We are at a moment of peril for financial markets.

I do not refer to the US and the banking industry being enmeshed in the worst crisis for 35 years. (Many people hark back to 1945, but they overlook how bad things were for financial institutions in 1973).

I mean the fact that everyone now insists that something ought to be done to stop this crisis recurring. They mean that more regulation is needed to prevent the Federal Reserve again having to rescue an investment bank such as Bear Stearns.

Take a deep breath, everyone. The last time that right-thinking Americans agreed on the need for more regulation as rapidly as possible, we got Section 404 of the Sarbanes-Oxley Act. Accounting firms were given a vague and onerous mandate and, the next thing anyone knew, New York was losing its financial strength to London.

So what should be done and, just as importantly, what should not?

First, proceed slowly. The damage from this crisis is done and it cannot be undone in retrospect. As Hal Scott, a Harvard finance professor, puts it: “There will be huge consequences for our economy from regulatory change and one lesson from Sarbanes-Oxley was not to rush.”

The US can start by ending the silly practice of only five (four, excluding Bear Stearns) big investment banks having all their activities overseen by a single financial regulator, and that regulator being the Securities and Exchange Commission. This is a relic of the botched repeal of Glass-Steagall, the 1933 act that separated banking and investment banking.

Instead of consolidating regulation, the US allowed nationally chartered banks to be supervised by the Federal Reserve while the SEC oversaw the broker-dealer arms of investment banks. The latter’s holding companies, which used their newfound freedom to form lending units (in Utah – don’t ask), remained unregulated.

When the European Union insisted on conglomerates having a single overall supervisor from 2004, Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns were shoved under the SEC. The days of this regulatory mish-mash are numbered. Either an entirely new regulator will be created or the Fed will be given oversight.

Giving overall responsibility to the Fed, while allowing the SEC to carry on regulating broker-dealer operations, would be simpler than setting up a new institution. The UK government opted for the grand approach when it removed supervision from the Bank of England and created the Financial Services Authority in 2001.

That looked good, but the collapse of Northern Rock exposed the dangers of removing banking supervision from the central bank. The Financial Services Authority’s report on Wednesday into how it handled the Rock does not make comforting reading.

The Fed should keep a keener eye on capital and solvency at investment banks, as Hank Paulson, the Treasury secretary, said on Wednesday. But that will not eliminate all problems. As Christopher Cox, the SEC’s chairman, noted plaintively last week, Bear’s capital and liquidity ratios met Fed and international standards.

What politicians should not do is rewrite banking and securities regulation to reinstate Glass-Steagall or to attempt to stop investment banks using securitisation, derivatives or investment vehicles – the things that, piled on top of each other, have caused mass disarray.

Financial technology cannot be put back in a box any more than information technology. This is the culmination of 30 years of innovation starting with the Black-Scholes option pricing model in 1973 but the notion that we can return to 1972, with credit held on bank balance sheets and investment banks just flogging securities on commission, is otiose.

All that would happen if Congress tried that would be a giant version of Sarbanes-Oxley. The global investment banking industry, which is dominated by US institutions, would be driven offshore to London or Zurich. It would find some jurisdiction where it could continue to operate in peace.

Instead of lots of new regulations, we need better incentives. Banks made too many subprime and junk loans and over-leveraged the financial system, because they did not believe they would suffer if the borrowers defaulted (although, as it turns out, they were wrong about that).

In future, they need to have reasons to fear losses as much as they covet profits. Here are two suggestions for ways to alter incentives:

First, regulators could insist on banks keeping a slice of the risk in any debt securities they sell from mortgage-backed bonds to leveraged loans. Insurers who sell catastrophe bonds to offset risk retain a slice of the exposure to stop them paying out insurance claims heedlessly when others are picking up the bill.

Second, investment banks could have a version of the Federal Deposit Insurance Corporation, which collects premiums from US banks to cover the cost of bail-outs. The FDIC premiums are set according to the riskiness of the individual institutions – banks with strong capital and low-risk operations pay less into the pool than those that are less stable.

Why not make investment banks pay a risk-related premium so that, in any future case of a Bear-style bail-out, the industry collectively foots the bill rather than the taxpayer? That would not only be preferable in terms of public interest, but would give individual investment banks incentives to operate cautiously.

There is no question that regulatory reform is needed after the shock of Bear Stearns. But a vast new regulatory infrastructure and set of rules is not the solution. A simpler structure and improved incentives would do the job better.