Joseph E. Stiglitz

is a Nobel laureate in economics, and author of Freefall: Free Markets and the Sinking of the Global Economy

It has taken almost two years since the collapse of Lehman Bros., and more than three years since the beginning of the global recession brought on by the financial sector's misdeeds for the United States and Europe to reform financial regulation.

Perhaps we should celebrate the regulatory victories. After all, there is almost universal agreement that the crisis the world is facing - and is likely to continue to face for years - is a result of the excesses of the deregulation movement begun under Margaret Thatcher and Ronald Reagan 30 years ago. Unfettered markets are neither efficient nor stable.

But the battle - and even the victory - has left a bitter taste. Most of those responsible for the mistakes - whether at the U.S. Federal Reserve and Treasury, Britain's Bank of England and Financial Services Authority, the European Commission and European Central Bank, or in individual banks, have not owned up to their failures.

Banks that wreaked havoc on the global economy have resisted doing what needs to be done. Worse still, they have received support from the Fed, which one might have expected to adopt a more cautious stance, given the extent to which it is evident that it reflects the interests of the banks that it was supposed to regulate.

Thus much is being left up to regulators. And that leaves open the question: Can we trust them? To me, the answer is an unambiguous no, which is why we need to "hard-wire" more of the regulatory framework. The usual approach - letting regulators work out the details - will not suffice.

And that raises another question: Whom can we trust? On complex economic matters, trust had been vested in bankers and in regulators, who often came from the markets. But recent events have shown that bankers can make megabucks, even as they undermine the economy and impose massive losses on their own firms.

Bankers have also shown themselves to be "ethically challenged." A court of law will decide whether Goldman Sachs' behavior - betting against products that it created - was illegal. But the court of public opinion has already rendered its verdict on the ethics of that behavior.

As always, the "devil is in the details," and financial-sector lobbyists have labored hard to make sure that the new regulations' details work to their employers' benefit. As a result, it will likely be a long time before we can assess the success of any law Congress ultimately enacts.

But the criteria for judgment are clear: The new law must curb the practices that jeopardized the global economy, and reorient the financial system toward its proper tasks - managing risk, allocating capital, providing credit (especially to small- and medium-size enterprises), and operating an efficient payments system.

We should toast the likely successes: Some form of financial-product safety commission will be established; more derivative trading will move from the shadows to exchanges and clearinghouses; and some of the worst mortgage practices will be restricted. Moreover, it looks likely that the outrageous fees charged for every debit transaction - a kind of tax that goes not for any public purpose but to fill the banks' coffers - will be curtailed.

But the likely failures are equally noteworthy: The problem of too-big-to-fail banks is now worse than it was before the crisis. Increased resolution authority will help, but only a little: In the last crisis, the U.S. government "blinked," failed to use the powers that it had, and needlessly bailed out shareholders and bondholders - all because it feared that doing otherwise would lead to economic trauma. As long as there are banks that are too big to fail, government will most likely "blink" again.

It is no surprise that the big banks succeeded in stopping some essential reforms; what was a surprise was a provision in the U.S. Senate's bill that banned government-insured entities from underwriting risky derivatives. Such government-insured underwriting distorts the market, giving big banks a competitive advantage, not necessarily because they are more efficient, but because they are "too big to fail."

The Fed's defense of the big banks - that it is important for borrowers to be able to hedge their risks - reveals the extent to which it has been captured. The legislation was not intended to ban derivatives, but only to bar implicit government guarantees, subsidized by taxpayers (remember the $180 billion AIG bailout?), which are not a natural or inevitable byproduct of lending.

There are ways to curb big banks' excesses. A strong version of the so-called Volcker rule (designed to force government-insured banks to return to their core mission of lending) might work.

The provision on derivatives is a good litmus test: the Obama administration and the Fed, in opposing the restrictions, have clearly lined up on the side of big banks. If effective restrictions survive, the general interest might indeed prevail over special interests, and democratic forces over moneyed lobbyists.

But if, as most pundits predict, these restrictions are deleted, it will be a sad day for democracy - and a sadder day for prospects for meaningful financial reform.

This article was distributed by Project Syndicate.