6 simple steps to fix Wall Street

By Allan Sloan with Doris Burke Fortune
Sunday, May 9, 2010

The first thing you learn when you start looking at Wall Street, which I've been doing for 40 years, is to never trust the salesmen. What they promise you isn't necessarily what you get. You need to use common sense, watch out for your own interests and at least make an attempt to understand the fine print.

The same principle applies when you examine plans to reform Wall Street. The Street certainly needs to be fixed, heaven knows. Its excesses are largely responsible for the financial crisis that brought markets crashing down in 2008 and plunged the economy into recession. The government needs to step in: to stop people from being cheated, to help capitalism regain some of the public trust it's lost, and to make markets transparent enough that people other than a handful of elite insiders can figure out what's going on.

Salesmanship, however, isn't confined to Wall Street. President Obama's recent speech at New York City's Cooper Union college, just north of Wall Street, sure was a great pitch. Who can disagree with wanting "a commonsense, reasonable, non-ideological approach to target the root problems that led to the turmoil in our financial sector and ultimately in our entire economy"?

What we'll get from the legislation, however, isn't necessarily what we heard from the Salesman in Chief.

As I write, it's impossible to predict what will emerge from the legislation -- one bill passed by the House, one pending in the Senate -- kicking around in Washington. But something will. Hey, even Goldman Sachs chief executive Lloyd Blankfein seems to think so. "Clearly, the world needs more regulation," he told the Senate. 'Nuff said.

The point of the legislation shouldn't be to do what's easily sellable or to punish Goldman, everyone's favorite whipping boy. It should be to make the financial system work better for all of us.

So with assistance from some of my Fortune colleagues, I'd like to propose six simple steps to help fix the financial system. They would change Wall Street's incentives to make game-playing more expensive for the firms and the players; force both institutions and individuals to put serious amounts of their own money at risk, which would reduce future taxpayer losses; and give regulators, creditors and the general public access to information that Wall Street now hoards to enhance its profit margins.

These proposals aren't a perfect solution -- nothing is -- but had they been in place, AIG might have avoided a meltdown; Lehman Brothers' collapse wouldn't have been as messy; and Goldman's infamous Abacus deal, in which taxpayers in Britain and Germany indirectly forked over $990 million to Goldman might never have taken place. But it did, sending those $990 million to John Paulson's hedge fund.

I'll get to the Simple Six in a minute. But as someone who's seen many "reform" plans -- remember Sarbanes-Oxley? -- fail to achieve their goals, let me offer my negative take on two widely touted ideas that sound great but that just don't seem workable in the real world.

First, it would do more harm than good to create a systemic-risk office. We already have a body that's supposed to guard against risks to the financial systems of the United States and the world. It's called the Federal Reserve. The Fed's primary job, like that of the world's other central banks, is to keep the financial system functioning properly. We don't need a startup bureaucracy trying to do that. The new office and the Fed would end up tripping over each other. Worse, the giant, "systemically important" institutions subject to the riskocrats' rules would carry an implicit federal guarantee against failure. It would give them an unfair advantage by allowing them to raise money more cheaply than smaller institutions, which would not have a federal safety net against failure. That would encourage financial gigantism, which is not good.

Second, we shouldn't adopt the Volcker Rule. Named after former Fed chairman (and current Obama adviser) Paul Volcker, this is a cornerstone of Obama's proposal. But like Obama's speech, the Volcker Rule is better as a sound bite than a solution. Volcker's idea -- separating risk-taking from insured deposits -- sounds great. Implementing it strikes me as impossibly complicated. It's much better to inject more capital -- and more fear of failure -- into the system than to try to define "proprietary trading" and micromanage complex financial companies.

So let's move on to what we should do. Elements of our Simple Six are in the pending legislation. If they're part of what's adopted, we could get true and lasting reform. If they're not, it won't be long before Wall Street is back to business -- and bailouts -- as usual.

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