Let's just leave aside for now who is sorting out the 'financial meltdown' and the lack of penetrating questions about this (I hadn't seen that actual term, financial meltdown, used in the IHT in a headline until an Opinion piece in Friday's paper btw!!), namely an ex-Goldman Sachs chief who got us into this mess (that's him up there - yes, I know you know that, so why do the IHT keep running boring pictures of men in suits whose faces we already know? Another question...)What blew me away from the article below, which could have been given the entire front page, was the fact that the absolutely key SEC meeting back in 2004 that got us into this thing - that the IHT now, only now, dares to refer to as a financial meltdown - was NOT attended by anyone from the MSM, INCLUDING THE NYT.(What did get most of the IHT front page on Friday was the fighting in Pakistan; again, for anyone who follows my blog A Place in the Auvergne check out the labels Afghanistan/Pakistan and Financial Meltdown to see when I first started using those labels, when I first made the fighting in Pakistan my lead daily story and where the NYT story sits in the news cycle).In fact a software engineer from Indiana was more on the ball about the implications of this meeting for investment banks,the credit markets and the global financial system than the entire journalistic might of the NYT, WSJ, FT etc etc etc.And why this pretty damning admission was buried in the 19th para is another very good question as it is extremely newsworthy in and of itself. So this is a double fault for me: being 4 years behind the news curve, and then not making that fact itself the front of the news curve.Hello Newspaper 1.0: it's no point telling us about this meeting now, interesting as it may be for historians, whom I'm sure will do a better job of putting the past together than the IHT/NYT. What we want - given that you know when these types of hearings are going to take place - is to have people smart enough to understand the possible implications and report on it, before the meeting takes place, not four years later.U.S. regulator's 2004 rule let banks pile up new debt
By Stephen Labaton
Friday, October 3, 2008
"We have a good deal of comfort about the capital cushions at these firms at the moment."
- Christopher Cox, chairman of the U.S. Securities and Exchange Commission, March 11, 2008.
As rumors swirled in March that Bear Stearns faced imminent collapse, Christopher Cox was told by his staff that Bear Stearns had $17 billion in cash and other assets - more than enough to weather the storm.
Drained of most of that cash three days later, Bear Stearns was pushed into a hastily arranged merger with JPMorgan Chase - backed by a $29 billion dowry of taxpayers' money.
Within six months, other lions of Wall Street would also either disappear or transform themselves to survive the financial maelstrom - Merrill Lynch sold itself to Bank of America, Lehman Brothers filed for bankruptcy protection, and Goldman Sachs and Morgan Stanley converted themselves into commercial banks.
How could Cox have been so wrong?
Many events in Washington, on Wall Street and elsewhere around the United States have led to what has been called the most serious financial crisis since the 1930s.
But decisions made at a brief meeting on April 28, 2004, explain why the problems could spin out of control. The Securities and Exchange Commission's failure to follow through on those decisions also explains why regulators did not see what was coming.
On that bright spring afternoon, the five members of the SEC met in a basement hearing room to consider an urgent plea by the big investment banks. They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast growing but opaque world of mortgage-backed securities, credit derivatives - a form of insurance for bond holders - and other exotic instruments.
Five investment banks led the charge, including Goldman Sachs, then headed by Henry Paulson Jr. Two years later, he left Goldman to become the U.S. Treasury secretary.
A lone dissenter - a software consultant and expert on risk management - weighed in from Valparaiso, Indiana, with a two-page letter to warn the commission that the change would be a grave mistake. He never heard back from Washington.
One commissioner questioned the staff about the consequences of the proposed exemption. It would only be available for the largest companies, he was reassuringly told - those with assets greater than $5 billion. "We've said these are the big guys," said one commissioner, Harvey Goldschmid, provoking nervous laughter, "but that means if anything goes wrong, it's going to be an awfully big mess."
Goldschmid, an authority on securities law from Columbia University in New York, was a behind-the-scenes adviser in 2002 to Senator Paul Sarbanes when he rewrote U.S. corporate laws after a wave of accounting scandals.
"Do we feel secure if there are these drops in capital we really will have investor protection?" Goldschmid asked.
A senior staff member said the commission would be hiring the best minds, including people with strong quantitative skills, to parse the banks' balance sheets. Annette Nazareth, the head of market regulation, reassured the commission that under the new rules, the companies for the first time could be restricted by the SEC from excessively risky activity.
"I'm very happy to support it," said Commissioner Roel Campos, a former U.S. government prosecutor and owner of a small radio broadcasting firm in Houston who then deadpanned: "And I keep my fingers crossed for the future."
The proceeding was sparsely attended - none of the major media outlets, including The New York Times, covered it.
After 55 minutes of discussion, which can be heard on the Web sites of the agency and The Times and its international edition, the International Herald Tribune, William Donaldson, then the SEC chairman and a veteran Wall Street executive, called for a vote. It was unanimous. The decision, changing what was known as the net capital rule, was completed and published in the Federal Register a few months later.
With that, the five big independent investment firms were unleashed.
In loosening the capital rules, which are supposed to provide a buffer in turbulent times, the SEC also decided to rely on the firms' own computer risk models, essentially outsourcing the job of monitoring risk to the banks. Over the following months and years, all would take advantage of the looser rules.
The leverage ratio - a measurement of how much the companies were borrowing compared to their total assets - rose sharply at Bear Stearns, to 33 to 1. In other words, for every dollar in equity, it had $33 of debt. The ratio at the other companies also rose significantly.
The 2004 decision gave the SEC, for the first time, a window on the banks' increasingly risky investments in mortgage-related securities. But the agency never took true advantage of that part of the bargain. The supervisory program under Cox was a low priority.
The SEC assigned seven people to examine the parent companies- which last year controlled financial empires with combined assets of more than $4 trillion. Since March 2007, the supervisory office has not had a director.
And as of September 2008, the office had not completed a single inspection since it was reshuffled by Cox more than a year and a half ago.
The few problems the examiners preliminarily uncovered about the riskiness of the companies' investments and their increased reliance on debt - clear signs of trouble - were all but ignored.
The SEC's division of trading and markets "became aware of numerous potential red flags prior to Bear Stearns's collapse, regarding its concentration of mortgage securities, high leverage, shortcomings of risk management in mortgage-backed securities, and lack of compliance with the spirit of certain" capital standards, said an inspector-general report on Sept. 26.
But the division "did not take actions to limit these risk factors."
The commission's decision to effectively outsource its oversight to the companies themselves fit squarely in the broader Washington culture of the past eight years under President George W. Bush.
As with other agencies, the SEC's decision was motivated by industry complaints of excessive regulation at a time of growing competition from overseas. The 2004 decision was aimed at easing new regulatory burdens that the European Union was about to impose on the foreign operations of U.S. investment banks. The Europeans said they would agree not to regulate the foreign subsidiaries of the investment banks on one condition - that the commission became the regulator of the parent companies, along with the brokerage units that the SEC already oversaw.
A 1999 law, however, had left a gap that did not give the commission explicit oversight of the parent companies. To get around that problem, and in exchange for the relaxed capital rules, the banks volunteered to let the SEC examine the books of their parent companies and subsidiaries.
A lone voice of dissent in the 2004 proceeding came from the software consultant from Indiana, who said that the computer models run by the companies - and that the regulators would be relying on - could not anticipate moments of severe market turbulence.
"With the stroke of a pen, capital requirements are removed!" the consultant, Leonard Bole, wrote to the SEC on Jan. 22, 2004. "Has the trading environment changed sufficiently since 1997, when the current requirements were enacted, that the commission is confident that current requirements in examples such as these can be disregarded?"
He said that similar computer standards had failed to protect Long-Term Capital Management, the hedge fund that collapsed in 1998, and were unable to protect companies from the market plunge of October 1987.
The SEC's most public role in policing Wall Street is its enforcement efforts. But critics say that in recent years it has failed to deter market problems.
"It seems to me the enforcement effort in recent years has fallen short of what one Supreme Court justice once called the fear of the shotgun behind the door," said Arthur Levitt Jr., who was SEC chairman in the administration of President Bill Clinton. "With this commission, the shotgun too rarely came out from behind the door."
Cox was a close ally of business groups in his 17 years as a member of the House of Representatives from one of the most conservative districts in Southern California. Cox had led the effort to rewrite securities laws to make investor lawsuits more difficult to file. He also fought against accounting rules that would give less favorable treatment to executive stock options.
Under Cox, the SEC responded to complaints by some businesses by making it more difficult for the enforcement staff to investigate and bring cases against companies. The commission has repeatedly reversed or reduced proposed settlements that companies had tentatively agreed upon. While the number of enforcement cases has risen, the number of cases involving significant players or large amounts of money has declined.
Cox dismantled a risk management office created by Donaldson that was assigned to watch for future problems. While other financial regulatory agencies criticized a blueprint by Paulson that proposed to reduce their stature - and that of the SEC - Cox did not challenge the plan, leaving it to three former Democratic and Republican commission chairmen to complain that the blueprint would neuter the commission.
In the process, Cox has surrounded himself with conservative lawyers, economists and accountants who, before the market turmoil of recent months, had embraced a far more limited vision for the commission than many of his predecessors.
On Sept. 26, the commission formally ended the 2004 program, acknowledging that it had failed to anticipate the problems at Bear Stearns and the four other major investment banks. "The last six months have made it abundantly clear that voluntary regulation does not work," Cox said.
Cox declined requests for an interview. In response to written questions, including whether he or the commission had made any mistakes over the past three years that contributed to the current crisis, he said, "There will be no shortage of retrospective analyses about what happened and what should have happened."
He said that by last March, he had concluded that the monitoring program's "metrics were inadequate."
I think this stunning journalistic failure is worthy of a bit more than a one sentence nod in para 19 and I'd love to know which media did attend, if "none of the major media outlets, including The New York Times, covered it."
The arrogance of it!
Because I'd sure like to be reading the 'minor' ones who did.
READ AN ALTERNATIVE IHT DAILY NARRATIVE AT
A PLACE IN THE AUVERGNE
International Herald Tribune
IHT
New York Times
NYT
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