: they systematically underestimated the chances of an extreme, unlikely event like the current crisis.

3) A speculative bubble in the various tiers of the mortgage market. Borrowers, bankers and investors systematically mispriced the risk they were taking on.

I don't know how to stop asset price bubble, and neither does anyone else. By the time an asset price bubble is obviously a bubble, it has taken on a life of its own. In the late 1920s, the Fed tried to calm down the stock market by raising interest rates. Unfortunately, this only attracted more foreign money to make margin loans. The investors paid no attention--why worry about 10% interest when stocks are going up 20% a year? You can tamp them down by ratcheting up interest rates at the first sign of sector inflation--but then you risk destroying a natural and good reallocation of capital between sectors.

I'm also not clear on how regulators will be better at pricing complex derivatives than bankers are--the bankers are, after all, trying to make money; they didn't misprice the things on purpose. In banking, in particular, the regulators can't pay enough to attract top financial talent; no SEC employee is going to make twice what the president of the United States does. We can just tell the regulators to be more conservative, but that risks stifling a lot of helpful economic activity.

Likewise, there are clearly very real costs associated with mortgage securitization, which were not properly appreciated until now. But I'm fairly sure that we wouldn't be better off without securitization.

I'm not against some sort of financial regulation to prevent this, but I want to know what sort of financial regulation. The laws that get passed after these sorts of events tend to be driven more by fear than common sense. Moreover, they're somewhat superfluous, because the fear--the collapse of overoptimistic expectations into a mild permanent pessimism--is already doing a lot of your job for you. Asset bubbles seem to be features of markets, but experimental economics suggests that the cure is knowledge--people who have been burned in speculative bubbles don't make that particular mistake again. It's plausible to argue that the reason financial markets were relatively quiet between the 1940s and the 1970s is that the memory of the Great Depression was seared into everyone's brain.

My default approach on all of these things is typically American: wind it up in an orderly fashion, and make sure that the profligates suffer for their mistakes enough to discourage them, and everyone else, from doing it again. I'm not against prospective regulation, if it's good--but that requires something a little more specific than "Beef up the SEC". Calls for "more regulation" are like calls for "more virtue"--the devil is in the details.