This is a piece of investigative journalism by Reuters' Charles Levinson that the Banking industry and the SEC would really prefer that Americans just ignore. And they'll probably get their wish. Few in Middle America will will spend their Sunday morning coffee-sipping time reading this. It will never make the "featured article" on any search engine's news web site, competing next to "Eleven Movies With Bad Endings" or the most recent incident of police misconduct caught on a cell-phone camera.
Financial regulation doesn't lend itself to Americans' distressed attention spans. It's dry and complicated--its subject matter too esoteric and just plain boring for ordinary Americans to take the time out of their daily grind to try to decipher, and that's exactly the way the industry likes it. Opacity is their friend. But the Reuters article really tells you most of what you need to know why efforts to rein in the banks, hedge funds and other financial institutions following the financial crisis of 2008 were doomed from the start, will continue to be largely for show, and are already setting the stage for another crisis which may turn out to be as big and devastating as the last one.
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Keith Higgins is one smart lawyer. He was the Chair of the ABA Committee on Securities Regulation and a partner at Ropes and Gray, representing corporate clients in mergers, acquisitions, compliance, offerings and governance, to name just a few of his talents. So when the Financial Crisis hit and it looked like the Banks were facing some tough new rules on disclosing the same potentially toxic asset-backed securities and financial instruments that had crashed the economy and turned Henry Paulsen and George W. Bush ashen-gray with fear, he spent a lot of his time sending letters to the SEC, and they listened to him. His mantra--the Banks could do no wrong:
In letters to the Securities and Exchange Commission, Higgins argued that divulging more details about the mortgages and other financial products that go into such securities would only confuse investors. And it was investors, with “insufficient understanding and … commitment” to their investments, who had been the real cause of the crisis, he argued in a July 2008 letter.
Higgins did more than write letters. The American Bar Association played an important role in the SEC's decision-making, as Banks rely on corporate counsel to oppose Rulemaking that could infringe on their profits. The ABA Division Higgins chaired was dominated by former SEC lawyers and essentially acted as a proxy for the banks with regard to any pending rulemaking on the Disclosure issue (Reg AB II):
Banks were helped by a particularly vocal and effective advocate: the American Bar Association. The ABA’s Committee on the Federal Regulation of Securities – that’s the committee with four former SEC employees – wrote 94 comment letters to the SEC and other regulators after the crisis, making it one of the most prolific commenters on SEC rules. Nearly all of the comments parroted letters from banks and financial industry lobbyists.
Higgins, chair of the committee when the SEC started drafting Reg AB II, personally signed 46 of the letters.
Asset-backed securities (such as the same type of collateralized debt obligations --and "credit default swaps"--that were bundled into toxic securities to cause the financial crisis) are particularly attractive to Banks because they eliminate the need for a bank to build up capital reserves:
Every additional dollar in assets on a bank’s balance sheet requires holding more idle cash in capital reserves to cover those assets if they drop in value. The increase in reserves means less revenue and earning power and smaller employee bonuses.
Off-balance-sheet vehicles free banks to make more loans and build assets without having to add to capital reserves. These assets include all sorts of things: Treasury securities, home and commercial real estate mortgages, auto loans, even “junk” loans used to finance leveraged buyouts. Banks bundle the assets into securities, sell the securities to investors, and then park the assets in separately incorporated off-balance-sheet vehicles.
The great Financial Crisis of 2008 left no doubt that the "sophisticated investors" to whom such contrivances were sold with little or no formal disclosure process regarding their content were really not so sophisticated after all, particularly in the private, largely unregulated "off-the books" market. So after the calamity of 2007-2008 when such assets drastically lost value, prompting the Banks to rush in to bail these assets out (and wrecking the U.S. and global economy in the process), such securities were targeted by Federal regulators and Dodd-Frank specifically for more disclosure, on the theory that people would be more circumspect if they knew the risk of what they were buying, and banks would have a greater degree of responsibility for those instruments. The Rule being drafted was known as "Reg AB II".
As of 2013, though, the woefully underfunded SEC was still hammering out that same Disclosure Rule probably on their vintage cathode-ray PC's. They needed some help. So who did they get to lead the 500 overworked SEC guys in drafting Reg AB II?
You guessed it:
Washington, D.C., May 15, 2013 —
The Securities and Exchange Commission today named Keith F. Higgins as the new director of the agency’s Division of Corporation Finance.
The Division of Corporate Finance of the SEC is tasked with "ensur[ing]e that investors are provided with material information in order to make informed investment decisions, both when a company initially offers its securities to the public and on an ongoing basis."
Keith's resume was impeccable:
“Keith is a widely-respected expert on the securities laws with a wealth of knowledge and experience in the many issues confronting the Division,” said Mary Jo White, Chair of the SEC. “He understands and appreciates the importance of our disclosure laws in helping to ensure that investors get the information they need to make informed investment decisions.
Unfortunately his "understanding and appreciation" of the importance of disclosure laws turned out to be, apparently, the same "understanding and appreciation" that his former clients had demonstrated and that he himself had championed while in private practice.
When the final version of Reg AB II came out last year, disclosure rules advocated by many within the agency had been stripped out. Of particular concern: Banks could continue to sell asset-backed securities to institutional investors on the private market with no new disclosure requirements.
The SEC can be a stepping stone to white-shoe firms for some, but the prime MBA and Securities legal talent bypasses the government and goes into the private sector, where they're paid far, far more. The agency can't afford to hire the best and brightest from Harvard, so they naturally genuflect when talent such as Higgins' appears to save the day. As
Reuters' investigation, also published in
Pro-Publica, points out, the percentage of Financial services veterans on the Federal Accounting Standards Board (FASB), which sets accounting standards for public companies, went from 0% to 25% between 1993 and 2006 (the article also describes how the efforts of Robert Herz, former Chairman of the FASB, advocating for tougher accounting rules before the Financial Crisis, were stymied and evaded by the financial industry to the point where Herz was essentially forced out in 2010, only to see his successor handpicked by the industry).
The SEC claims that the decision regarding Reg AB II was made before Higgins' tenure at the agency and that he was not personally responsible for the decision. For purposes of understanding the fallout from the symbiotic, perpetually revolving-door relationship between the SEC and the financial industry, whether he personally signed off on the Final reg it would seem to be irrelevant. He signed 46 letters to the SEC seeking to curb it and was clearly influential in its drafting. He was then put in charge of its issuance and implementation. Higgins was tapped by SEC Chairwoman Mary Jo White. White's husband was a partner at one of the country's top law firms, Cravath Swaine and Moore:
Higgins was close to White’s husband, John White, a partner at Cravath, Swaine & Moore LLP who had himself chaired the SEC division when Higgins was head of the ABA committee, according to people who know both men.
So while Higgins was writing letters to his friend Mr. White of the SEC urging the abandonment or wholesale watering down of disclosure provisions regarding asset-backed securities, Mrs White was angling for the top job at the SEC. One month after she succeeded to the SEC throne, she tapped Higgins to lead the issuance of the very Rules he had opposed.
Hey, it's an intimate club.
While the market for asset backed securities is today is not comparable to what existed before the crisis, the regulatory framework (or lack thereof) that caused the crisis in the first place has essentially survived unscathed, due to the lobbying efforts of the banks and their incestuous relationship with the SEC and FASB. Nor is the problem limited to the banks, as hedge funds and private equity funds have resumed their off-the-books dealings with comparable ferocity.
The result has been predictable, Despite the support of SEC staff and the ratings agencies, despite the support of investors who want more Disclosure of off-the-books financial instruments, the SEC's Rulemaking has since ground to a halt and there are virtually no new Disclosure rules regarding the same type of asset-backed securities whose implosion caused the Financial Crisis to begin with:
On August 27 last year, 52 months after the original draft proposal of Reg AB II was floated, the SEC adopted the final version. The 683-page rule detailed a raft of new disclosure requirements for asset-backed securities - but only for those registered with the SEC for general offer to the public. For the same securities sold on the private market, disclosure requirements remained scant.
As a result, the Banks are pouring more and more into such investments:
“What’s playing out is exactly what we were worried about,” said Sheila Bair, former chairwoman of the Federal Deposit Insurance Corp. “Most everything is going into these private markets where regulations require little visibility of what’s happening.”
With their access to off-balance-sheet entities largely preserved, the banks continue to hold vast sums of securitized loans offshore and off their books. Together, JPMorgan Chase & Co, Bank of America Corp, Citigroup, Wells Fargo & Co, Goldman Sachs Group Inc and Morgan Stanley hold nearly $3.3 trillion of securitized loans in off-balance-sheet entities.
Meanwhile the average bonus for
all Wall Street employees jumped 15% in 2013 to
$164,000, their highest level since the Financial Crisis.