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How to Ground The Street

Institutional shareholders, in particular mutual funds, pension funds and endowments, must reengage in corporate governance. Over the past decade, arguably the sole challenge to corporate mismanagement and poor corporate strategies has come from private-equity firms or activist hedge funds. These firms were among the few shareholders or pools of capital willing to purchase and revamp encrusted corporate machines. So it shouldn't be surprising that the corporate world has taken a skeptical view of them -- especially short-selling hedge funds, which have often been a rare voice raising the alarm.

Boards of directors were also missing in action over the past decade; not only did they not provide answers, they all too often failed even to ask the appropriate questions. And the roles of compensation committees, of course, must be totally rethought. No longer can Garrison Keillor's brilliant observation about our kids -- that they are all above average -- apply to CEOs and propel failed leaders' paychecks through the roof. Today's momentary public oversight and outrage over executive compensation, while long overdue, is no substitute over the long term for firm standards set by compensation committees and boards of directors.

Finally, we need to completely overhaul the federal financial regulatory framework.

Let's leave aside the ideological hesitancy that has long hamstrung regulatory agencies. Today's balkanized regulatory framework for financial services no longer matches in any way the needs of a fully integrated global financial system. The divisions of the past -- commercial banking vs. investment banking vs. insurance vs. hedge funds vs. private equity -- have become distinctions without a difference. But these old boxes and formalities still determine how entities are viewed and regulated. It should surprise nobody that capital found the crevices in the regulatory framework. That is what capital is paid to do. But we failed to respond with a regulatory framework flexible enough to plug the leaks.

We do not need additional fragmented areas of federal regulation to handle hedge funds, sovereign wealth funds or derivatives. We need a unified approach that addresses the underlying issues: what kinds of leverage we wish to tolerate, how to measure risk, how much disclosure various trading products should provide. We cannot survive with the current system: the SEC, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Fed, the Office of Thrift Supervision and on and on. We must go from the Rube Goldberg structure we now have to a sleek iPod design that is cleaner, has better operating software and may even look good.

We began to try to craft such a unified model in New York, as did Treasury Secretary Henry M. Paulson Jr. in Washington last year. But it is urgent that we finish the job. Having flooded the market with cash and seen the government take a chunk of many of our largest financial institutions, we now need to craft the rules that will apply to all market participants.

Three overarching priorities should guide government actions in the new structure. First, we need better control of systemic risk. The currently splintered federal regulatory authority, the continued presence of off-balance-sheet transactions for financial entities (even post-Enron) and the failure to subject major players to any government oversight means that nobody can really understand the full risk facing the financial system.

Second, investors must be protected with adequate, accurate information. Firms must offer transparency both to individual investors and to government regulators.

And third, as Eric R. Dinallo, the superintendent of the New York State Insurance Department, has wisely pointed out, we will have to step back from the current environment in which government has become a guarantor of all major risk. The so-called moral hazard will serve to devalue risk in the market, and this too will have a debilitating long-term effect on capital flows. Only if private actors have to bear the real risks they incur will the market function properly. We are now perilously close to nationalizing risk.

As the rules of modern capitalism are rewritten over the next year, those who benefit from the enormous flow of cash being spread throughout the U.S. economy must be expected to compete within a system of rules that creates a true market -- based on sound, skilled regulation, vigorous corporate governance and transparency.

Although mistakes I made in my private life now prevent me from participating in these issues as I have in the past, I very much hope and expect that President Obama and his new administration will have the strength and wisdom to do again what FDR did.

Eliot L. Spitzer was governor of New York from 2007-08 and state attorney general from 1999-2006.


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