I suppose things like this shouldn't surprise me anymore, but yet, I was shocked today when I saw this courtesy of the NY Sun:
The Securities and Exchange Commission can blame itself for the current crisis. That is the allegation being made by a former SEC official, Lee Pickard, who says a rule change in 2004 led to the failure of Lehman Brothers, Bear Stearns, and Merrill Lynch.
The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults.
Now I am not an economic genius by any stretch of the imagination, but I do have a business degree and did take a couple of semesters of economics. That said, I don't think it took an economic genius to figure out what might happen when you let these firms go from a debt-to-net capital ratio of 12 to 1 to a ratio of as high as 40 to 1. The SEC (which was actually following the lead of the similar body for the EU) claims the new rules actually provided BETTER oversight through the use of sophisticated computer models and closer monitoring by SEC staff. But I think the important point here is that things that were hard and fast rules before became more like guidelines.
More from the NY Sun article:
In addition to computerizing the risk calculations, the new program required time-consuming oversight of the broker dealers by SEC officials, and in many cases, the use of subjective judgment calls.
"An important component of the CSE program is the regular interaction of Commission staff with senior managers in the firm's own control functions, including risk management, treasury, financial controllers, and the internal auditor, as well as onsite testing to determine whether the firms are implementing robustly their documented controls," SEC chairman Christopher Cox testified in a hearing of the House Committee on Financial Services in July.
Well, I know lipstick on a pig is the popular aphorism these days, but if this isn't the wolf guarding the henhouse, I don't know what is. Even if you want to give people the benefit of the doubt, and assume that most of these people's motives were good, the second something goes from a rule to a guideline like this, you introduce so many more chances for failure. Maybe an over-zealous employee convinces the overseer to make one small exception for this one case. Maybe an overseer has a personal crisis and suddenly finds himself willing to take a payoff. Maybe (and this seems most likely in this administration) someone at the firm has friends in Washington who can have the overseer fired if he makes waves. Frankly, at this point, it doesn't matter. What does matter is that once again, the government let the people with the money change the rules in an effort to squeeze a few more bucks out of the system.
Oh, and if you think that maybe they've learned their lesson this time, let's pick this up from the end of the NY Sun article:
The SEC said it has no plans to re-examine the impact of the 2004 changes to the net capital rule, and last week, it put out a proposal to revise the rule once again. This time, it is looking to remove the requirement that broker dealers maintain a certain rating from the ratings agencies.
That's right, the SEC uses independent rating agencies to look at the condition of investment companies. And those companies are required to maintain a minimum rating with them. Hmmm, I wonder what might happen if THAT rule goes away...