The apparent return of Paul Volcker to the forefront of financial reform has led to a fresh round of debate about what's needed to deal with banks too big to fail.

If nothing else, it suggests that the bank lobby may not be able after all to head off far-reaching changes.

We've pointed to some of what's necessary even if the so-called Volcker Rule prevails, including a firm crackdown on OTC derivatives, but even that isn't enough to limit moral hazard, that is, the financial blackmail that arises from bailing out banks when their risk taking results in losses, as a number of blog posts and press reports observe today.

As usual, however, the Times report on the topic fails to explain how the Bank of England's chairman, Mervyn King, would go further than Volcker to address the problem.

Oh sure, it mentions that King favors converting banks from corporations into mutual funds to limit their use of leverage, but that's a far cry from Volcker's plan to spin off proprietary trading and other non-deposit taking businesses, which the Times doesn't get into.

What's more, as Yves Smith and Christopher Whalen explain, even that doesn't go far enough. And the reason has to do with the fact that the capital markets have replaced deposit-taking commercial banks as the main source of credit. Indeed, investment banks for that reason will still pose systemic risk even if they no longer are covered by federal insurance.

Recall that runs on investment banks Bear Stearns and Lehman Brothers as well as insurer AIG threatened to take down the financial system not because they posed risk to commercial bank depositors but because they risked blowing up money-market mutual funds, which aren't covered by deposit insurance but pay more interest than banks do, and so represent far more of the money supply.

That uncomfortable fact escapes this FT columnist's notice today but not that of Steve Waldman.

Waldman's elegant market-based solution: Insure depositors, not banks, and impose a high limit.

While that wouldn't prevent banks or funds from getting bailed out when the system runs into trouble, or subject ordinary households to risk, it would require wealthy depositors to bear more responsibility for where they deposit their cash, and therefore to exercise more caution about what institutions they're willing to trust. And that would go a long way to imposing what almost everyone agrees is a more effective check on risk taking than regulatory oversight can ever be, that is, market discipline.