Reader William Kidder, who has been in the interest rates business since 1966 and managed a recognized government bond dealer in the 1970’s (some regard him as the father of the matched book) offered a proposal on how to clean up some of the problematic practices that have led to our credit crunch.
Kidder admits that his program is a tad idealistic, but operates along different lines than other programs advanced thus far. It has the advantage of having few moving parts (although several key items would need to be fleshed out a bit more).
From Kidder:
The Good Citizen Fund: Proposal For Private Regulation Of The Financial Sector
These four ‘instant reforms’ could be implemented tomorrow morning by regulators of banks, GSE’s, exchanges, and broker/dealers. At first, compliance with the reforms would be voluntary, but they will be made legal and binding as quickly as possible.1) No credit extensions to entities which do not agree to reforms
2) Stricter minimum margin rules for credit extensions (sliding scale from 2%)
3) No new off-balance sheet items unless exchange-traded or very collateralized
4) No more netting of trades unless settlement date is within 30 calendar days.How To Enforce The Reforms?
Banks, GSE’s, exchanges and broker/dealers that agree to comply with the four reforms will be listed immediately on the Fed’s public website. The website will include a warnings and notices as follows:WARNING: AN UNLISTED FIRM MAY NOT BE ELIGIBLE FOR ACCESS TO THE FEDERAL RESERVE
The listed firms below have agreed not do business with unlisted banks, GSE’s, exchanges and broker/dealers after April 30 and to implement certain reforms.
Good Citizen Awards: If your employer is listed and you know of any violation which occurred after April 30, you should inform your immediate supervisor about your concerns. If the violation continues after another week after notifying your supervisor, please report the violation to the Federal Reserve Bank at 800-000-000. Your privacy will be protected.
If inspectors find the reported violation exists — or that you had good reason to suspect one — you will receive a $10,000 (or more) Good Citizen reward. If the inspectors find the suspected violation did not occur, no action will be taken against you or your firm. But always act in good faith.
If a firm incurs a second violation, it may pay a $1 million penalty in order to remain on the ‘reformer list’ or choose to delist and not pay the penalty.
Subsequent violations will carry a penalty of $5 million each. All violations, penalties paid, and voluntary delistings will be noted at the site.
If a firm does not agree to comply with the voluntary reforms by April 30, the Fed will consider a ‘bad faith’ market participant and may deny it access to repo, the discount window and other financial support. Further, if a firm fails to meet the April 30 listing deadline, it will not be added to the eligible ‘reformer’ list before June 1 (and on monthly dates thereafter).
Any firm with more than $10 billion in assets that elects not to be a ‘reformer’ will be listed separately with the following warning:
THESE FIRMS ARE UNSUITABLE COUNTERPARTIES FOR MEMBERS OF THE PRIVATE REFORM MOVEMENT
These firms with assets over $10 billion have elected not to join the voluntary reform movement of the financial sector. Therefore, members of the reformerer group will not conduct any business with the entities list below:
End of Federal Reserve Message.
To implement the plan, the Fed simply sets up
(1) a telephone number and recorder to take reports of suspected violations
(2) appointed approriate staff to handle the phones
(3) open a ‘special purpose’ account to handle Good Citizen income and expensesPrivate Regulation Of The Financial Sector
The proposed new regulatory company will be a private company (‘Good Citizen’) authorized by Congress to oversee compliance of existing regulatory framework of the financial sector, propose new regulations and changes, and to provide ‘bailout’ insurance.Good Citizen will be organized along the lines of a mutual insurance company and funded by tax-deductible premiums based on total employee compensation (especially bonus payments). We envision as much as 25% annually, but with a generous dividend after two years experience. The company will have a small staff to gather reports of possible infractions and coordinate remedies with existing regulators.
Participants in the financial sector must purchase an insurance policy and agree to comply with its conditions. Transactions with uninsured parties in the financial sector are not permitted.
The financial sector includes entities which conduct business in securities (securities will be very broadly defined) including banks, broker/dealers, exchanges, inter-dealer brokers, leveraged hedge funds and private entities, insurance companies offering credit enhancements for securities and counterparties. Affiliated companies or closely-tied entities which are at least 20% owned (actual, constructive or contingent) must also be insured. This includes all ‘off-shore’ and international subsidiaries and affliates.
There will a very generous reward system for Good Citizens, including payments for ‘good-faith’ false alarms. Good Citizens will be anonyomous and their privacy protected.
There will be incentives and dividends for faithful compliance and cooperation. There will also monetary penalties for infractions including the ‘death penalty’ cancellation of the policy.
Non-US Companies and Entities
Central banks and regulatory authorities outside the US will be asked to cooperate with the spirit of the Good Citizen program and not permit ‘loophole’ competition that disadvantages members of the reform movement. Reformers will be encourage to inform the Good Citizen company of foreign abuses and the company will follow through with Congress and other US regulators.
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Sounds alluring.
But believe me when I say, You will never ever want something like this proposed Good Citizen program in a demcratic country.
And I know you will all jump on me when I say this. But it is in the essence of the idea not different to what the Stasi in the German Democratic Repubic did. They used the same kind of argument and it led to a society in which every citizen grassed on its neighbours. You had a country populated by police spys. (I am from Germany. I know what I am talking about)
Maybe I am overreacting but I think you do not want to implement anything like this where a citizen is REWARDED for snitching about another one. Even if it happens only in a small part of the business world this is lethal to any healthy and liveable society.
This is not intended to be any criticism on Mr. Kidder. But this type of enforcement cannot be the solution. You would try to solve one bad in potentially installing an even bigger one. Remember Orwell
-Georg
I’m all for accomplishing Kidder’s 1-4: These are the minimum reasonable floor boards to fair practice reforms in the industry. And his insight that the Fed’s announced willingness to _withhold_ repos from non-participants is cogent. Since the bid totals for the TAR in December, ’07, it’s been evident that Fed credit is the only thing keeping many financial concerns simulating lifelike activity. A threat to cut them off would be bracing indeed. . . . Course this Fed doesn’t have gut one to actually cut off or constrain anyone, but maybe they wouldn’t have to with this proposal.
I’m dead against a private Good Citizen outfit, though. It’s clear that William Kidder wants to keep _public_ regulation to a minimum. There are good reasons for that perspective, I don’t mean to denigrate it. I would see such an outfit being _massively ripe for exploitation_. We see what happened with private bond raters who had a stake in the outcome. Yes, this proposal is intended to rebalance the stake of the ‘examiners.’ I would much prefer public employees who face severe statutory penalties for misfeasance or nonfeasance as well as rich incentives for productive result. The industry can always find a way to provide richer incentives for laxity.
Good effort, though.
*boof* TAF in December, 07
Can anyone explain why this is necessary: “4) No more netting of trades unless settlement date is within 30 calendar days.”?
For one not of the libertarian religion, is there a clear and cogent argument from the facts why ‘private’ regulation (??) is a useful innovation? (I don’t regard ‘govt reg is always inefficient or distorting’ as a clear and cogent argument – it’s rhetoric.)
Above we have an example of East German uses of citizens spying on one another.
Are there real world good examples of regulations of this type working in the financial industry? Any strong argument for such a ‘private’ regulatory system should have this as part of the foundation.
It seems to me that since the enforcement mechanism is the Fed, the notion this is private is specious anyway. If you disagree, on what grounds?
Kidder responds: I am a civil libertian, so of course I agree that snitching and spying on one’s fellow citizens is horrible. But in this case, we are talking about self-regulation of Wall Street firms which are treated as TOO BIG TO FAIL and not talking about society at large.
Question: What is one’s duty to report law-breaking in general? A tough one. But more relevant to today’s problem, what is the duty of an employe to report of a workplace violation occurring in a self-regulated industry?
I argue that ‘self’ in self-regulatory extends to all employees, not just the legal or compliance departments. Moreover, under the proposal, all parties know in advance that violations can and should be reported. So is a violation report really snitching?
Further, the plan envisions the entire industry has a huge financial stake in avoiding a bailouts or claims. Everybody has to work to weed out the problems in order to get back most of the premiums paid to the insurance company. Also, the plan builds counterparty trust — which has gone missing and become a major problem that cosmetic changes can’t fix.
Think of the adage ‘it takes one to know one’. By setting up a mechanism for regulators to tap into the Street grapevine and knowledge, the regulators will have an edge missing now. For example, did you ever think the Fed was sharp enough to keep up with Bear Stearns? Of course not.
In general I like this idea of returning public censure as a means of enforcement. The gentleman with E. German experience may not be aware of the role of such censure in American history.
I would greatly strengthen the privacy of the whistle blower, even from lawsuits. I trust that the firms targeted will try to blackball the whistleblower. In general such a group will need some quasi-governmental status and support. Obviously connected to the Fed.
I am at a loss as to why the federal government should continue to give brokers access to taxpayer money with out a return on investment? Why should the corporate officers of these bankrupt corporations continue to draw their high salaries and bonuses?
Before Wall Street can continue with business as usual Wall Street must first come to grips with the fact they have a financial obligation the American taxpayers. As of today all I’ve be able to surmise is that the bail out was an obligation that the American people should be grateful to shoulder.
I have to say I am not really familiar with the role of censure in American History. But I will definitely look that up. From my memory I recall that there where some important distinctions however between public censure and the hypothetical system, which Mr. Kidder kindly put to discussion in this post.
I absolutely agree to Mr. Kidder that if someone gets aware of a wrong around him he should do everything possible to right it. I mean that is the basis of every real democratic society.
In my humble opinion it becomes extremely dangerous however, when you start REWARDING such behaviour. And I think that is also the biggest difference to the American system of public censure, the kind anonymous commentator referred to. History has shown that if you link “a duty to report” with rewards, it pushes that nasty part of human nature to the top that will lead to snitching and spying in the end. An evil combination of curiosity, jealousy, distrust and schadenfreude combined with the self-delusion of serving a common good. That is just the way humans are. Everywhere.
And I absolutely understand that you want to limit such a system to financial institutions. But beware social dynamics and the workings of governments. If you start implementing something like this in a small part of the society – even in a curbed form – there will be no barriers to implement it more generally.
-Georg