"Was this a crisis of institutions, markets or economic ideas?" Lord Adair Turner asked his audience at the J.W. Marriott Hotel in Washington this morning about last year's economic collapse. Turner, the chairman of the United Kingdom's Financial Services Authority, argued for the last of these explanations, contending that the crisis disproved the intellectual belief in purely self-regulating markets and should usher in a necessary era of self-reflection within the financial sector.

Turner spoke this morning at the first of a series of National Journal-sponsored events about the United States and the global economy, moderated by Atlantic Media Political Director Ronald Brownstein. At the Financial Services Authority, Turner has been at the helm of the U.K.'s financial reform efforts, pushing for tighter restrictions on the sector.

The efficient-market theory, based on the premise that people make rational financial decisions and that markets are inherently self-correcting, is dead, Turner said. Thus, regulatory bodies need to re-evaluate how they track, assess and manage the economy.

His remarks focused on rebalancing the economy and finding "optimal" levels for financial and regulatory instruments, from risk and speculation to banks' capital requirements and liquidity.

Turner argued in particular for creating stricter capital requirements for banks, and he implored economists to answer the tough question of how much capital is optimal to encourage economic growth but avoid facilitating risky investments. "The reason regulatory authorities have evaded it... is because it's an incredibly difficult thing to answer," Turner said.

Creating higher capital requirements for banks should be "the core of the policy response," Turner said. Some economists worry about what an increase in capital held by banks will do to the trading market, but Turner said that decreasing volume isn't necessarily a bad thing, as it can lead to less market volatility, depending on the circumstances. "If they also reduce the volume of trading... that may be a perfectly acceptable side effect," he said.

In addition, Turner suggested the possibility of taxing leverages or foreign exchange transactions, noting that there is a bias toward debt inherent in current tax systems.

Turner said he was encouraged by the policy response to the crisis thus far at both a national and international level, but stressed that ultimately the global financial system needs to be simplified.

While international progress has been made, he said, noting the G20 talks in Pittsburgh, ultimately there are no binding commitments among nations on how to regulate the global economy. "Fundamentally what we're trying to accomplish is to agree," Turner said. But "we do not have a treaty-based organization with international lawmaking power," making enforcement of any agreements difficult.

Ultimately, Turner said, economists must rethink traditional economic rules and models. "We need to go back to basics and ask questions about the role of the financial system," he said.

evaughan@nationaljournal.com