June 30 (Bloomberg) -- If the U.S. government is serious about fixing the banking system, it will hire people like Brooksley Born, and pay them heed.

Born, as head of the Commodity Futures Trading Commission in 1998, warned that financial derivatives were a time bomb.

Her proposal to control the trading of instruments whose value depends on movements in other markets was stopped dead by Federal Reserve Chairman Alan Greenspan and Treasury Secretary Robert Rubin, not to mention Congress and, naturally, lobbyists for Wall Street, which continued to profit from the ever- increasing trading in derivatives.

“My voice was not popular,” Born said last month. “I was aware that powerful interests in the financial community were opposed to any examination of that market.”

Imagine what might have happened if Born had won her point. The collapse of the market for credit-default swaps, which became a derivative of choice, may have been avoided.

There still would have been the subprime-mortgage mess but U.S. taxpayers might have saved a trillion dollars or two in bank bailouts.

The government now is stewing over how to clamp down on the likes of Citigroup Inc., Bank of America Corp. and Morgan Stanley to prevent future disasters.

Controlling derivatives would be a good start. Banks should be well capitalized and trades must be guaranteed.

Mountains of Debt

Hedge funds, which can cause market turmoil, need to disclose more. So should leveraged-buyout firms, which like to be called private-equity firms to disguise the mountains of debt that hang over their investments.

U.S. President Barack Obama proposes putting the Fed in charge of monitoring banks considered too big to fail, supposedly making sure they won’t. It would be better to break up the banks, making them small enough to fail without harm to the system.

Congress is sure to pass a law designed to protect consumers from predatory financial companies. That’s all right, though it might be safer -- to paraphrase economist John Kenneth Galbraith -- to let people assume that all mortgage bankers and credit-card companies are crooks.

It doesn’t matter so much what laws are passed, or whether the Fed or the Securities and Exchange Commission get more power. What’s important is that the people in charge of an overhaul make the bankers twist and turn.

Hands Off

Current regulations didn’t work because regulators didn’t believe in regulation. Members of Congress, supposedly the watchdogs, put their faith in their political backers.

The Securities Industry and Financial Markets Association, a trade group for Wall Street, aims to oppose reform, saying it must fight against a “populist” backlash against the industry.

To avoid curbs on their executive bonuses, 10 banks have repaid $68 billion in money they received under the Troubled Asset Relief Program. Bankers will resist other changes as well.

The government needs people in charge who have more common sense and stronger wills than the recalcitrants. There are candidates around who know fraud and risk when they see it. Lieutenants are just as important as generals.

New people already are leading the Treasury, Timothy Geithner, and the SEC, Mary Schapiro. Perhaps the Fed should hire a bank chief executive to help it oversee that industry -- on the assumption an insider knows how to interpret the books.

In May, Born, who retired from the Washington law firm Arnold & Porter LLP in 2003, received a Profile in Courage award from the John F. Kennedy Library for political leaders who follow their conscience. Bank regulation should be placed in the hands of the courageous.

(David Pauly is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: David Pauly in Normandy Beach, New Jersey, at dpauly@bloomberg.net

Last Updated: June 30, 2009 00:01 EDT