The SEC Fiddled While Rome Burned (Part 1 of 3)
Part 1 of 3.
In 2004, the Securities & Exchange Commission made a decision that doomed our economy to failure. In a meeting lasting less than an hour on April 28, 2004, the agency approved of a rule that let the country’s five largest investment banks–including Bear Sterns, Lehman Brothers, and Merrill Lynch–stack huge debt loads on relatively tiny asset bases. It was the rope that the banks eventually hanged themselves with. And word has it that, while the Commissioners unanimously voted in favor of the rule, the tension in the air on that April morning was palpable. “I’ll keep my fingers crossed for the future,” said Commissioner Roel C. Campos, a former federal prosecutor and owner of a small radio broadcasting company in Houston.
Commissioner Campos’s words pretty much sum up the conduct of the SEC, purportedly the nation’s Wall Street watchdog, in the Bush years. In decision after decision, the agency erred on the side of Big Finance and then just kept its fingers crossed for the future.
Perhaps the SEC was essentially powerless to do anything else. As Bernie Madoff whistle-blower Harry Markopolos later testified, scant few, if any, at the SEC had even a basic knowledge of how the financial markets were operating and expanding. The main problem, according to Markopolos, was not that the SEC did not know how, or did not want, to regulate. It’s that they did not know what they were regulating.
As well, what does a supposed regulator do when his/her boss, George W. Bush, is a fervent deregulator? That was the question that Chairman Christopher Cox must have asked himself during his tenure from 2005 to 2009. All too often the answer for Cox was not much, especially when it came to large established financial institutions.
So where did the SEC go wrong? And can it get back on course as an effective cop on the beat?
The SEC is a creature of the New Deal. Founded in 1934, the agency was set up for the purpose of policing Wall Street and the securities markets after the excesses, foul play and rampant speculation of the 1920s led to the crash of 1929 and, ultimately, the Great Depression. In what was seen as a puzzling move at the time, FDR appointed Joseph P. Kennedy as the first SEC chairman. Kennedy had been a speculator in the 1920s, making a fortune trading on inside information (which was not illegal at the time) and otherwise exploiting the informational asymmetries that were present during this period. Kennedy had impeccable timing, however, and got out before the crash of 1929 with minimal damage, purchasing a Hollywood film company for a song, and then later profiting hugely on a prediction that Prohibition would be repealed. In truth, there was not too much daylight between Kennedy and the infamous “robber barons” that became the object of public scorn in the 1930s, blamed for precipitating the Great Depression. But Kennedy was a little smarter and a lot nimbler, which may have been why FDR singled him out.
It an of-quoted story, when FDR was asked why he appointed a former stock speculator as chairman of the SEC, Roosevelt said, “Takes a thief to catch a thief.” Roosevelt may have been right. Though he served a short tenure, Kennedy proved to be an exceptionally effective chairman, ushering in substantial reform and regaining the trust of the investing public. The conventional explanation for his effectiveness squared with FDR’s initial estimation: Kennedy had substantial experience in the markets and knew, perhaps too well, where the weak spots were.
The securities markets faced by Joe Kennedy in 1934, however, were small potatoes compared to the emerging financial networks of the 1980s and beyond. The complexities of derivatives, globalization, and the rise of labyrinthine, too-big-to-fail financial super-markets such as AIG and Citi Group, have all contributed to an increasingly opaque affair in which regulators, if they don’t do their homework, can easily lose their bearings.
It seems that with each passing day there’s a new headline about how the SEC has dropped the ball in recent years. Most recently, the SEC stands accused of failing to sniff out leads with respect to the Stanford Group, now alleged to have engaged in a global fraud scheme. In 2007, the agency found that Stanford did not have adequate capital to meet the requirements of being a broker-dealer. “A net capital violation is a major, major, major red flag,” says Greg LaRoche of LaRoche Research in Providence, R.I., who has examined 5,000 broker-dealers in the United States, fewer than 50 of which fell below the net capital requirements. “Generally when a firm has a net capital violation, it’s already on the brink of bankruptcy,” he said. “When you look at all of these things together, this is really serious. Either the firm is in big financial trouble, or it’s hugely incompetent. Neither one is good.”
Later in 2007, the Stanford Group was censured for providing “misleading, unfair and unbalanced information” about its certificates of deposit. Still, despite the seriousness of the firm’s misconduct, the SEC, rather than investigate further, merely imposed paltry fines in both these cases and then promptly closed the files. Whether this has anything to do with the mountains of cash sent to Washington by the firm’s chief, flamboyant billionaire Robert Allen Stanford, in attempts to curry political favor, is yet to be seen.
Yet perhaps the most glaring example of the SEC’s dereliction of duty is the Bernie Madoff case, since there were so many warning signs, dating back decades, that the SEC inexplicably refused to pursue.
(Stay tuned for Part 2)
Comments
Trackbacks