Hardly anyone who has an opinion on the matter believes our country has struck the right balance of regulatory oversight of our financial industry. Oftentimes this would be good news. Widely shared disappointment is frequently the hallmark of successful compromise. Compromise is essential because financial regulation needs to balance the urgency of preserving innovation in financial services with an eye towards mitigating the tendency towards the sort of moral hazard that fueled the last recession. Sadly, I think we have settled on exactly the wrong set of regulations. Emerging financial rules strangle innovation while doing nothing to prevent the sort of publicly insured financial meltdown that still burdens our economy.  So how is this and what to do?

Changes to financial regulations have largely been focused on expanding the reach of existing and new financial regulatory agencies, but these smart, engaged public servants are outgunned. The starting salary for a newly minted analyst at a top Wall Street firm is competitive with that of the secretary of the U.S. Treasury. While our federal government is endowed with educated, dedicated men and women, relying on them to choose public service at half the going salary is hardly a long-term strategy for success. No matter how hard we try, federal regulators are not going to have a sufficient grasp of the intricacies of new financial instruments. The best they can do is put brakes on the entirety of financial markets. This risks simply slowing the economy without reducing risk.

On the flip side, we still insure lost loans and implicitly guarantee large banks from stupendous losses. This promotes risky behavior in a regulatory environment that makes insufficient distinction between a $32,000 savings account and a $32,000,000 private equity fund. I propose a radical change.

The very complex nature of financial instruments makes them much like a prescription drug or electrical appliance. The quality and associated risks cannot readily be judged by even highly educated persons outside that narrow field. Assessing efficacy in prescription drugs is done by scientific researchers, but financial instruments are more like electrical appliances. The efficacy is easy to judge (does the toaster work, or does the instrument make money?). What matters is the risk involved. Here we ought to use the Underwriter's Laboratory model.

Founded in 1894, the Underwriters Laboratory is a non-profit that has rendered the most dangerous item in our homes (electrical current) nearly benign through rigorous third party testing. While the government uses UL, it is still private, and can pay market wages for the research talent it requires. Medical testing at the FDA does this also.

A financial Underwriters Laboratory could function the same way. New financial services and products (like those toxic assets) would have to meet standards set by the non-profit regulatory agency before they could be traded by FDIC-insured financial organizations. The cost of the testing is borne by financial firms, not taxpayers and there is still a final say by the FDIC. This is not perfect, just better than what we have now.