The walls established to protect the global economy from drowning in a sea of risk and uncertainly were breached, setting off the financial crisis. More than a year on, the global banking system has been saved but the levees have yet to be rebuilt or even reconfigured to prevent it from drowning under its own risk and debt yet again. There are a few things regulators and economists should know with enough clarity to act upon today, even if the fog of the financial crisis has yet to clear completely. Most important among these lessons is that a dependence on some obscure financial instruments helped to create the financial crisis. That banks can still generate profits with what Warren Buffet in 2003 called "time bombs", opaque derivatives and credit products, underscores how incomplete the regulatory response to the financial crisis has been. There remains no central clearing-house to reveal the derivatives contracts and speculative bets that banks have on their books.
The risks that these unregulated financial instruments presented to the global economy were compounded by the pay structure in high finance. Banks rewarded a frenzied search for quarterly profits instead of an effective allocation of capital over the long term. The new 50 per cent tax on banking bonuses in the UK and the levy proposed by the US president Barack Obama on banks that required government funding may be warranted, but both are more a response to political realities than regulatory imperatives. Little of what Mr Obama or the British prime minister Gordon Brown have enacted so far diminishes the type of systemic risks that helped to cause the financial crisis.
Mr Obama's announcement last week of a series of regulatory reforms appears to be the best effort yet, though the details and scope of his proposal remain limited. Mr Obama proposed that any bank that counts on the US federal government to insure its deposits will no longer be allowed to invest in hedge funds, which frequently rely on unregulated financial instruments and credit products to generate returns. In doing so, Mr Obama is attempting to re-erect the wall between commercial banking and investment banking that was created in response to the Great Depression but removed in 2000. This is a necessary reform in response to the last crisis, but much more must be done to anticipate the next one.
Contrary to what many of banking's rainmakers have told politicians at Whitehall and on Capitol Hill, the financial crisis was not a 100-year storm. It was the result of flawed choices and faulty assumptions. But one of the flawed choices today that may sow the seeds of the next crisis is a belief that governments can erect regulatory regimes on their own. Financial regulation will be only as strong as its weakest link. As London and New York remain the world's leading financial centres, the mantle falls upon the US and UK to co-ordinate a more global approach to market regulation.