An industry group representing Wall Street's biggest banks is proposing a wide-ranging set of reforms to make debt markets and financial institutions more resilient in the wake of the yearlong credit meltdown.

The group, co-chaired by Gerald Corrigan, a Goldman Sachs Group Inc. managing director and former president of the Federal Reserve Bank of New York, laid out 60 proposals in all in a report totaling more than 138 pages.

It recommended that banks be forced to account for more assets on their balance sheets, face tougher standards for selling complex debt instruments, accelerate reforms of the credit default swap market and implement tougher standards for managing their own risk and liquidity.

In an interview, Corrigan described the proposals as "a significant raising of the bar" for Wall Street. But it isn't clear to what extent the proposals will be adopted by banks and brokers.

The group, called the Counterparty Risk Management Policy Group, included representatives from nearly every big U.S. bank and broker. It has issued reports in past years — most notably one in 2005 — that weren't fully embraced by Wall Street.

The 2005 report included warnings about the workings of the collateralized debt obligation market, which subsequently experienced a boom and bust that has cost Wall Street hundreds of billions of dollars in write-downs and losses.

Corrigan said the latest report will cost financial institutions substantial sums to implement at a time when their profits are being squeezed. But the push for reform now, from the public and regulators shaken by the credit meltdown, is as intense as it has been for many years.

"Quite a few things went wrong in the last 12 months," Corrigan said, adding there was a need to "step back and aggressively think" about reform. The financial sector's losses and write-offs from the credit crisis are approaching $500 billion, and more losses are expected.

The area that seems ripest for change is the credit default swap market, where firms buy and sell derivative contracts that pay off if bonds or loans default. The market has exploded in size in recent years, and played a role in the collapse of Bear Stearns Cos., which was a counterparty on many of these trades. Regulators feared Bear's failure could send shockwaves through the markets and lead to losses for many financial institutions and investors, one reason they engineered a rescue by JPMorgan Chase & Co.

Regulators are pushing companies to match and confirm their swap trades electronically the same day the trades are made, a goal they hope will be met by the end of 2009 and which the Wall Street group endorsed. This will help ensure that financial institutions have up-to-date electronic records of their positions and exposures to other firms, and prevent the build-up of a backlog of unconfirmed trades.

The group also recommends an approach that determines how swap positions would be closed when a counterparty defaults. In such events, the group wants holders of the swaps on the other side of these trades to terminate all of their outstanding derivative contracts with the defaulting counterparty for a one-time payment amount. Some hedge funds have resisted this proposal. Only one hedge fund was represented on the group.

The group also broached a touchy subject on Wall Street — compensation. While it stopped short of formally recommending changes to the way that companies pay their executives, it did urge firms to weight their pay toward long-term stock incentives (as opposed to cash payouts) and that executives be rewarded for performance of the whole company, rather than individual units.

"It is likely that flaws in the design and workings of the systems of incentives within the financial sector have inadvertently produced patterns of behavior and allocations of resources that are not always consistent with the basic goal of financial stability," the report said.

Other recommendations included:

  • A call for regulators to formally meet with boards of directors of companies at least once a year;
  • Tougher accounting rules that would require many off-balance sheet credit vehicles to be counted as on-balance-sheet by financial firms;
  • Tougher stress tests for measuring firms' liquidity.

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