“He gains everyone’s approval who mixes the pleasant with the useful.”
Horace [Quintus Horatius Flaccus] (65–8 B.C.), Roman poet. Ars Poetica, l. 343 (c. 13 B.C.).
When companies, whether in the fields of finance, banking or insurance, or for that matter, any other industry, create new types of financial instruments, should they be immediately subject to regulatory review?
If one looks at the trademark and patent services of governments around the world, one must wonder why any firm seeking to create new and innovative financial instruments is not required to seek government approval and clearance before being able to offer such instruments to the public. At present, little, if any legislation is on the books to do this.
Perhaps, if it was, companies like AIG would not have been able to offer exotic Credit Default Swaps without proper regulatory controls. For that matter, the same would apply to many of the exotic instruments offered to American and international investors.
Wouldn’t it have been wonderful if some oversight and investigatory body cleared the validity of the investments offered by Bernie Madoff or Robert Allen Stanford prior to their being offered to the public? Or, if someone in government assigned new offerings or financial instruments to proper regulators for final approvals before becoming public, might it have been possible to prevent almost every single one of the present difficulties in the world economy?
Imagine, if you will, that CDS, was cleared first and assigned to a regulatory body before being offered? If that had happened, AIG would be a sound financial institution and the overall economy would be stable, with the taxpayers owning ZERO percent of that international company.
Legislators in Washington would be wise to consider creating a clearing house for any new financial instruments of any kind in which government officials would review every possible aspect of a new instrument and assign it to a regulatory body.
We don’t believe this clearinghouse should be connected with any particular regulator, but should be an independent entity, operated similarly to the US Patent and Trademark Office. Every new instrument type coming into the securities world should require a seal of approval before being registered with the appropriate regulatory agency prior to being offered for sale.
Doing anything less leaves investors at the mercy of people like Madoff and Stanford, among others, who sell financial products that are simply too good to be true.
If a product is valid, the company that plans to offer it should be able to prove the financial model behind the security and be given a five year protection so that others cannot offer the same or similar instruments for that time. This is similar to the way we protect pharmaceutical companies and patent holders.
Once cleared, the product would be verified once more through the regulatory body, to ensure that the principals behind it are sound and that it meets regulatory compliance. This in turn, along with the certification given by the regulator places the offering type under the full jurisdiction of the regulator. Language specific to that regulator would be placed prominently in the offering so that investors know whom to call in case of problems.
Those calls, should they come, must be quite seriously reviewed and checked for variations of the offering type or prospectus, and any other non-compliance.
These steps, not simple by any measure, would assure investors that they’re buying safe and sound investment types. A website should be posted to list all securities types once the regulatory certification is granted.
While this adds a layer of bureaucracy and costs to new offerings, it seems a miniscule price to pay to allow companies intending to offer new or exotic securities the protection of being cleared of any misgivings before their offering. Such a process would also help, just as the creation of the SEC did in the 1930’s, to restore confidence in the investor community.
Economists, here at the Institute and around the world project that the markets will take years to recover, as investors will likely remain averse to risk for probably a decade. Thus, it is imperative that government not only provide funds and backstops in finance, but new systems, not merely regulations, to restore confidence.
This process, of which we write, we believe should be implemented on an international, not simply a national level, so that any offering in one nation may not be misused in another, potentially causing harm to the country where the offering is officially made. The Stanford case, as we’ve seen, has proven a hardship for Antigua, as well as the United States, and such international cooperation would most assuredly prevent or reduce the opportunities some utilize to hide capital assets offshore.
Safety, security and protection through a clearinghouse process… who would have thought it necessary?