So what were the regulators doing when the banks nearly collapsed in 2008?

Many of our prejudices about the sort of people who become bureaucrats, and how they spend their working hours, have been confirmed by an official report that employees of the American Securities and Exchange Commission were watching pornography at the time.

The received version is that the bank crisis was caused by insufficient regulation. This is reflected in President Obama’s recent proposals to increase state supervision of Wall Street.

Yet banking is already one of the most heavily regulated sectors in business. The problem is that the calibre of the people who become regulators is very low relative to the people they are supposed to be regulating. The high salaries paid by the banks attract the brightest of the bright, and the bonus system gives them a personal stake in the success of their work. Fixed civil service salaries are attractive only to those without the talent or desire to make more money on their own, and they have no financial incentive to go beyond the bare minimum in their assignments.

Nevertheless, something still needs to be done to restore responsibility to the banks. Regulation transfers responsibility to the regulators when what we really need is for bankers to take personal responsibility for the consequences of their actions.

So here is a far more effective solution than any amount of regulation. The law of agency makes an employer legally responsible for the actions of all employees. So a third party who suffers as a result of the employees’ actions can sue the employer. Fair enough. However, it is very hard for that employer to recover any losses from employees whose negligence or incompetence caused those losses in the first place.

The law of agency should be changed to make it easier for employers to sue negligent or incompetent employees. If those who perform well get a “bonus”, it is only fair that those who are guilty of a gross dereliction of duty should get a “minus”. In practice, this means that those who are fired for cause would not walk away with the severance payments and pensions that have caused such public outrage – and those who remain will be far more careful than any regulation could ever make them.