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A New Regulatory Idea   (Oliver King-Smith, January 28, 2008)


I myself don't believe in too much regulation but over the past few months it has come clear to me that it is needed in banks. The problem I perceive is banks have figured out how to black mail the tax payer. I call this bankmail.

Now before people start screaming that what's needed is less regulation not more, here me out.

The problem is banks have figured out how to privatize the profits and socialize the losses. They do this by watching each other and following each other. Once they start to converge on an idea they all walk lock step down a path they know will end in disaster. But they figure if all the other banks are doing it, the government will be forced to bail them out, because the economic pain will be to great otherwise. Meanwhile they make amazing profits while the scam works.

Under the current system some CEOs are fired (usually with massive compensation both before and during the firing) but so what. You made a billion dollars.

Here is a sketch of a very different regulatory plan.

1) If a bank fails for any reason, there is an automatic 3 year jail sentence for all directors and officers who have worked at the bank at any time in the last 3 years. There is no chance of parole and the sentence can be increased to as much as 25 years by a judge if they feel the officer or director has acted in bad faith.

You will get a trial to determine if you worked at the bank in question as an officer or director, and to ascertain that the bank failed. Bank Officers are meant in the corporate sense, such as CEO, CFO, ... not the local loan officer.

2) If you need to go to the discount window, the bank must give up senior equity in the bank at 80% of current value for the amount taken from the discount window. In other words they are selling senior equity at 80% of true value.

This equity that the banks give up, will be sold on the open market within 5 years after the Fed receives it.

The proceeds of this money will be returned to all income tax filers at a flat rate the year after it sold by the Fed.

3) Banks will not be able to borrow more than 50% of their current market value from the discount window.

4) All senior officers and board of directors compensation, in excess of 10 million dollars, inflation adjusted, must be held in escrow for 5 years before being dispensed to the earner (the tax would also be payable at the time it comes out of escrow).

5) Escrow accounts must hold their assets in cash or cash equivalents and must be placed at an unaffiliated institution to the bank.

6) If for some reason a banks tier 1 capital falls bellow 8%, the escrow accounts will be used to restore tier 1 capital to 10%.

7) If the escrows accounts are required to restore the banks tier 1 capital, the money will be taken from the oldest accounts first. All monies taken will be forfeited by the beneficiary of the account. The bank can chose to recompensate the directors and executives that lose money from their escrow accounts, but the repayment is considered compensation in the year it is received and would need to be escrowed for another 5 years.

6) Attempts to increase the non escrowed compensation of directors or officers of a bank by using 3rd parties, SIVs, off balance sheet accounts, and kick backs, sub-banks, or any other method will upon discovery subject all officers and directors to a minimum 10 year jail sentences. All persons involved in setting up such schemes will be subjected to a minimum 5 year jail sentence unless they are the first to report it to the appropriate regulatory authority.

As I said this is a sketch. I am actually in favor of relax or eliminating other regulation on banks. The idea is to actually give banks more freedom to do as they chose.

However what this regulatory regime would do is tie the interest of shareholders and bank officials to the future. Banks would still have the ability to "bankmail" the tax payer, but senior members of the bank would pay a dear price for doing so.

The 3 year window was chosen as bubbles tend last around a little more than 3 years between blow up and collapse. Hence an official should be able to bail out if they feel their bank is being mad and avoid a jail term. The 5 year rule is designed to ensure that there is plenty of "capital" to help restore bank health in the event of disaster.

The goal is to prevent banks officials and shareholders from extracting huge payouts in the good times, and then getting bailed out when things go south.


For more on a wide array of other topics, please visit the oftwominds.com weblog.

                                                           


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