By now there are few people who do not acknowledge that the major American financial institutions and the markets they dominate turn out to have served the country badly in recent years. The surface evidence of this failure is the enormous losses—more than $4 trillion on the latest estimate from the International Monetary Fund—that banks and other lenders have suffered on their mortgage-related investments, together with the consequent need for the taxpayers to put up still larger sums in direct subsidies and guarantees to keep these firms from failing. With nearly 9 percent of the labor force now unemployed and still more joining their ranks, industrial production off by 13 percent compared to a year ago, and most companies’ profits either falling rapidly or morphing into losses, it is also evident that the financial failure has imposed huge economic costs.

The government has moved aggressively, and on several fronts, to stanch the immediate damage. The Federal Reserve has not only eased monetary policy to the point of near-zero short-term interest rates but created a profusion of new programs to extend credit to banks as well as other lenders. Congress, at the Obama administration’s behest, has enacted nearly $800 billion of new spending and tax cuts aimed at stimulating business and consumer spending. First the Bush administration and now Mr. Obama’s have experimented with one new plan after another to rescue lenders and reliquify collapsed credit markets.

But despite the universal agreement that no one wants any more such failures once this one has passed, there is a troubling lack of attention to reforms that might prevent such a crisis from recurring. By now everyone realizes that excessive risk-taking, systematic mispricing of assets, and, often, plain reckless behavior (not to mention some instances of criminality, although to date surprisingly few of these have come to light) helped cause the current mess. At the same time, most people recognize both that parts of the American economy have been capable of dynamic growth and that the US financial markets have had a part in promoting that growth. The result is a reluctance to consider changes to the current system. Substantial interference with financial markets, it is said, amounts in the end to centrally planned allocation of an economy’s investment process, and will result in technological stagnation and wasted resources. Milder attempts at regulation will either prove ineffective—the private sector can afford better lawyers than the government can—or at best merely lead financial institutions to relocate to more lightly regulated jurisdictions like the Cayman Islands.

As in past financial declines, what is sorely missing in this discussion is attention to what function the financial system is supposed to perform in the economy and how well it has been doing it. Today attention is mostly focused on banks’ and other investors’ losses from buying mortgage-backed securities at inflated prices. What is neglected is the consequence: if the…