In the next few days the European Commission will tell us how Europe’s regulatory regime for financial services should be reformed in the aftermath of the credit crisis. As a starting point the Commission has the report from Jacques de Larosière’s taskforce, which was commissioned by President Barroso last October and published earlier this week.

No doubt this report will give comfort to the Commission, for it spells evolution not revolution, recognises the limited competence of EU institutions in financial supervision and does not seek to impose new pan-European powers for regulating the sector. It will be a useful antidote against those (including governments) who want a much more aggressive approach to financial services regulation.

Alan Greenspan recently admitted that as chairman of the Fed his basic assumption was that the self interest of banks and bankers ensured that they would never do anything which ran counter to their own long-term commercial advantage. This assumption was key to Greenspan’s light-handed approach to regulation, as it was for most governments and regulators across the globe.

How wrong they were! The general assumption these days seems to be quite the opposite. That’s hardly surprising, given the fine mess which financial engineering has got us into. Both the regulators and the practitioners failed because each depended on the other.

Just take the example of the individual misjudgements revealed in the $50bn collapse of the Madoff funds. Investment firms trusted the regulators to guarantee compliance, while the regulators trusted the investors to do their due diligence. (How Charles Dickens would have jumped at the chance to create a Mr Madoff as one of his characters!).

Everyone is now seeking a new model for financial supervision and regulation. President Obama is pressing Congress to approve a tougher regulatory framework to protect consumers and investors; the April G-20 meeting in London will discuss a stricter global regulatory regime; and Europe is wrestling with the perennial question: should financial regulation be managed nationally or at the European level?

Lamfalussy and the Financial Services Action Plan sought to close this argument, constructing a sharing of the burden between EU legislation and national implementation. Jacques de Larosière’s taskforce goes down a similar road. It rejects the idea of a pan-European regulator, but would create a European Systemic Risk Council (ESRC) chaired by the ECB president and consisting of the ECB general council, one Commissioner and the chairs of each pan-EU committee on banking, insurance and investment services.

The ESRC’s fundamental task would be “macro-prudential supervision” – essentially to keep an eye on the big picture (but not the regulation of individual firms) and to warn of troubles ahead. It might bring the ECB closer to the heart of economic policy making, with enhanced influence, but no teeth as far as I can see.

At the level of individual firm supervision, a European System of Financial Supervisors (ESFS) would give a stronger European dimension to the activities of national regulators, although it would still be the competent authorities of member states which retained the power to act, subject to the FSAP legislation. There is an interesting contrast with European competition policy, where the anti-trust powers of the Commission provide the backing to ensure coherence between national authorities in the European Competition Network.

De Larosière’s report is no root-and-branch reform. It advocates greater co-ordination and co-operation but no real transfer of power. It recommends that supervision should be extended to those currently unsupervised financial institutions with “potential systemic risk” such as some hedge funds, more clarity for dealing with cross-border banking failure (the Fortis case), greater national supervision of credit agencies and a big commitment to the IMF for dealing with the global context.

In his introduction to the report De Larosière sets out the choice:  “chacun pour soi” beggar-thy-neighbour solutions; or the second – enhanced, pragmatic, sensible European co-operation for the benefit of all to preserve an open world economy” . Barroso described the report as “balanced and rich” which I guess makes it a good trailer for the Commission’s forthcoming proposals.

Just a week ago I suggested that continental Europe seemed rather detached from the global credit crisis.  Whoops! What terrible timing!

In the last seven days Europe has been hit by the storm force winds of this crisis. Liquidity has dried up, governments have been forced to rescue one institution after another, Iceland’s banking system seems close to meltdown, the Irish, the Greeks and the Germans have promised open-ended guarantees for bank deposits and the European Commission has been left floundering as the cry of sauve qui peut echoes across the EU.

Even Peter Mandelson has been brought back to London to shore up Gordon Brown’s war cabinet.

The Paris meeting of the Big Four was a show of solidarity but little more. The participants looked forward to tighter regulation in the future, but offered nothing at an EU level to cope with the current crisis.

It is only the state aid rules which have offered any sort of EU framework for national measures and several banking mergers and bailouts have been rapidly approved.

Deposit guarantees are a different matter. Commissioner Neelie Kroes fiercely attacked the Irish government for failing to discuss its guarantee scheme with Brussels in advance. It seems that she has made some progress concerning the detailed application of the scheme but not in the fundamental principle of an open-ended guarantee. The Brits and the French may now be forced to introduce similar deposit security, especially if the Germans go ahead, but the taxpayer liabilities are formidable.

It all demonstrates the massive cross-border implications of such measures. Inside or outside the eurozone, Europe must find ways to work more closely together in tackling the crisis.