An Example of Lax Oversight in a Free Market

Back in 2004 large investment banks went to the SEC because they were being pressured by the European Union to open their books to either the EU or the SEC. The banks chose the SEC. However, the SEC did not have the authority to oversee the parent company of these large banks, they could only monitor their broker/dealer subsidiaries. A deal was made. The banks would allow the SEC to examine their books. In return, the banks would be allowed greater leverage of their capital. Before this change, the debt-to-equity ratio was maxed out at 12-to-1. After the change, it seemed that the sky was the limit, ratios of 35-40-to-1 became common. So, you had banks using borrowed money to ‘invest’ in low quality mortgages and the 21st century CDO, CDS and other types of securities.

Need I say that Congress said nothing about this fundamental change in the rules of the game? Nor did Congress do anything when HUD changed its rules to make it easier for the predatory practices of some mortgage brokers. And Congress was silent when the Comptroller of the Currency prevented states from enforcing state laws against predatory lending.

But back to the SEC. Did it ever really look at the books of these large investment banks? Not in a very serious fashion. As Stephen Labaton reports in the NY Times, “The commission assigned seven people to examine the parent companies — which last year controlled financial empires with combined assets of more than $4 trillion. Since March 2007, the office has not had a director. And as of last month, the office had not completed a single inspection since it was reshuffled by Mr. Cox more than a year and a half ago. The few problems the examiners preliminarily uncovered about the riskiness of the firms’ investments and their increased reliance on debt — clear signs of trouble — were all but ignored.”

Maybe McCain had something when he called for firing Cox. Here’s a guy who’s been on the side of the investment banks since his days as a Congressman. Again quoting Labaton, “Under Mr. Cox, the commission responded to complaints by some businesses by making it more difficult for the enforcement staff to investigate and bring cases against companies. The commission has repeatedly reversed or reduced proposed settlements that companies had tentatively agreed upon. While the number of enforcement cases has risen, the number of cases involving significant players or large amounts of money has declined.

Mr. Cox dismantled a risk management office created by Mr. Donaldson that was assigned to watch for future problems. While other financial regulatory agencies criticized a blueprint by Mr. Paulson, the Treasury secretary, that proposed to reduce their stature — and that of the S.E.C. — Mr. Cox did not challenge the plan, leaving it to three former Democratic and Republican commission chairmen to complain that the blueprint would neuter the agency.”

I'm sure similar tales of an abandonment of one's responsibilities by our leaders and their appointees will surface.