The SEC and the Financial Crisis

1
The SEC and the Financial Crisis

• University of Wisconsin-Madison
• Center for World Affairs and the Global Economy
• March 25, 2009
• _________________________________
• Darian M. Ibrahim
• Assistant Professor of Law
• University of Wisconsin Law School

2
Overview

• Why talk about the Securities and Exchange
  Commission?
• Untold Story
• Most Attention on Treasury Department/Federal
  Reserve
• Exception John McCain Fire Christopher Cox!
• Important Story
• SEC Regulates Investment Banks
• Investment Banks key players in subprime
  securitizations and CDS/derivatives markets
• Plan of Attack
• Examine SECs past, present, and future
• Past and present will focus on SECs origins and
  purposes, culpability for current mess
• Future will put SEC in context of broader U.S.
  financial regulatory structure

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SECs PastOrigins Purposes

• Origins of SEC
• Great Depression Swindlers selling worthless
  stock
• SEC Administrative Agency created after Great
  Depression as part of FDRs New Deal
• Administers 1933 Securities Act (offerings of
  securities) 1934 Exchange Act (ongoing
  obligations for public companies)
• Disclosure philosophy (Sunlight is best
  disinfectant)
• Purposes of SEC
• To protect investors by eliminating fraud
• Eliminate fraud by requiring truthful disclosure,
  enforcing
• Is it Working?
• U.S. has been global financial leader
• Still some spectacular failings (Enron, WorldCom,
  Madoff)

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SECs PresentThe Current Financial Crisis Is
the SEC to blame?

• Arguments that SEC is culpable
• Oversight over Investment Banks (Big Five Bear
  Stearns, Lehman Brothers, Merrill Lynch, Goldman
  Sachs, Morgan Stanley)
• Investment Banks Way Overleveraged, SEC allowed
  it
• Prudence D/E Ratio of 1
• Pre-2004 Hard Net Capital Rules (D/E Ratio of
  15)
• 2004 Hard Net Capital Rules (D/E Ratio of 15)
  ? Soft Internal Risk Models (D/E Ratios of 30)
• Result More Purchases of Toxic Assets Less
  Ability to Cover Losses ? Failures ? Domino/Chain
  Reaction effect
• Arguments that SEC is not culpable
• Designed to deal with fraud, not chain reactions
  (systemic risk)

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SECs FutureWill it Survive?

• Challenges from the Current Crisis
• Focus going forward on systemic risk, not fraud
• Wither the Investment Bank

• Lehman Brothers

• Bear Stearns ?
• Merrill Lynch ?

JPMorgan Chase (Fed) Bank of America (Fed)

• Goldman Sachs ?
• Morgan Stanley ?

Bank Holding Company (Fed) Bank Holding Company
(Fed)

• Challenges even before Current Crisis
• Competitive Global Markets, SEC Regulation Too
  Costly
• Treasurys 3/08 Blueprint for Financial
  Regulatory Reform
• Twin Peaks model of financial regulator
  (systemic risk oversight under Fed, all types of
  investor/consumer protection under new business
  conduct regulator)

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U.S. Financial Regulatory StructureShould we
move to Twin Peaks or a Single Regulator?

• Current Structure Separate Regulators by
  Industry
• Securities/Futures SEC, CFTC
• Banking Federal Reserve (OCC, FDIC, OTS)
• Insurance States
• Swaps (including credit default swaps) No One
  (Congress, 2000)
• Should U.S. Consolidate its Regulators?
• Arguments For
• Other Countries Doing It (UK single regulator,
  Australia twin peaks)
• Industries are Consolidating (e.g. Citigroup
  Banking Insurance)
• Economies of Scale/Efficiency Gains (adaptive
  capacity)
• Arguments Against
• Political Impediments Make Unrealistic
• Loss of Sector-Specific Expertise