New Security

In a fascinating op-ed piece in the NYT, William Cohan suggests a practical and effective approach for controlling the excesses of Wall Street. You remember, the excesses that have come very close to destroying our economy.

Cohan begins by recounting the early days of Wall Street, when every financial firm was a partnership, not a corporation. The senior partners were personally liable for the risks that the firm took. Their fiduciary responsibility (to their clients and in the creation of investment products) was driven by self interest—they didn’t want to take irresponsible risks because if things went bad, their net worth would go to zero.

Cohan has very little faith that the 2000 page Dodd-Frank financial reform bill will have any real effect, other than creating massive new government bureaucracies and little else.

Here’s what Cohan suggests:

… I propose that each large Wall Street firm create a new security that represents — and is secured by — the entire net worth of its 100 top executives. This security would be subordinated to all other creditors as well as to all preferred and common shareholders; in other words, if a firm goes bankrupt, this security is the first to be wiped out.

Had such a security existed at the time of the collapse of Lehman Brothers, the net worth of the top 100 Lehman executives — no doubt totaling several billion dollars — would have been collected after liquidating everything they owned and paid to Lehman creditors, who under the current system will be lucky if they get back 10 cents on the dollar.

Wall Street’s first reaction to this idea — aside from profanities — will be that it cannot possibly be done. Or that it would somehow threaten the sanctity of our capital markets.

But, in fact, it can and should be done. Indeed, Wall Street has all the intellectual capital it needs in its own archives to construct such a security: in the old partnership days every partner signed an agreement requiring him (and rarely her) to put his net worth on the line every day. Surely, clever Wall Street lawyers can draft a 21st-century version of the old partnership agreement.

Whether the progressives in the Obama administration like it or not, most people act in their own best interests, and Wall Street people exemplify this. They wouldn't like it much, but Cohan’s approach would work. He writes:

Pretty harsh, right? Maybe, but Wall Street deserves no sympathy. Had this security, or something like it, been in place at every Wall Street firm five years ago, there would have been no mortgage bubble, no financial crisis, no deep and unsettling economic recession with nearly 10 percent unemployment, no need for the Troubled Asset Relief Program, and no need for Dodd-Frank or Basel III.

Heh. And I suspect the geniuses in the Obama administration and the Congress could draft the legislation to implement the new security in considerably less than 2,000 pages.