Centre for Economic Policy Research

Session 4: Remedies
Karen Johnson 
Federal Reserve Board
Karen Johnson was very much in agreement with the basic approach and 
conclusions of the Report, despite the fact that she differed in some instances with
particular points or recommendations. She agreed with the fundamental point
that a market solution to the conflict of interest problem should be preferred.
Examining a variety of experiences, both failed and successful ones, would seem
to be a fruitful approach to assessing the relative merits of the alternative 
remedies. Such a comparative review is not developed in the Report. In order to
come to conclusions with respect to remedies, it is necessary first to judge the 
relative seriousness of the different elements of the problems caused by a 
potential conflict of interest. The cure should not turn out to be worse than the
disease. In that context it is necessary to step back from the problems of the 
financial sector and take a broader perspective.
Clearly the Report cannot address all aspects of conflicts of interest. Still, it is
worthwhile remembering that conflicts of interest and principal-agent problems
exist throughout the corporate world – both financial and non-financial. It 
cannot be expected that solutions to conflicts of interest will provide general 
solutions to corporate governance. This is especially true with respect to the issue
of audit firms. Johnson thought that it would be a mistake to approach reform of
the incentives facing audit firms as if they were to be the policemen bringing
malfeasance in corporate management under control. The Sarbanes-Oxley
approach is correct in addressing the behaviour of both financial and non-
financial corporations and putting responsibility for truthful reporting squarely at
the highest level of management. The Sarbanes-Oxley Act should be judged from
the broad corporate governance perspective. Success within the financial sector
may depend on resolving problems in the non-financial sector.
The Report very correctly emphasizes the importance of transparency and thus
the potential benefit of regulation that promotes transparency. Transparency by
itself, however, will not achieve very much. Indeed ‘leave it to the market’ and
‘regulate for transparency’ should be combined into one strategy. Public policy to
promote transparency is not needed for the really big players to make good 
decisions. The Report provides several examples of markets achieving the right
balance, such as underwriting in the United States before the Great Depression
where the large firms saw their own interests clearly. At least in the United States,
most regulation with respect to transparency is for consumer protection. This is
why regulations must forcefully meet the needs of smaller, individual investors.
Open publication of the record of analysts’ recommendations judged against 
outcomes might be one way to alert them to possible biases by particular analysts
and firms.
Johnson differed from the Report on the question of rating agencies, 
particularly with respect to structured finance. It is a complicated, changing area
of financial innovation and practice. Involving the raters in the structuring of a