With the recent upheavals in the world financial markets there has already been calls to regulate. Arguably these calls are not wrong. The question, rather than should we regulate, is how and what do we regulate?
The financial crisis is one of market failure due to the lack of accurate and timely information about risk. The regulation needs to focus on correcting the issue of the markets providing accurate and timely information about risk.
The regulation needs to ensure that everyone involved in the market has knowledge of the real risk that various instruments and securities have. This will require the regulation of the ratings agencies as they failed to properly provide information on the risk involved in various securities. Or the rating of securities is handled by an independent body charged only with ensuring the risk of a security is accurately measured and information provided to the market.
The second bit of information is where the risk is. Here the accounting rules need to be change to ensure that risk cannot be shifted off-balance sheet so the risk "disappears". Essentially, if there is control and/or liability those risks need to show up on the balance sheet.
