Financial regulation can't work.  No matter how you try it's bound to fail.  Here's why.

Financial regulation can’t work for several fundamental reasons.

First, financial wizards are smarter than regulators.  Financial analysts have a massive financial incentive to work around regulation. Regulation is a bureaucratic activity that requires a more regimented and less flexible kind of thinking, and there is little incentive to go above and beyond the call of duty. If a regulator was as smart, he would be in finance where he could make a lot more money.  The finance wizards will always figure out a way to get around the regulations and outsmart the regulators.  Even if a smart regulator realizes that something is wrong, he has little power to change the regulations.

Second, to make matters worse for the regulator, the cozy relationship between big business and government will prevent it.  Furthermore, there were lots of smart people watching the economy, but very few realized it was headed for collapse.  In fact, most of the top financial wizards didn't realize it until too late.

Third, while it's easy to spot the problems in hindsight, it's almost impossible to choose the people with the right foresight and put them in charge.  In fact that would be a big mistake.  Even Nobel Prize winners, like the managers at colossal failure of a company, Long-Term Capital Management, can make economy-busting mistakes.  That's the problem with 'flexible regulations'.  The experts are often wrong, and certainly would never agree on what needs to be changed and how.

Fourth, regulations are created in the wake of a crisis.  They may prevent the same crisis from recurring, but there are too many ways to undermine an economy.  It is impossible to predict all of them and set up regulations to prevent them, without putting a stranglehold on business.  Already businesses are overloaded with regulations such as Sarbanes-Oxley.  They cannot be competitive with even more regulations.  Either they would lose out to foreign competitors, or non-regulated businesses would simply move into the field by creating new unregulated markets, as has happened in the Bahamas, the Isle of Man, and elsewhere.

Effective regulation would require that the government be more motivated to prevent a catastrophe than the smartest industry types are motivated to make money.  That will never happen. (Not to mention that the government be as smart as big business - will never happen.)

Financial regulations can't work.  It's a law of nature.  There's no way around it.

The only way to solve the problem is to end government's "100% guarantees" on financial instruments, which would obviate the need for regulation.   In the case of the credit crisis, banks would still be able to lend if AIG failed, because they would not be bound by inappropriate reserve requirements (based on AIG-insured bond ratings).  This would have greatly mitigated the credit crisis.  Best of all, the taxpayer would not be on the hook.

Now with that having been said, some basic regulation is good.  Certainly anti-monopoly regulation is very important.  No one business should be allowed to control any single market.  Competition is the life-blood of capitalism.  As well, all businesses should be required to uphold their fiduciary duty to their shareholders.  The rule of law must prevail, and that requires a strong government.

So now you might wonder, why does regulation work in the case of such things as health and safety?  First of all, in these cases, the interests of industry and government are fundamentally aligned.  For example, airlines and the government work together cooperatively to develop maintenance regulations.  It's in neither party's interest if a plane crashes.  Nor, with respect to health codes, if a patron at a restaurant gets sick from incorrectly prepared food.  Secondly, the taxpayer is not on the hook if the business fails (bailouts of airlines and auto companies notwithstanding).  And finally, no industry has the short-term profit potential as the financial industry.  The financial industry would never cooperate with the government to create regulation, and if they did, one would be wise to be suspicious.