The most important thing lawmakers could do to reform our financial system is impose tough rules limiting the debt and risky investments that banks and other financial institutions can pile up.

Normally, setting capital standards should be up to regulators, just as setting short-term interest rates is up to the Federal Reserve. But the financial industry, especially in good times, always will press for relaxed stand-ards. So in the case of how deeply indebted an institution can become, it's time that a cap be written in the law.

Canada caps leverage for financial institutions at 20-to-1, meaning for every $20 invested or lent, $1 must be set aside. It's no accident that Canada came through the economic crisis in much better shape than U.S. markets.

By comparison, Wall Street banks such as Bear Stearns and Lehman were operating with ratios of 30-to-1 or greater.

Requiring banks and brokerages to set aside more capital will give the financial system a bigger cushion in the next crisis.

The Senate also should do more to tighten supervision of derivatives trading. On that score, the reform bill passed earlier by the House didn't go far enough. By some estimates, only half of the trading in these risky securities would be shifted onto exchanges, where it can be subjected to capital and margin requirements.

Like the House measure, the Senate bill taking shape would create a council of regulators made up of the Fed, the Federal Deposit Insurance Corp. and the Treasury. That body, with the approval of three bankruptcy judges, could authorize the "orderly liquidation" — not a bailout — of distressed financial firms.

The House measure, however, holds out the prospect of continued bailouts. It would offer federal backing for bank debt if a "liquidity event" threatens the financial system. The Senate should close off the possibility that taxpayers will ride to the rescue.

Lawmakers in both the House and Senate are putting heavy reliance on a new regulatory structure and a new bureaucracy. The agencies might well prove helpful. But we're likely to be better off relying on tougher capital standards — to keep the system from becoming clotted with debt and risky investments in the first place.