After dedicating most of 2009 to jump-starting financial markets through stimulus packages, developed countries are now turning their attention to reforming the basic architecture of those markets, especially the incentives for risk-taking. In a major step towards regulating systemic risks, the United Kingdom last week announced a one-off 50 per cent “super-tax” on bankers’ discretionary bonuses exceeding £25,000. The move could raise £550 million, which would be used to help reduce unemployment, according to Chancellor Alistair Darling. However it has generated, as expected, a torrent of resistance from financial services firms, including threats that they would mass-migrate to other countries. By way of response, an aide to the Chancellor has asserted that the solution was for the banks to “pay less in bonuses” and to realise that this tax was “about changing their behaviour, not raising revenue.” Other members of the European Union such as France and Germany have come out in support of the policy, with France imposing a similar super-tax on bonuses exceeding €27,000. Executive pay has come under fire in the United States too. Kenneth Feinberg, President Obama’s pay czar, has sharply cut cash compensation, requiring instead that 175 most-paid executives in bailed-out companies hold stock compensation for two to four years.

Yet pay is only one dimension of a culture of excessive risk-taking, which precipitated the credit crisis on the back of lax regulatory standards and the availability of cheap credit. Only a comprehensive overhaul of regulatory oversight, of the kind passed by the U.S. House of Representatives last week, stands a reasonable chance of changing deeply entrenched attitudes towards risk. The reform proposals, which mirror some of the policies enacted in the EU, include tighter regulation of derivative instruments, procedures for managing collapse at large banks without resorting to taxpayer money, and the creation of a Consumer Financial Protection Agency to monitor lending practices. The bill also seeks to empower lawmakers to oversee the functioning of the U.S. Treasury — not a bad thing considering it was the Treasury, under Alan Greenspan, that stubbornly held interest rates at artificially low levels, setting off credit-driven asset bubbles. Finally, the reforms seek to extend the powers of the Securities and Exchange Commission to aggressively patrol the fringes of the financial universe, including hedge funds, with the aim of foiling would-be Madoffs and Rajaratnams. Even as the U.S. and Europe struggle to get unemployment under control over the coming years, they would do well to persist in their mission to curb financial excess through serious institutional reforms.