This is a fateful week for financial regulation and the financial system.

European leaders are trying to reach a consensus on how to give Greece some breathing room to salvage its economy and to recapitalize the continent's banks. Since the banks are heavily invested in Greek bonds, the more relief the Europeans give Greece, the more they will have to spend recapitalizing their own banks.

Meanwhile, on this side of the Atlantic, regulators are grappling with two momentous issues: how to implement the so-called Volcker Rule, which seeks to limit the ability of federally insured banks to engage in inherently speculative trading activity; and how to carry out another key section of the Dodd-Frank Act, which gives regulators the authority to take over large failing financial institutions.

The Financial Stability Oversight Council, a body created by Dodd-Frank made up of senior bank regulators, is meeting today on the issue of how to deal with failing banks. Meanwhile, the Federal Deposit Insurance Corporation is issuing regulations to carry out the Volcker Rule.

A 206-page draft of the proposed rule was leaked to The American Banker newspaper, and the problem is that it has too many loopholes. In principle, banks are permitted to "make markets" for bona fide customers who want to execute trades but not to engage in purely speculative trades for their own accounts. The problem is that derivatives markets have become so Byzantine that any skilled trader can disguise a bank transaction as a customer transaction.

The problem is not that the proposed regulation is a deliberate capitulation to the banks. It's that the "Volcker Rule" itself was a poor substitute for the now-repealed Glass-Steagall Act, which flatly prohibited commercial banks from behaving like investment banks. But the Obama administration stopped short of calling for a new Glass-Steagall Act and instead conjured up a vague "rule" -- much to the surprise of Paul Volcker, who was hastily drafted to attend the naming ceremony when the president went though a brief populist incarnation after Scott Brown's surprise Massachusetts Senate victory in January 2010.

My educated guess is no matter how the minutiae of the Volcker Rule come out, the big banks will find ways to speculate with federally insured money. And shame on that.

Speaking of which, the other fateful action this week here will set some guidelines, under the FSOC, for dealing with a potential insolvency of a large "systemically significant" financial institution. Here again, the interesting and momentous questions are offstage. Whatever the Council decides, the real issues are political.

If a large bank, say Bank of America, is on the verge of going bust, will Treasury Secretary Tim Geithner have the nerve to recommend seizing it and breaking it up, as newly authorized under the Dodd-Frank Act? Geithner's strategy, since the first phase of the crisis, has been to talk up and prop up, rather than break up large, failing banks. And President Obama as been surprisingly docile in letting Geithner call the tune, rather than getting differing views from multiple regulators who do not see eye to eye with Geithner.

This week, the third-quarter financial reports of the big banks will be released, and they are expected to be ugly. The balance sheet of Bank of America is clogged with non-performing mortgages. Citigroup and Morgan Stanley have large exposures to Greek bonds, which are far from out of the woods.

Geithner's strategy in 2008-2009 of throwing money at insolvent banks and hoping for the best is a proven failure. Weakened banks have been dragging down the rest of the economy, prolonging its deep slump.

Obama has been talking a bit more like a populist lately. He even has some obliquely kind words for the Occupy Wall Street demonstrators, saying that he sympathizes with their frustrations. That's pretty bold for Obama. Let's see if he is bold enough not to be led down the garden path again by Geithner.

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