These costs will be steep. But the alternative is worse: a market collapse that could result in the loss of millions of jobs.
I suggest seven reforms:
1. The government should have a central regulatory focus to assess risk across financial markets, regardless of corporate form. The government should have the power and capacity to intervene, when appropriate, either by forcing companies to cut back on leverage or by raising their capital requirements.
2. Any financial institution that stands to benefit from Federal Reserve assistance in a crisis must be subject to regulatory scrutiny to make sure it is managing its risk prudently. The Federal Reserve should have the right to command the information it needs to make judgments and to impose the biggest capital requirements on those who take the greatest risk.
3. Regulators must be given the ability to do their own assessment of capital liquidity and risk and not leave the task to banks and credit rating agencies.
4. Credit rating agencies should be required to certify to their boards—with corresponding liability—the independence of the rating process from borrower influence.
5. Mortgage brokers must be licensed nationally. In the housing bubble, we've had too many inappropriate or fraudulent mortgages.
6. The banks must enhance the transparency of their financial risks and exposure. They should be obliged to retain a significant part of the risk on their own balance sheet, if they originate securitized obligations, so that they will bear some cost if things go wrong.
7. Fannie Mae and Freddie Mac should be forced to raise adequate additional equity capital quickly.
The categorical imperatives are: greater disclosure, more oversight, improved risk-management by our banks and investment institutions, and new regulatory agencies to make sure this all happens. The current system of voluntary codes and industry standards is broken.