Opinion: A new approach to financial regulation.

It has been five years since the US Congress enacted the landmark Dodd–Frank Wall Street Reform and Consumer Protection Act; and despite the fact that about 20% of the Act has yet to be implemented (1), several legislative initiatives are now attempting to soften or roll back key provisions. This pattern of regulatory action and reaction is not new. The financial excesses of one period often lead to asset bubbles that burst, ushering in a new period of much greater regulation. This, in turn, is systematically weakened over time as markets recover and we forget the reasons why we imposed such stringent regulations in the first place. Even before Dodd– Frank, the financial industry was among the most highly regulated of industries in the world. However, the many layers of regulation and multiple regulatory agencies were insufficient to prevent financial crisis. Why? We propose that the financial system has crossed a threshold of complexity where the system is evolving faster than regulators and regulations can keep pace. For example, the system is now truly globally connected, but coordination across sovereign jurisdictions is difficult to achieve. This new situation calls for a new perspective, one based on a different paradigm than the ones on which financial regulation is currently based, such as efficient markets, rational expectations, and models patterned after the physical sciences. The challenge of complexity is not unique to finance but applies as well to other human endeavors, including the management of environmental systems, international relations, cyberterrorism, and bioterrorism. In some cases, this challenge has been met successfully by implementing perspectives and methods from evolutionary biology, game theory, and complex systems theory, in partnership with domain experts in each field of application. These ideas have generally not been applied to financial regulation, despite a National Research Council report on systemic risk that was cosponsored by the Federal Reserve Bank of New York and the National Academy of Sciences to encourage such partnerships (2), and sympathetic perspectives by prominent regulatory insiders (3, 4). Evolutionary principles have, of course, been applied to many economic contexts, but they have had little impact to date on financial regulation. Here, we advocate changing the regulatory ecosystem by proposing collaboration among experts in various disciplines and professions. Biological systems have faced a range of challenges throughout evolutionary history, and this has led to solutions that are adaptive, hierarchical, modular, and with sufficient redundancy to minimize the chances of collapse. We can learn a great deal from biological systems in designing new regulatory frameworks for financial systems, which face similar challenges. We do not