The financial reform blueprint to Right: Paul Steiger, Becky Quick, Larry Ingrassia, James Stewart, Bethany McLean, Carol Loomis, Allan Sloan, Joe Nocera By Becky Quick, contributer, Edited By Hank Gilman & Doris Burke

(Fortune) -- One think about the Wall Street financial debacle is that few people can agree on what the real lessons are and what we can do about preventing the next collapse, or near collapse, of the financial system. As Congress gears up for another run at regulating Wall Street, we gathered a hall-of-fame panel of business journalists for some answers. Our group included Fortune's Carol Loomis and Allan Sloan, two of the profession's legendary writers and both winners of the Gerald Loeb Lifetime Achievement award (and recipients of a slew of other Loebs); Paul Steiger, former managing editor of the Wall Street Journal, which hauled in 16 Pulitzer Prizes during his tenure, and now chief of ProPublica, a not-for-profit investigative-reporting organization; and New York Times business editor Larry Ingrassia, who has covered a market crash or two in his time. He's supervised Pulitzer-winning teams and reporters at both the Wall Street Journal and the Times. We also have two former Fortune hands on the panel: Joe Nocera of the New York Times, an award-winning columnist and author, and his writing partner, Bethany McLean. They are writing a book on the Wall Street mess. Bethany, one of the journalists who first exposed Enron, is a Vanity Fair contributor and co-author of the bestselling book The Smartest Guys in the Room with Fortune's Peter Elkind. (Peter's latest book, on the trials of Eliot Spitzer, is excerpted in this issue.) Finally, there's James B. Stewart of The New Yorker and SmartMoney. Jim won a Pulitzer at the Wall Street Journal and is an accomplished author; among his titles is the highly regarded Disney War. The panel was moderated by CNBC anchor and former Wall Street Journal reporter -- and current Fortune columnist -- Becky Quick. So what did they conclude? Basically that Wall Street, no matter what, can't be left to its own devices -- and you can't go wrong with transparency. Edited excerpts:

Quick: Have we learned lessons from this time around? Paul, I'll start with you.

Steiger: Regulators need to pay attention not only to the money supply but to what people are doing with the money. While the focus was on how much liquidity should be supplied to the system, we turned the financial industry into a giant videogame.

Ingrassia: I think there was risk embedded in so many different types of products that even senior-level people didn't understand on Wall Street. When it finally all started unraveling, they realized the interconnections were far deeper and more troublesome than they could possibly have known. And it raises a lot of questions about innovation on Wall Street and where it's going.

McLean: I'm not sure we have learned the lesson that what's good for consumers is good for banks. We've seen that when financial institutions made loans to people who couldn't pay them back, that was bad for consumers and it was also bad for financial institutions. And yet the debate is still taking place as if banks' and consumers' interests are two separate things.

Stewart: We've learned, at a really profound level, that when markets fail -- and they will fail -- you have to have government intervention. In a sense, the Keynesians have been vindicated. The free-market people are still out there, very vocal, but I think anyone who really steps back and looks at this objectively will agree you only have the government when markets fail.

Loomis: And thank heavens it was there in that terrible week in September. What I learned then was the speed with which markets can disintegrate. It's one thing to say that the markets live on the expectation of prompt payments. It's another to see what happens when the expectations get blown up.

Sloan: The thing we should have learned and probably haven't is that while we were regulating the trees -- where every little thing had to meet its own criteria -- no one was looking at the forest. And old-fashioned as I am, I used to think that was the job of the Federal Reserve Board, which completely failed. Not so much in interest rate policy, but at its job to help maintain the stability of the system.

Quick: Larry?

Ingrassia: While the regulatory performance up to the crash was terrible, the response -- a combination of the Keynesian and plain old financial backstopping -- worked so well in stopping the downward spiral that there's a tremendous tendency on the part of the banking industry to want to go back to business as usual.

Stewart: We should be considering what could cause the next problem. We don't need to go back and reinvent the wheel. After Enron we had Sarbanes-Oxley, but that didn't help this time. We need to be anticipating what the next problems are going to be, and clearly derivatives have that potential.

Quick: Are the solutions out there right now? A risk office? A consumer protection agency?

Sloan: Instead of trying to rewrite rules, which everybody here believes you can get around, you need to change the incentives. I've invented something that I call the Sloan Poison Pill.

McLean: I'm going to like this.

Sloan: If a bank company has access to the Federal Reserve's discount window, it gives the Treasury a poison pill. If your bank needs emergency help, the federal government suddenly owns 80% or 85% of it for almost nothing. The shareholders are diluted, and the CEO is personally barred from ever getting stock compensation again. I think that would give you the right set of incentives.

Nocera: Yes, compensation is a problem. But, you know, it's wrong to say derivatives did not play a bigger role here than the way people are compensated. Subprime mortgages could be amplified 10, 15, 20 times. And one of the reasons they were so attractive to the banking system was that if you had these triple-A tranches, you basically had to put no capital up against them. So there's a different kind of incentive besides equity, and that's a capital-requirement incentive -- if you said, "Look, fellows, we're not going to stop you from doing derivatives transactions, but you're going to have to put up capital commensurate with risk." And you can't just say because you've gotten it insured with a credit default swap that you've eliminated the risk. We don't believe that anymore.

Quick: So what's fair?

Nocera: The capital requirements used to be 8%, and they've basically gotten diluted down, through the use of financial engineering, to 3% or 2%.

McLean: Transparency would also make a huge difference. One of the greatest feats of Wall Street is getting all its clients to lobby against putting derivatives on exchanges because it would (supposedly) hurt their ability to use derivatives. In reality, it would be the best thing for clients because they'd be able to see how much Wall Street firms were ripping them off.

Nocera: Why do we require that if you own more than 5% of a company's stock, you have to disclose that? And yet you don't have to disclose any level of concentration as far as derivative holdings are concerned. That was a big problem with AIG (AIG, Fortune 500). They didn't have to disclose any of that. The disclosure would alert the market to where the risk exists. I don't think the solution is all that complicated. What's depressing is that [proponents] can't seem to get it through Congress.

Quick: The heat seems to have been taken off. I mean, this was under the spotlight a year ago.

Sloan: Well, you know, if the Federal Reserve Board actually did what it's supposed to do, they could just say, "This is the rule. We are the bank regulator. We're doing it." You'd see it happen tomorrow.

McLean: What is amazing, though, is the power of the free-market ideology. That it works. That the market works -- despite whatever evidence we've seen that it doesn't seem to work that way. I can't come away from this without saying that everybody who professes to believe in the free market is a hypocrite. They believe in it -- as long as it's going their way. As soon as it is not going their way, they want to be rescued: It's the short-sellers who are to blame. It's somebody else's fault.

Quick: Paul Steiger?

Steiger: Can I switch to what I think is one of Wall Street's overarching questions, which is what Wall Street's purpose is? It raised capital for businesses so that the economy could flourish. But it morphed in the past couple of decades. A lot of these products have their purpose. It's like any good thing that you take to the ninth-plus-one level and it becomes a disaster. So what we've done in the past 10 years is, our financial markets have created so many financial products that existed simply as zeros and ones of electronic grids. They weren't adding an iota to liquidity. But they've created a videogame environment where these guys could make enormous sums of money. Individuals at hedge funds and investment banks and corporations were making enormous sums of money, but they were progressively putting the whole society at risk. And when the system failed, it just wasn't "We killed ourselves."

Ingrassia: You kill everybody.

Sloan: There's this myth promoted by Wall Street and occasionally by us that Wall Street serves the economy. Its real purpose is to make money for people on Wall Street. Capital raising, as Paul has said, has become progressively less important. The profits come from Wall Street doing various things for its own account -- and very complicated things nobody understands -- because that's where the big profits are.

Steiger: And that is the change. Back in the '70s, people accepted the fact that people on Wall Street are attracted to those jobs because they like to make money, but as a society we embraced that because it did have this role in raising capital. We would not have Silicon Valley were it not for Wall Street. The banks would not have loaned money to that industry. But when you take a good thing and push it to the limits and beyond, you create a monster, and that's what we've done here. I don't know how to fix it -- I think Joe's notion of capital requirements is very good. I'm not sure what consumer protection does because you're trying to rule on individual transactions. I think structural issues are much more important, and we should have a much more serious embrace of those issues. Instead, what we have is a certain amount of panic in Congress, and Wall Street and the bankers trying to block new rules.

Quick: Is part of the problem that when Wall Street first started going public and started playing with other people's money, they got a little looser and faster with things? Like executive compensation?

Nocera: The fact that they weren't playing with their own capital once they went public is a real difference-maker. But I'd like to bring up a different point entirely that we haven't talked about. That is, when we talked about social utility, there's no question that the original creation of mortgage-backed securities was something the country basically needed. The S&Ls were in collapse. But once the system revved up, the link between the borrower and the lender was severed. And so suddenly the mortgage originator, the lender, didn't really have to care anymore whether the borrower could pay back the money. And Wall Street didn't care either, because they were going to sell it to investors. I just think it was a corrosive mindset. The other thing that's happened is that because Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) are buying all the mortgages now -- nobody else is -- they are in a position to crack down on that.

McLean: Despite all the complaints about Fannie and Freddie, until they lost their way, that was the role they always played in the mortgage market. They were the cops on the beat. They enforced the standards. And until they started to fall victim to this whole homeownership thing -- "Get people in homes. Got to keep our profits up by subprime mortgages" -- that was exactly the role they played. And so it makes you wonder: Despite all the complaints about the government-sponsored entities, it worked.

Quick: What happened to set us off course? How come none of the alarm bells went off in the right places in Washington?

Sloan: It's because there came to be a disconnect between the person making the loan and the ultimate owners of it. And people did not have skin in the game. My whole plan to save everything is to give people skin in the game.

Quick: Let's get back to derivatives. Carol?

Loomis: I just read the other day there was a little bit of tide turning toward tougher regulation of derivatives. And I think that's what's needed. Derivatives are a genie out of the bottle. Whether they can ever be put back in is the big question. But if people are moving in that direction, that's hopeful.

Nocera: Do you have some ideas of what ought to be done?

Loomis: Well, the best thing would be to wipe them out. [Laughter.] I don't see things quite headed in that direction. I certainly think that every derivative that can be should be cleared by a clearinghouse. And transparency is what's needed. When the world fell apart in 2008, nobody had any idea what derivatives were out there. I do think transparency is going to come, and we're even seeing the Street sign on to some of these ideas a little bit.

Nocera: It's curious you say they should be wiped out, because every story about derivatives, even the most critical ones, always says they can be a useful risk-management tool, that they serve a role: to allow companies to hedge interest rate risk, or currency risk, or credit risk, for that matter. You sort of think that's all bogus?

Loomis: I think that's been greatly overamplified. I talked to a very smart fellow in Washington about that very subject -- that every story says that. But then you conclude, well, does it really matter if these things exist? I realize farmers have been hedging their crops for what? One hundred fifty years? But basically we could get along without a lot of this, and that's the direction I think we should go.

Quick: Let's focus in on what things should look like five, 10, 20 years from now. Is there something that needs to be done in Washington in terms of looking at risks systematically? Can the Fed do it, or does there need to be another office?

Sloan: The Fed can absolutely do it. The Fed can do whatever it wants to do. It has to want to do it and needs to explain it in a language approaching English -- something that will sell in Congress. The Fed has enormous authority. It invented 10 different loan programs to deal with the crisis, putting trillions and trillions of dollars to work without any backing from Congress. They could change a whole bunch of rules. But for years under Greenspan, and to some extent now, they're doing all these small-bore things and not looking at the big picture. And they ought to be the ones to do it.

Ingrassia: I agree. But a lot of us think -- and maybe this is one good point the banks have -- that a lot of this stuff is in place. If it was actually enforced -- if the regulators actually enforced a lot of what's in place -- we wouldn't need as many new rules.

Stewart: There really needs to be an authority that resolves nonbank systemic risk. Someone has to have the authority to step in and do to AIG and Lehman Brothers what was done to Washington Mutual and Wachovia. That seems so simple and straightforward once you get over the controversial stuff.

Nocera: I'm a little skeptical about a systemic-risk panel or something like that because of what we have all seen in the aftermath. That is that large derivative books created an interconnection between firms and banks and created a systemwide liquidity crisis and panic. But would these new regulators see the next thing that could create a systemic risk -- or the thing after that?

McLean: I think there's another thing [regulators] could do: Pay attention to the skeptics. There's a bias in every part of the business world that skeptics must somehow be crazy or against Mom, America, and apple pie. People see things. Back in 2001, analyst Josh Rosner wrote a piece called "A Home Without Equity Is Just a Rental With Debt." In 2007 he and Joseph Mason published a paper questioning the triple-A ratings of CDOs. There was no shortage of skeptics all the way through this. People were pointing out exactly what the problem was going to be.

Loomis: Well, nobody has a better right to make that point than Bethany, who was a skeptic on a very important thing [Enron]. But it's hard. The press has got to come in and take a measured look and be the skeptic. And maybe someone reading in Washington will say, "That's right. We should be thinking about that."

Nocera: The press didn't really cover derivatives per se. When the crisis was gathering, I felt like I had to learn what a CDO was. I didn't know, and I have been doing this for a long time.

Ingrassia: Like [former Citibank adviser] Bob Rubin. [Laughter.]

McLean: Maybe the key lesson from the crisis is that anything is possible. I remember George Soros saying to me when this was getting started that a major investment bank was going to go down. I sort of shook my head and thought, "Not possible." Actually, the financial system as we knew it came to an end. And once you operate from that premise, it makes you look at things a different way.

Quick: Okay, so we learned that lesson from this. Will we carry it forward?

Sloan: If you put fear in the system. I don't mean fear as in hiding under a bed. But that someone at a big financial institution needs to know he's going to lose his job and he's going to lose a lot of money if he really screws up. He'd better keep an eye on it.

Jamie Dimon [CEO of J.P. Morgan Chase (JPM, Fortune 500)] has spent zillions of years dealing with messed-up financial firms and happens to be very good at minimizing risk. But a lot of these people are professional managers and aren't financial people. You need someone who can be taught to be afraid. And that was one thing missing. People weren't afraid until it was too late. They weren't afraid when the stock market tanked two years ago; they weren't afraid of the housing market; they weren't afraid of the derivatives market because everything was supposedly hedged. It's almost impossible to write regulations under those circumstances. You need to change the incentives in the system.

Stewart: It's worth remembering, too, that there were all these intellectual underpinnings for this decline. These Yale economists won Nobel Prizes for showing that if you were diversified enough, risk went down. So if you owned a million subprime mortgages and put them together, you suddenly have a triple-A security. If the ratings agencies say it.

Nocera: One of the reasons we had the crisis is that our entire society -- Wall Street and Main Street -- had forgotten that anything is possible. We were three generations out from the Great Depression, and that memory has vanished.

Steiger: I can remember -- and, Allan, you can probably remember -- when the general tone of coverage of investing was fear and loathing. Like in 1982, when the market had spent a decade going nowhere. But then suddenly Paul Volcker took the wraps off the money supply, the stock market shot up, and the prophets of doom in journalism and elsewhere began to be viewed as the boys who cried wolf. And remember [when] Alan Greenspan said "irrational exuberance"? It was like the whole world was going to crush him to death.

Quick: Carol, aside from the derivatives regulation, what else do you think is absolutely essential? Where are we likely to be five years from now?

Loomis: Well, I hope we're not reading articles in the newspaper about what Washington is trying to decide to do. We'll have a systemic-risk agency -- I think putting it within the Fed would be the best thing. And I think we'll still have the SEC trying to make up for ignoring [Bernie Madoff whistleblower] Harry Markopolos. It won't be perfect, but the new rules will be good. The FDIC was one of the greatest inventions ever. And we will have the chance to make some really important strides in regulation. But as Joe says, we'll forget and we'll go back and we'll have more bubbles of one kind or another.

Carol Loomis, Allan Sloan, Paul Steiger, Larry Ingrassia, Joe Nocera, Bethany McLean, Peter Elkind and James B. Stewart contributed to this article. To top of page

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