There is a literature on how best to regulate systems in the face of such Knightian uncertainty. It suggests some guideposts for regulation of financial systems. First, keep it simple. Complex control of a complex system is a recipe for confusion at best, catastrophe at worst. Complex control adds, not subtracts, from the Knightian uncertainty problem. The US constitution is four pages long. The recently-tabled Dodd Bill on US financial sector reform is 1,336 pages long. Which do you imagine will have the more lasting impact on behaviour?

Second, faced with uncertainty, the best approach is often to choose a strategy which avoids the extreme tails of the distribution. Technically, economists call this a “minimax” strategy – minimising the likelihood of the worst outcome. Paranoia can sometimes be an optimal strategy….

Third, simple, loss-minimising strategies are often best achieved through what economists call “mechanism design” and what non-economists call “structural reform”. In essence, this means acting on the underlying organisational form of the system, rather than through the participants operating within it. In the words of economist John Kay, it is about regulating structure not behaviour…

I personally sympathize with simpler controls for the banking industry.

The committee had already agreed to a soft phase-in for its net stable funding ratio, which covers a bank's longer-term liquidity. That measure will be tested from 2012 and become mandatory in January 2018.

On Tuesday the committee said it would also have a softer phase-in for its liquidity coverage ratio (LCR), which will require a bank to hold enough highly liquid assets, mainly government bonds, to cover 30 days of net cash outflows.

The LCR observation period will start next year but the committee still wants the rule to become a minimum global standard in January 2015.

Its current manifestation is faintly ridiculous: Lenders can't say for sure who holds a mortgage—which means that sales can't go through. Buyers won't put down good money for a property if they aren't sure they'll get clear title to it, nor will lenders extend loans. Buyers of hundreds of billions of dollars' worth of mortgage-backed securities may have grounds to sue.

So much has been said about the recent problem with US mortgage foreclosure documentation. It would be interesting to find out if any other markets had developed mechanism similar to MERS and how do they operationalize it. It seems ridiculous to me to shred the original paper documents after digitization.

With an international dataset of credit default spreads as a credit risk measure, we propose a novel empirical framework to identify the structure of credit risk network across major financial institutions around the recent 2007-2008 global credit crisis. The findings directly shed light on credit risk transmission in a financial network and help find systemically important financial institutions from the perspective of interconnectedness. Specifically, Lehman Brothers, Morgan Stanley, Safeco, Chubb, and possibly AIG in the US and BNP Paribs, Dresdner bank, and UBS in the Europe are primary senders of credit risk information. Goldman Sachs, Bear Sterns, Bank of America, and Metlife in the US and Barclays, RBS, Commerzbank, and HVB in the Europe play the role of the exchange center on the credit market by intensively receiving from some financial institutions and then transferring credit risk information to others. Finally, Citigroup, Wachovia, JPMorgan and Hartford in the US, and ABN AMRO, ING, Rabobank, and Deutsche Bank in the Europe appear to be prime receivers of credit risk information.

An attempt in the right direction. (data driven) However, it is the national regulators who will implement the add-on for systemically significant banks, and I still has doubt if they will be willing to base that add-on on international interconnectedness.