The new president of the Federal Reserve Bank of New York today told a congressional hearing that neither federal regulation of the volatile government securities market nor voluntary industry standards likely would have prevented the collapse of E.S.M. Government Securities Inc.
E. Gerald Corrigan told the House Banking subcommittee on domestic monetary policy, however, that if the Fed and other government regulators had acted sooner, they might have lessened some of the ripple effects of E.S.M.'s downfall. The failure of E.S.M. led to the temporary closing of 71 thrift institutions in Ohio and severe losses for several municipal investors. The subcommittee is chaired by Rep. Walter E. Fauntroy (D-D.C.).
Officials at the New York Fed had heard rumors as long ago as 1983 that something was amiss at the Florida firm, Corrigan said.
Investigators have said that E.S.M. used the same government securities as collateral for multiple repurchase agreements, a type of loan against the securities. It wasn't discovered until too late because most of the investors didn't actually take delivery of the securities.
Fed staff officials mentioned the reports to federal and state regulators, but took no action, Corrigan told members of a House Banking Committee subcommittee. E.S.M. was one of the relatively few dealers that filed voluntary reports with the Fed, and those reports "looked just fine," he said.
"With the benefit of hindsight, perhaps . . . somebody should have picked up the phone and said, 'Dammit, what's going on down there?' " Corrigan said. He did not say exactly what the government could have done.
To reduce the possibility of similar occurrences, Corrigan advocated a set of voluntary guidelines to be set by May 1 under which unregulated dealers would set aside a portion of their capital related to the riskiness of their investments to cover potential losses.
Two of the three congressmen at the hearing and the representatives from large government securities dealers believed guidelines would not be enough, however. Rep. Bill McCollum (R-Fla.) said he would introduce legislation Tuesday to give the Federal Reserve unspecified powers over the government securities market. Rep. Jim Cooper (D-Tenn.) called the guidelines a "very weak, hands-off policy."
And Richard M. Kelly, of the Public Securities Association, called for a law mandating that unregulated dealers comply with the capital standards. He was speaking for 36 "primary dealers," firms that are authorized to buy government securities directly from the New York Fed.
Those primary dealers, which must meet certain standards set by the Fed, then trade with the smaller, unregulated firms. Kelly said he did not support stricter regulation of primary dealers.
Corrigan did not rule out some kind of regulations, and he said that the Fed, the Treasury Department and other regulators were studying the issue and would make a decision in the next few months. But he noted several problems that regulation could cause.
For one, defining who is a dealer is tough, Corrigan said. All sorts of entities, including corporations engaged in other businesses, trade government securities. By a narrow definition, there may be 100 secondary dealers, he said. A broader interpretation could include thousands of dealers.
Certification or licensing also could create a false sense of security, implying that the firm was safe, Corrigan said in response to repeated questions about why the Fed was unwilling to either certify the firms or require that investors take delivery of the collateral.
He said, however, that some form of registration and occasional government inspection of a dealer's books "would not be the end of the world."