For market-based regulation to work, the incentives of investors and other private actors must align with the objectives of the government regulator. In particular, private investors must be sophisticated enough to understand and monitor the financial condition of the firm and be persuaded that they will experience significant losses in the event of a failure.
But as the crisis has shown, the success of this approach of national responsibility hinges on one condition: ensuring that public finance problems do not derail the whole financial system.