In the aftermath of the financial crisis, the focus has been on better accounting for risk, better matching employee pay with the long term value they generate, and creating new regulations to “fix” the markets.
Arguably, better matching pay with value created is ideal, but it is also difficult to measure, which is why we rewrite the rules of financial services compensation every 15 years or so. Creating new regulations and better modeling risk both have the same problem: how do you accurately identify and measure risk? If you subscribe to murphy’s law (maybe it should be renamed Taleb’s law), you will take on too little risk. If you use the computer programs of recent years, you will obviously take on too much.
I think the best solution will be the one that fights complexity with simplicity. If banks are required to hold a percentage of the assets they generate, they will be much more invested in generating quality assets. If non-bank financial institutions are allowed to do the same things as banks, why are they regulated differently? All of the slicing and dicing of securities combined with the insuring and reinsuring created a tangle beyond comprehension of any participant, let alone risk management (this might be pushing it, but all these agreements remind of the secret alliances that were a part of making world war I a world war — no one knew enough about everyone else’s commitments to take appropriate action).
Financial innovation will always outpace regulation because there is money to be made, but smart regulations will make the system simpler and clearer, rather than adding pages and pages of new rules to administer and loopholes to exploit. Although, all those regulations and loopholes do make for big business…