SEC allows investment banks to go unregulated

Introduction

The Securities and Exchange Commission’s (SEC) laissez-faire attitude toward regulation of investment banks is widely believed to have contributed to the depth of the current economic crisis. That the SEC was asleep at the switch was on clear display in March, when its chairman, Christopher Cox, declared he felt “a good deal of comfort” about investment banks’ capital cushions. Just three days later, Bear Stearns collapsed and was bought by JP Morgan Chase in a hastily arranged deal backed by $29 billion in taxpayer funds. The sale of Bear Stearns, one of the first rumbles in the financial earthquake, was presaged by a 2004 SEC decision that loosened capital rules and allowed brokerage units to take on greater debt. Since then, investment firms’ debt-to-assets ratios have risen — in Bear Stearns’ case, to as high as 33 to 1. Simultaneously in 2004, the SEC began outsourcing risk monitoring responsibilities to the banks themselves, while assigning only seven staffers to oversee the five largest investment houses, which controlled more than $4 trillion in assets. Despite the companies’ vanishing cushion against investment losses, the SEC did nothing in the case of Bear Stearns to address the bank’s issues of heightened risk. As an SEC inspector general’s report put it in September, it is “undisputable” that the SEC “failed to carry out its mission” in that case. The public has ended up footing much of the bill.

Follow-up:
SEC Chairman Cox, Federal Reserve Chairman Ben Bernanke, and Treasury Secretary Henry Paulson have all acknowledged recent regulatory failures. In September, prompted by the onset of the worst financial crisis since the Great Depression, Cox dismantled the 2004 program that permitted self-monitoring among firms. An SEC spokesman noted that in October Cox told Congress, “We have learned that voluntary regulation does not work.” Further, the SEC’s oversight responsibilities now largely shift to the Federal Reserve, though the commission continues to oversee investment banks’ brokerage units. Recommendations by the SEC inspector general for tighter limits on borrowing and risky investing practices are also being considered.