Amid high drama in bank boardrooms, the chief executives of Citigroup, Merrill Lynch and UBS have gone in short order. And with good reason, in the light of the huge losses these men presided over in asset-backed securities. Yet it is important to recognise, when considering any response to this continuing debacle, that the extreme nature of this financial cycle is partly the product of the very regulatory system that govern the operations of large financial institutions. Likewise, executives' behaviour has been a direct response to flawed incentive structures in individual banks.

It was the 1988 Basel Accord that first created the opportunity for regulatory arbitrage whereby banks could shunt loans off the balance sheet. In effect, a new capital discipline designed to improve risk management had the unintended consequence of creating a parallel banking system whose lack of transparency explains the market seize-up since August.