Real Fin Reform

So much of the debate has become dominated in populist clap trap measures (looking at you Huff Post), that an idea this sound doesn't get much audience.

From Barry Ritholtz:

While researching Bailout Nation, I did discover one group of Wall Street firms whose senior management took a very measured approach to managing risk. They managed to engage in risk taking and speculation in a fashion that was responsible, and avoided trouble.

The group? Wall Street partnerships.

There is a simple explanation for this: Unlike corporations, Partners have “joint and several liability.” Every partner is fully liable, up to the full amount of the relevant obligation, for the actions of every other partner. This has the effect of focusing the minds of management on exactly what the worst case scenario of their behavior can wreak. Imagine if a partnership like Lazard Freres (since gone public) or Brown Brothers Harriman embraced risk the way their publicly traded brethren did. The liabilities form the losses falls first tot he partnership. Once those assets are exhausted, the creditors can proceed to recover losses from the personal assets of every partner. Bank accounts, Houses, boats, vacation property, 401ks, cars, jewelery, watches, etc. are all fair game for creditors.

The obvious problem is how to encourage banks to move to this model? Merely mandating that any bank (define as you like) become a partnership of some sort runs into any number of problems, not the least of which is the inefficiency of cutting them off from equity financing. But perhaps there could be a new legal structure whereby a partnership could sell a minority stake as equity on to the market. This would allow the financial flexibility of equity without the agency problem inherent in risk allocation with what amounts to other people's money.

Presumably the cost of financing for a bank with this new hybrid structure would be lower. If it wasn't constructed so, then what is the point? The hope is that such an advantage would essentially drive several firms to to this model so as fund themselves more cheaply.

Someone smarter than me can punch holes in that, but for now it's a start.