The world's largest banks and securities firms recommended yesterday that lenders collect better information about big borrowers and adopt other common-sense practices of risk management to improve the financial industry's ability to handle the type of sharp, unexpected swings in securities prices that rattled markets last fall.
The companies said that if their recommendations had been in place industry-wide last September, the near-collapse of the hedge firm Long-Term Capital Management L.P. would not have threatened the entire U.S. financial system and could have been more easily managed by Long-Term Capital's lenders.
"We all feel highly confident in saying that it is very unlikely that the situation would have ever reached the proportions it did were all these recommendations in place last year," E. Gerald Corrigan, managing director of Goldman Sachs Group Inc., said yesterday.
The recommendations made yesterday were part of a report issued by a task force formed by a dozen banks and securities firms in January in response to Long-Term Capital's problems and calls for more government regulation of hedge funds and their complicated investments. Corrigan and Stephen G. Thieke, managing director of J.P. Morgan & Co., were co-chairmen of the task force.
Hedge funds are large, essentially unregulated investment funds for wealthy investors. As part of their investment strategy, they often invest in complicated financial contracts called derivatives.
Long-Term Capital averted collapse when federal regulators orchestrated a $3.6 billion rescue of the firm by its 14 largest lenders. Federal regulators acted on the belief that Long-Term Capital had borrowed so much money -- $125 billion with only $4.7 billion in capital -- that its failure could cause a meltdown in financial markets.
The task force's report suggests that if its recommendations are adopted, additional government regulation will not be needed. In April, a White House task force of federal financial regulators recommended that Congress pass a law to require more public disclosure by hedge funds and that new regulations be adopted to require lenders to publicly disclose when they have high concentrations of loans to highly leveraged institutions such as Long-Term Capital.
In addition to collecting more information about borrowers, the task force recommended that lending companies make sure top management knows how much risk a company has assumed, that companies improve their credit risk evaluations, and that industry make the procedures for dealing with defaults and bankruptcies uniform.
Securities and Exchange Commission Chairman Arthur Levitt Jr., who encouraged the companies to form the task force, praised the group's effort yesterday. Treasury officials, who head the White House task force, would not comment.
In addition to Goldman and J.P. Morgan, the other members of the task force are Barclays Capital Inc.; Bear, Stearns & Co.; Chase Manhattan Corp.; Citigroup; Credit Suisse First Boston; Deutsche Bank; Lehman Brothers Inc.; Merrill Lynch & Co.; Morgan Stanley Dean Witter; and United Bank of Switzerland.