Jesse Eisinger's column this month is about the different regulatory structures in London and New York, and how they both failed. I asked him about it:

Jesse, you travelled to London for your latest column, and came away with the conclusion that neither the UK's principles-based regulatory approach nor the US's rules-based system have worked very well in practice. That said, you do seem to think that a principles-based approach might be the way to go:

Britain has the right structure but the wrong approach to remedy its problems. The U.S. has the wrong structure and, in recent years, the wrong approach. We can still learn from the rest of the world. An F.S.A. would work in the States, provided it had teeth.

Are you saying that the US should scrap thousands of rules and regulations, and give a super-regulator teeth to punish financial companies for transgressions which might not be against any particular written law? Is there any precedent, anywhere in the world, of such a regulator really working, and not being captured by those it would regulate?

His rather excellent response:

Ask leading questions much?

The answer to your question is: No.

I'm happy to expand on that. Laissez-faire regulation on both sides of the Atlantic has clearly failed. I'm trying to understand why and think about how to fix things.

Here in the U.S. the Reaganite experiment of financial deregulation reached its apogee roughly in the 2004 to 2006 period. That wasn't supposed to happen. The pendulum was supposed to swing back to a more regulation in the aftermath of the stock market bubble, the accounting fraud pandemic and the Wall Street research scandals. Yet after SOX was passed and the Spitzer-inspired reforms, The Wall Street Journal edit page and the US Chamber of Commerce et al spent years railing about the regulatory overreach. Sarbanes-Oxley purportedly was having malign effects on American competitiveness and New York was threatened by London and Hong Kong. We were strangling technological innovation. The reality is that we were blowing another bubble, while the SEC and the Fed shirked their regulatory duties. I have no doubt that a concerted regulatory effort starting around 2004 or 2005 to regulate mortgage lending and to examine leverage in the system would have helped enormously, had the regulators been given the mandate. But the Bush-era SEC and a Greenspan-led Federal Reserve had no interest.

One point about London, which I think is underappreciated in the States, is that they were running an even purer laissez-faire financial experiment. I was puzzled how that happened, but the reason turns out to be fairly obvious: The FSA, the British super-regulator, was created when the financial services industry was strong. And the British economy is even more dependent on the financial services sector than the U.S.

What's interesting is that even though we have two different structures and two different approaches, we both got into very similar problems. We have a deeply overleveraged financial system and a bursting housing bubble.

To go to your question, I'll concede that the words "structure" and "approach" are doing a lot of work in those sentences that you quoted from my column. By "structure," I am referring to the super-regulator structure of the FSA, with its wide-ranging jurisdiction. By "approach," I'm referring to the laissez faire hands-off nature of the FSA, versus the enforcement orientation of the SEC. The FSA prefers to have open dialogue and historically the SEC -- much less so under the Bush/Cox regime -- was more aggressive. File the "principle-based" vs. "rules-based" debate under "approach."

To answer your question: I think "principle"-based regulation is pretty much a crock. But it's beside the point. The "principle" approach is a euphemism for being hands-off. As you see from my column, the FSA has virtually no enforcement staff or budget. So the British regulators couldn't enforce principles if they wanted to.

I think we should stick to rules. Principles are what firms need to adhere to themselves, by creating internal cultures that respect the rules, the regulator, and their customers. For instance, some firms have in-house risk management departments that are the "risk police" and some have risk management sitting at the table as a partner. At the Risk Police firms, you push deals you can get away with. That's bad for the firms and bad for the markets. Our regulators could try to find ways to encourage the creation of internal cultures that reward high principles as well..

Regulators need to enforce the rules. This is the problem. It's been exacerbated by our ridiculously Byzantine regulatory structure. It's obvious to most people that we need a radical overhaul of our regulatory structure, but if it's not back by a regulatory attitude change then it will be for naught.

Here's where I would start: The US needs a significant amount of regulatory consolidation, and I think the FSA is a decent enough starting point. We need to wipe out the CFTC and combine it with the SEC. We don't need myriad bank regulators or state insurance regulation, so let's consolidate those. We need to bring derivatives and most off-exchange contracts under the SEC umbrella explicitly. And just maybe our elders were onto something with Glass-Steagall and we should consider bringing it back. I can't see how that would work, to be honest.

In addition, I like the idea that the FSA, rather than the Bank of England, has regulatory authority over banks. I'm inclined to think that monetary policy is a hard enough job without having to think about bank regulation too. But I'm open to hearing opposing views on whether the Federal Reserve here should be stripped of its banking regulatory authority. At a minimum, we should have a radical consolidation of our bank regulators, as I say. And if we keep the current system, investment banks should -- and will be, I expect -- brought under the Fed's jurisdiction. Then we need to have regulators much more focused on leverage and capital requirements.

But the main point of the column is that regulators have to regulate. We need to bring back regulation's good name. Everything follows from that, um, principle.

In my October column for the magazine, I'm going to propose a non-regulatory fix that we need in addition. Stay tuned!