I tend to favor market-based solutions, with as little government regulation as practicable. But for markets to work, the players have to keep long-term risks firmly in mind; they can't just chase blindly after short-term gains in the pretense that the risks don't exist. (Another reason why face the facts isn't bad advice to live by, not to mention a corollary of the First Commandment.) On that score, MIT professor Andrew Lo was quoted in yesterday's NY Times as saying something sensible:
Financial regulation, Mr. Lo said, should be seen as similar to fire safety rules in building codes. The chances of any building burning down are slight, but ceiling sprinklers, fire extinguishers and fire escapes are mandated by law.
“We’ve learned the hard way that the consequences can be catastrophic, even if statistically improbable,” he said.
Steve Lohr, In Modeling Risk, the Human Factor Was Left Out, NY Times, Nov. 5, 2008.
There's always a danger that excessive regulation will stifle innovation. But the right amount of regulation serves as a kind of institutional memory, forcing market players to think about, and act on, lessons learned painfully in the past.