Regular readers of this blog know that I strongly believe that the U.S. has so far wasted the opportunity the last financial crisis gave us to reform Wall Street. Despite the chorus of voices saying that it’s time to fix the heart of the capitalist system, regulatory responses have been weak or inconsistent, and that is putting it mildly. So with that background, it was great to read on FT today about a recent speech given by Bill Dudley, who leads the NY Fed, which traditionally has had an all-too cozy relationship with its neighbors on Wall Street.
Mr. Dudley, speaking at a “Workshop on Reforming Culture and Behavior in the Financial Services Industry,” laid out a three-part proposal for curbing the excesses of the past two decades. As the FT notes, his ideas are worth supporting not just because they are radical (for the Fed at least) but also because someone in his position is making them at last.
His proposal, as noted, has three parts:
1) Bankers must defer part of their income into the future in case wrong-doing results in penalties via a “performance bond” mechanism. This mechanism would not only ensure that those who violated a law paid for the crime, it would create a stronger culture of self-regulation which, in the end, is the best kind. As Mr. Dudley notes in his speech:
Each individual’s ability to realize their deferred debt compensation would depend not only on their own behavior, but also on the behavior of their colleagues. This would create a strong incentive for individuals to monitor the actions of their colleagues, and to call attention to any issues. This could be expected to help to keep small problems from growing into larger ones.
Importantly, individuals would not be able to “opt out” of the firm as a way of escaping the problem. If a person knew that something is amiss and decided to leave the firm, their deferred debt compensation would still be at risk. This would reinforce the incentive for the individual to stay at the firm and to try to get the problem fixed.
2) Bankers will be registered and tracked throughout their lifetime, and all bankers will get a kind of “credit score” based on their record of compliance. Also, any banker convicted of serious crimes will be barred from working in finance for life. This second part has the good effect of making the cost of violations even stronger for younger bankers, thus promoting a new, more vigilant culture today among the people who will lead Wall Street tomorrow. As Mr. Dudley notes:
As a complementary step to the registry, it would be helpful if individuals in finance who are convicted of an illegal activity were prohibited from future employment in the financial services industry. Currently, Section 19 of the Federal Deposit Insurance Act prohibits anyone convicted of a crime of dishonesty, breach of trust, or money laundering from working at an insured depository institution or bank holding company.
One possibility could be to amend Section 19 to cover the entire financial services industry. The precise formulation of an amendment would need to be worked out, but the application should be sufficiently broad so that it also covers asset managers, hedge funds and private equity funds.
Like the registry, a broad and permanent industry prohibition changes the time horizon for the perceived costs of misconduct—from a one-time fine, or perhaps a few years in prison, to a lifetime prohibition from earning a living in finance, regardless of the type of employer involved.
3) Banks that cannot manage themselves in an ethical manner will be broken up:
If those of you here today as stewards of these large financial institutions do not do your part in pushing forcefully for change across the industry, then bad behavior will undoubtedly persist. If that were to occur, the inevitable conclusion will be reached that your firms are too big and complex to manage effectively. In that case, financial stability concerns would dictate that your firms need to be dramatically downsized and simplified so they can be managed effectively.
One hopes that these proposals, which are simple but important steps in the right direction, will be taken seriously and put into effect. The odds against that happening are long, given the lobbying power of the banks. But perhaps if others of Mr. Dudley’s stature pick join the chorus, these reforms will become reality.