Yesterday on FOX Business Network I was interviewed by Connell McShane and discussed the Federal Reserve’s “regulatory fixes” for the sub-prime mortgage market. During the interview, I suggested that the new Federal Reserve regulations are a joke and make us a global laughing stock. I stated that the “US doesn’t have a shortage of laws” but that our regulators and the Administration need to be serious about their jobs as market “cops”. The clip is presented at the bottom of this blog entry.

Since the interview I have received e-mails and calls criticizing me for complaining about Washington but not providing suggestions that can help the problem. So after two days of criticism here goes… five regulatory fixes that can happen immediately and without additional legislation.

FIX #1 - Restore transparency by enforcing securities disclosure laws including Sarbanes Oxley. Full and fair disclosure of all relevant information to make informed investment decisions is the cornerstone of free markets. For decades the SEC was a dedicated and diligent disclosure cop. For the past several years they haven’t been on the job. Management teams aren’t held accountable and daily “surprises” are taken for granted from the banks and brokerages.

The SEC’s enforcement failures sanction “bad” corporate behavior and make the SEC a cheerleader for “moral hazard” in action. Disclosure and transparency are so weak that management teams don’t even know what their companies are doing or why.

Financial services reform starts with active and persistent enforcement of the securities laws, some of which have been on the books since the 1930’s. No additional legislation is necessary for this change to be enacted immediately.

FIX #2 - 5 year phase in of regulatory and accounting consolidation of all off balance sheet assets, liabilities, derivatives and credit default swaps. As off balance sheet items are consolidated with the owning institutions, existing capital requirements will kick in and require adequate levels of capitalization. During the phase in period pro forma disclosure with full management explanations should be required so everyone can evaluate risk. The reason that a phase in period is necessary is because many banks and other financial services companies would be insolvent without time to recapitalize and repair their balance sheets.

The SEC, Federal Reserve, OCC, OTS and state banking regulators have the regulatory authority to immediately make this accounting change on call reports, including bank holding companies, and the SEC has the authority to require this for all public companies (by amending Rule S-X and Rule S-K). No additional legislation is necessary for this change to be enacted immediately.

FIX #3 - Direct regulation of large broker dealers by the Federal Reserve through amendment of Primary Dealer Agreements. All of the large US brokerage firms are primary dealers and have a “contractual relationship” with the Federal Reserve. It is important for the primary dealers to maintain their “special status”. In order to maintain their primary dealer status, all such firms need to adhere to certain capitalization and safety and soundness standards. Amending the primary dealer minimum standards will provide the Federal Reserve with the necessary oversight that they need to make sure that the large brokerage firms are adequately capitalized and don’t create systemic risk to the financial system.

Suggested modifications to the relationship between the Federal Reserve and the primary dealers include enhanced capital and operating requirements, adherence to safety and soundness requirements, enhanced disclosure requirements and consolidated capital requirements (i.e., including all affiliates of the broker dealer taken on a consolidated basis). Currently, brokerage firms have the option to not be primary dealers and the Federal Reserve can exclude any firm from being a primary dealer if it doesn’t comply with Federal Reserve requirements. But all of the large firms need to be primary dealers for valid business reasons and they will all comply with reasonable requirements to maintain that status. No additional legislation is necessary for this change to be enacted immediately.

FIX #4 - Fix mark to market accounting rules. The SEC has the ability to unilaterally and immediately fix the mark to market accounting rules by amending Rule S-X and Rule S-K.  Mark to market accounting rules need to be changed so that they don’t apply to investments where there isn’t a “market” (hence nothing to mark to).  And, the fantasy of marking liabilities to “market” as if they aren’t going to be repaid by the borrower is a ridiculous and dangerous application of what I believe is the worst accounting rule ever. No additional legislation is necessary for this change to be enacted immediately.

FIX #5 - Require all regulated entities and publicly traded companies to stop outsourcing their credit decisions to rating agencies. While ratings are a valuable tool that when properly used are extraordinarily important to the credit evaluation function, banks, brokerages and other regulated and/or public companies cannot continue to completely outsource their credit decisions to the rating agencies. Credit evaluation policies and procedures must be amended, disclosed and followed. No additional legislation is necessary for this change to be enacted immediately.

Sunshine’s Fixes rely on a common sense approach to application of regulatory authority that will have an immediate impact on investor confidence. Our financial markets don’t have to continue to be the global laughing stock and it is essential to our economy that we improve immediately.

How about if the regulators start this process now?

 Disclosure: None