A Wall Street Reform Idea That Would Change Everything
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When it comes to watching and understanding Wall Street there are few analysts more shrewd and dispassionate than James Grant, the editor of Grant’s Interest Rate Observer (boring title, yes, but a Bible for investors).
And Grant has just proposed driving a stake through the heart of the reality that Wall Street’s profits are privatized (massive bonuses) and its losses are socialized (taxpayer bailouts). Here’s Grant’s analysis (full essay is here):
The trouble with Wall Street isn’t that too many bankers get rich in the booms. The trouble, rather, is that too few get poor — really, suitably poor — in the busts. To the titans of finance go the upside. To we, the people, nowadays, goes the downside. How much better it would be if the bankers took the losses just as they do the profits.
Happily, there’s a ready-made and time-tested solution. Let the senior financiers keep their salaries and bonuses, and let them do with their banks what they will. If, however, their bank fails, let the bankers themselves fail. Let the value of their houses, cars, yachts, paintings, etc. be assigned to the firm’s creditors.
Grant doubts that any system which does not demand true accountability from the people making decisions and taking risk will prevent ballooning bubbles, boisterous bacchanals of risk-taking, and bilious bailouts.
From the administration and from both sides of the congressional aisle come proposals to micromanage the business of lending, borrowing and market-making: new accounting rules (foolproof this time, they say), higher capital standards, more onerous taxes. If piling on new federal rules was the answer, we’d long ago have been in the promised land.
His solution: put executive wealth on the table when it all goes belly-up.
In Brazil — which learned a thing or two about frenzied finance during its many bouts with hyperinflation — bank directors, senior bank officers and controlling bank stockholders know that they are personally responsible for the solvency of the institution with which they are associated. Let it fail, and their net worths are frozen for the duration of often-lengthy court proceedings. If worse comes to worse, the responsible and accountable parties can lose their all.
I like it. I like it alot. Simple, elegant, and a sharp wake-up smack to the face of Wall Street. Of all the complex and loophole-ridden proposals you have heard so far to “reform” Wall Street, can you think of a single one that would do more to induce Wall Streets overseers to act with more caution and responsibility? I thought so.
Unfortunately, it’s probably way too good an idea (which is to say it would be effective and scare the hell out of lots and lots of Wall Street campaign donors) to actually become part of the fast-moving financial reform debate. But you never know. A lot of people take James Grant very seriously. So let’s hope the “Grant Rule” takes its rightful place alongside the “Volker Rule.”
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Mr. Zimmermann,
As a metaphor, the idea of seizing the goods of bankers when their bank fails is great, as a reality it is of course impossible. The whole point of a company being “Incorporated (Inc.)”, or as is now more common, “Limited Liability Corporation (LLC)”, is to protect the individuals from such liability, hence “limited liability”. This would require overturning over 100 years of legal construction.
The simpler solution is simply to get rid of the bail-outs by not allowing companies from being “too big to fail”. Let the company fail, that is how the legal system is set up. The individual banker who screwed the whole thing up will be out of business too.
Though I wonder if even a LLC would allow some sort of clawback system whereby failure requires return of wealth (bonuses) accrued from the LLC. That would effectively put any banker’s personal wealth in play.
In response to another comment. See in context »Mr. Zimmerman,
Yes that is possible but only if personal fraud is demonstrated. If a CEO used fraud in a personal capacity, then his personal good could be become targets for either civil or criminal actions. However, that would be him personally defrauding the company that he was working for. So long as he is acting as a agent for the company, in the company’s interest, he cannot be personally liable. It is the fictitious but legally real person of company that can be charged.
In response to another comment. See in context »Mr. Zimmermann,
You make a great point – one that I made in the comments section earlier today in response to Sahil Kapur’s article (http://trueslant.com/sahilkapur/2010/04/22/in-speech-to-wall-street-obama-chases-the-impossible/).
Regulators are always trying to come up with these fancy schemes about regulating something that can’t even be regulated in the first place, when the best way to make sure behavior doesn’t get out of hand is to allow for the consequences of bad behavior to take place (failure!).