October 1, 2009
On Tuesday September 29, H. David Kotz, Inspector General of the Securities and Exchange Commission, issued two reports, recommending 58 changes to improve the way the agency investigates and enforces violations of securities laws, as a result of the SEC’s failure to investigate the Bernie Madoff Ponzi scheme. The reports exposed a shocking degree of ineptitude at the SEC. On September 10, Mr. Kotz testified before the Senate Banking Committee. You can find the prepared testimony here. (I suggest starting at page 8.) Having read that testimony, I wasn’t too shocked at what Mr. Kotz had to say in Tuesday’s reports. Nevertheless, as Zachery Kouwe explained in The New York Times, the level of bureaucratic incompetence at the SEC was underestimated:
Many on Wall Street and in Washington were surprised that some of Mr. Kotz’s proposals, like recording interviews with witnesses and creating a database for tips and complaints, were not already part of the S.E.C.’s standard practice.
The extent of dysfunction at the SEC has been well-documented. Back on January 5, I wrote a piece entitled: “Clean-Up Time On Wall Street”, expressing my hope that the incoming Obama administration might initiate some serious financial reforms. I quoted from Steven Labaton’s New York Times report concerning other SEC scandals investigated by Mr. Kotz last year. My posting also included a quote from a Times piece by Michael Lewis (author of Liar’s Poker) and David Einhorn, which is particularly relevant to the recent disclosures by Inspector General Kotz:
Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become.
Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors.
This sentiment was echoed on Tuesday by Barry Ritholtz at The Big Picture website:
The agency is supposed to be an investor’s advocate, the chief law enforcement agency for the markets. But that has hardly been how they have been managed, funded and operated in recent years.
Essentially the largest prosecutor’s office in the country, the SEC has been undercut at every turn: Their staffing was far too small to handle their jurisdiction — Wall Street and public Corporations. Their budgets have been sliced, and they were unable to keep up with the explosion in corporate criminality. Many key positions were left unfilled, and morale was severely damaged. A series of disastrous SEC chairs were appointed — to be “kinder and gentler.” Not only did they fail to maintain SEC funding (via fines), but they allowed the worst corporate offenders to go unpunished.
Gee, go figure that under those circumstances, they sucked at their jobs.
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The bottom line of the SEC is this: If we are serious about corporate fraud, about violations of the SEC laws, about a level playing field, then we fund the agency adequately, hire enough lawyers to prosecute the crimes, and prevent Congress critters from interfering with the SEC doing its job.
To be blunt: So far, there is no evidence we are sincere about making the SEC a serious watchdog with teeth.
Congress sure hasn’t been. Staffing levels have been ignored, budgeting has been cut over the years. And it’s the sort of administrative issue that does not lend itself to bumper sticker aphorisms or tea party slogans.
Financial expert Janet Tavakoli explained in a presentation to the International Monetary Fund last week, that regulatory failures in the United States helped create an even larger Ponzi scam than the Madoff ruse — the massive racket involving the trading of residential mortgage-backed securities:
Wall Street disguised these toxic “investments” with new value-destroying securitizations and derivatives.
Meanwhile, collapsing mortgage lenders paid high dividends to shareholders (old investors) and interest on credit lines to Wall Street (old investors) with money raised from new investors in doomed securities. New money allowed Wall Street to temporarily hide losses and pay enormous bonuses. This is a classic Ponzi scheme.
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Had regulators done their jobs, they would have shut down Wall Street’s financial meth labs, and the Ponzi scheme would have quickly choked to death from lack of monetary oxygen.
After the Savings and Loan crisis of the late 1980’s, there were more than 1,000 felony indictments of senior officers. Recent fraud is much more widespread and costly. The consequences are much greater. Congress needs to fund investigations. Regulators need to get tough on crime.
As Simon Johnson and James Kwak explained in The Washington Post, the upcoming battle over financial reform will be hard-fought by the banking industry and its lobbyists:
The next couple of months will be crucial in determining the shape of the financial system for decades to come. And so far, the signs are not encouraging.
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Even back in April, the industry was able to kill Obama’s request for legislation allowing bankruptcy judges to modify mortgages. Five months of profits later, the big banks are only stronger. Is Obama up for this fight?
Our new President must know by now, that sinking a three-point shot is much easier than the juggling act he has undertaken with health care reform, the wars in Iraq and Afghanistan as well as his recent quest to help Chicago win the bid for the 2016 Olympics. If Mr. Obama can’t beat the health insurance lobby with both the Senate and Congress under Democratic control — how will the voters feel if he drops another ball in the fight for financial reform? Thanks to Harry Truman, the American public knows where “the buck stops”. The previously-quoted Washington Post commentary looked even further back in history to explain this burden of leadership:
During the reign of Louis XIV, when the common people complained of some oppressive government policy, they would say, “If only the king knew . . . .” Occasionally people will make similar statements about Barack Obama, blaming the policies they don’t like on his lieutenants.
But Barack Obama, like Louis XIV before him, knows exactly what is going on. Now is the time for him to show what his priorities are and how hard he is willing to fight for them. Elections have consequences, people used to say. This election brought in a popular Democratic president with reasonably large majorities in both houses of Congress. The financial crisis exposed the worst side of the financial services industry to the bright light of day. If we cannot get meaningful financial regulatory reform this year, we can’t blame it all on the banking lobby.
Let the games begin!
Simon Johnson In The Spotlight
October 12, 2009
An ever-increasing number of people are paying close attention to a gentleman named Simon Johnson. Mr. Johnson, a former chief economist at the International Monetary Fund, now works at MIT as Professor of Entrepreneurship at the Sloan School of Management. His Baseline Scenario website is focused on the financial and economic crises. At the Washington Post website, he runs a blog with James Kwak called The Hearing. Last spring, Johnson turned more than a few heads with his article from the May 2009 issue of The Atlantic, “The Quiet Coup”, in which he explained that what happened in America during last year’s financial crisis and what is currently happening with our economic predicament is “shockingly reminiscent” of events experienced during financial crises in emerging market nations (i.e. banana republics and proto-capitalist regimes).
On October 9, Joe Nocera of The New York Times began his column by asking Professor Johnson what he thought the Wall Street banks owed America after receiving trillions of dollars in bailouts. Johnson’s response turned to Wednesday’s upcoming fight before the House Financial Services Committee concerning the financial reforms proposed by the Obama administration:
This week’s battle over financial reform has been brewing for quite a while. Back on May 31, Gretchen Morgenson and Dan Van Natta wrote a piece for The New York Times entitled, “In Crisis, Banks Dig In for Fight Against Rules”:
In case you might be looking for a handy scorecard to see which members of Congress are being “lobbied” by the financial industry and to what extent those palms are being greased, The Wall Street Journal was kind enough to provide us with an interactive chart. Just slide the cursor next to the name of any member of the House Financial Services Committee and you will be able to see how much generosity that member received just during the first quarter of 2009 from an entity to be affected by this legislation. The bars next to the committee members’ names are color-coded, with different colors used to identify specific sources, whose names are displayed as you pass over that section of the bar. This thing is a wonderful invention. I call it “The Graft Graph”.
On October 9, Simon Johnson appeared with Representative Marcy Kaptur (D – Ohio) on the PBS program, Bill Moyers Journal. At one point during the interview, Professor Johnson expressed grave doubts about our government’s ability to implement financial reform:
Sound familiar? If you change the topic to healthcare reform, you end up with the same bottom line: “These reforms will turn out to be essentially meaningless.” The inevitable watering down of both legislative efforts can be blamed on weak, compromised leadership. It’s one thing to make grand promises on the campaign trail — yet quite another to look a lobbyist in the eye and say: “Thanks, but no thanks.” Toward the end of the televised interview, Bill Moyers had this exchange with Representative Kaptur:
As we all know, our system of legalized graft goes beyond the halls of Congress. During his Presidential campaign, Barack Obama received nearly $995,000 in contributions from the people at Goldman Sachs. The gang at 85 Broad Street is obviously getting its money’s worth.