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).
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 expenses
Private 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.