In the past two decades, dramatic changes in information and telecommunications technologies have transformed our domestic financial markets. As a result, Franklin R. Edwards writes in The New Finance: Regulation and Financial Stability, "the current system of bank regulation is out of step with today's financial realities and needs to be substantially changed."

Mr. Edwards, professor and vice-dean of the Columbia University Graduate School of Business, contends that banks have shouldered the heaviest part of the burden of coping with these changes in the financial markets, as is reflected in the rapid decline of traditional commercial banking. The disappearance of more than 4,000 banking organizations from 1980 to 1994 is striking evidence of this decline. In a struggle to maintain profitability, banks have increased their risk taking, expanded into nontraditional financial activities, and undergone massive consolidations. Together, these developments have led to an unwarranted increase in risk for bank customers.

In sharp contrast to the crises banks have faced, the rapid growth of pension funds and investment (or mutual) funds "has been nothing short of phenomenal." This growth mirrors an increased willingness of Americans to hold liquid assets whose values change on a daily basis, depending on the performance of underlying assets. By fundamentally changing the way individuals invest their money, the transformed financial markets have increased concerns about the stability of those markets. But, responding to warnings of a financial meltdown, Mr. Edwards counters that "those fears are overblown and the proposed cures for the maladies that have been perceived--additional government regulation of nonbank financial institutions and markets--would be far worse than whatever problems we may have." He maintains that "instead of tinkering with the present system, we need to rethink our entire regulatory system."

Mr. Edwards calls for a regulatory structure that will provide equality in competition for financial institutions and simultaneously safeguard the financial system in order to increase efficiency and decrease risk. The New Finance presents such a plan. The key is "protecting the payments system by collateralizing or backing it with private assets sufficient to ensure that participating institutions will always be able to meet their payments obligations." Within this system, a new form of financial institution would be created: "collaterized banks." These new banks would be the only institutions within the system allowed to give demand deposits: they would be required to invest all depositor funds in short-dated, low-risk assets.

Reforming the current system of regulation is imperative, Mr. Edwards insists, as it "is not only inefficient, but also dangerous, because it is deceptive. It lulls us into believing that it is adequate to cope with the financial risks that now exist, while in reality it is not." Despite inevitable controversy over how to modernize financial regulation, a crucial shift must occur. To increase both stability and efficiency, Americans must move away from government guarantees and regulation and must allow private markets to play an enhanced role in controlling institutional risk taking.