Swallowing the national toad: Germany's top regulator says it's time the industrialized world swallow its pride and implement some aggressive regulatory reforms.

• Author: Sanio, Jochen

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For some time now a strange phenomenon has been observable: People who used to employ convenient euphemisms such as "turbulence" and "turmoil" can no longer avoid using the word "crisis." Even so, I would still regard this term as rather temperate language, because a crisis, as a famous German-speaking writer once remarked, is very often a productive state of affairs: By calling for immediate remedial action, it can erode established patterns of behavior and disrupt the ingrained ways of conventional thinking. As German regulators are irrepressible optimists, living by the motto "think positive," I wouldn't argue with the use of the word "crisis"--if we could only convince the markets to panic constructively.

Instead, they have been panicking in the old self-defeating way, driven by herd behavior, which has created a financial inferno worthy of portrayal by a modern-day Dante. There have been heavy casualties along this ride to disaster. The traumatic events that have unfolded over the last few months are forcing financial regulators to re-examine their current maxims. It is clear that the preconceptions that made sense in the past do not fit the present. Maybe the regulatory framework has been erected on insufficient or even false premises, and we have relied on a fair-weather construction that works only as long as cold winds are not blowing. Maybe disaster myopia had inflicted us and blinded us to the true risks of the financial sector. Nothing is what it seemed any more, and we might be forced now to pop a few balloons of self-delusion.

For years national supervisors have been arguing over what is the best system of supervision--and in so doing we have wasted valuable time. Now that the old order is crumbling and we are under terrible pressure, all of a sudden fraternization is breaking out all over. What unites us now is the urgent need to reshape banking regulation so as to prevent crises like the present one ever happening again--or at least not with this destructive force. So one or two countries are just going to have to swallow a national toad--that is, swallow their pride and bite the bullet--of Basel II, for example. I take the liberty of saying this on U.S. soil.

The subprime crisis has provided dramatic evidence of the dangerous loopholes and inadequacies that were inherent in the international regulatory system--and still are. The rigid intellectual approaches of Basel I, the fatal loopholes in the quantitative standards, the culpable neglect of risk management systems--the list of mistakes in the old Basel rulebook is a long one. Thanks to Basel I, banks were able to engage in regulatory arbitrage on a hitherto unknown scale and pump themselves full of risk unchecked.

Many of the catastrophes of the recent past would not have happened at all under Basel II. It is a tragedy that it has taken ten years to...