The emergency action taken last week by Northern Rock to safeguard its stability was the culmination of a month of chaos in the world’s financial system after the meltdown of the American sub-prime market.

Yet, sizeable though it was, the global impact of the sub-prime failures has been disproportionate to the initial problem primarily because their toxicity had been diced and spliced into a multitude of seemingly safe securities. As Stuart Hills, of O’Melveny & Myers, says: “People just don’t know where they stand and that’s why there is such fragility in the market.” Neil Mirchandani, of Lovells, agrees: “The bankers and lenders are simply unable to work out their exposure.”

For lawyers, the key question now is whether more or better regulation may have forestalled this crisis.

Opinions, it must be said, are split. One “magic circle” lawyer, speaking last week for the minority view, insisted that the time had come for the regulators on both sides of the Atlantic to require a greater level of sophistication in the reporting of how risk is being packaged. “For a start I think that the regulators themselves should have made more of an effort to understand what was happening,” he said. “If they understood it, they could take steps to ensure that its impact was reduced.”

So is the solution simply a requirement for greater honesty and openness about the deals being done?

“This all stems from a period when financial products were being sold that carried with them a high level of reward but also a high level of risk,” the magic circle lawyer said. “People were told about the rewards but not about the risks. Improve the transparency and you will get the problem down to a reasonable proportion. But I’m afraid there has been a lot of greed and naivety around.”

But can the regulators protect against naivety? That was definitely not the majority view last week in London. Instead, most lawyers felt that the regulators and regulation were doing all that could be expected of them. “I would be very wary of introducing enhanced regulation at a time like this,” Hills says. “I think that we should all be calm and see how it plays out.”

John Ahern, a financial services specialist in DLA Piper’s regulatory group, says that his concern would be that greater regulation would stifle innovation. “We’ve got a lot of risk disclosure already,” he says. “I’m not sure that we need any more.”

But does this mean that there is no room for improvement? A number of lawyers highlight scope for reviewing how the credit ratings agencies have conducted themselves – “Although I hope that they won’t be made the scapegoats,” Hills says – but there is a rejection of the view that the so-called “exotic products” are the root of the problem. In fact, Hills suggests, these have helped to spread the risk of the sub-primes. “While there will be some pain it will be spread, bearably, across the market,” he says.

Yet there is a view that a blind eye was turned to the state of the market. Bob Goldspink, of Morgan Lewis, makes the point that what the lenders tripped over could well be systematic fraud. Indeed, it has been suggested that half the sub-prime borrowers lied about their income. It is likely then that the regulators will be asking lenders whether they followed correctly their own procedures and systems. Rob Falkner, of Morgan Lewis, says, as a postscript to the crisis, that the regulators will be looking at institutions to study whether they followed their own credit and risk-management rules and whether the proper procedures and checks were in place.

Georgia Quenby, of McDermott Will & Emery, says that the problems stemmed from having “an ocean of liquidity” available and this made lenders careless. “What we are now seeing is a return to prudent lending and, personally, I don’t see what the regulators could have done to intervene. The market is now starting to correct itself.”

As part of this process we are likely to see greater prudence all round. Mark Campbell, of Clifford Chance, says: “When markets are hot, people aren’t much interested in listening to legal advice. But when times are risky, they are likely to start valuing legal advice more.”

What is also happening behind the scenes is a plethora of disputes over defaulting on loans and sale of collateral. To avoid making things worse, there is little litigation. Instead, valuations are being checked and lawyers are negotiating refinancing deals quietly. “Refinancing is the new restructuring,” Quenby says. Meanwhile, Ahern says that he is inundated with calls from clients who want help in assessing whether they can still meet their regulatory capital requirements.

So while the markets settle down, it is likely that banking lawyers will have a quiet autumn. But the talk is focused on next year. “There will be a backlog in the system by then and we’ll be working hard to catch up,” one lawyer says. So relax – get ready for the new year.

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