Posted by: Robert Hutchinson
October 03, 2008
Topic: Topics

Chairman of the Securities and Exchange Commission Christopher Cox has offered up various excuses as to why the agency he heads is not really at fault.

Treasury Secretary Paulson has pointed out that the root problem is housing and the securitization of mortgages used to finance it. The subprime mess has dragged down investment bank after investment bank, created massive defaults, and posed systemic risk not only to the U.S. but the global economy. Estimates of losses range from $700 billion to $1.3 trillion. During the past several years, Wall Street has peddled these subprime securities issues, often with little understanding of their real risks, and in many cases making no meaningful disclosure of them - but always with its hand out for the fees. The Wall Street party was on, and it was at the investors' expense.

Where was the SEC? Today there is a lot of talk about new laws and new regulations; the truth is that there are fraud laws on the books - ones drafted after the 1929 Crash and the excesses Wall Street produced then. Those same laws were in effect after the dot.com bubble and crash, aided and abetted by Wall Street, that in its wake produced Sarbannes-Oxley.

The problem is the fraud laws have simply not been enforced in a meaningful way, with Cox being the most recent and conspicuous example. Compare this with one of his predecessors, former Chairman William Donaldson a well known, respected financial figure who was forced out of office because he actually did attempt to regulate Wall Street. After that a more congenial, let's-not-rock-the-boat-today "regulator" was needed, so Cox was selected, who presumably could be relied upon to do very little - window dressing. That is exactly what happened, or didn't happen, and so flaky, toxic subprime bonds were allowed to proliferate one after another, infecting banks and economies here and throughout the world, like some hideous death producing world-wide pandemic.

Compare also this "hear no evil, speak no evil, see no evil" approach with that of Elliot Spitzer, love him or hate him, and the bold actions he took against an entire array of companies. Maybe not always the best or most effective action, and, yes they were often calculated to grab headlines - but he did something! This was one attorney general of one state with far less resources than the federal government.

Meanwhile, Cox sat back and watched. The green light was given and Wall Street happily sped toward disaster.

There is another gathering tsunami called Collateralized Debt Swaps ("CDS") which was allowed to proliferate in the last ten years, like deadly nuclear armaments. Indeed Warren Buffett has called these financial weapons of mass destruction - these have mushroomed from $144 billion to $62 TRILLION! Not billion but trillion. This staggering sum about four times the Gross Domestic Product and six times the current national debt. It exceeds the total value of the largest 5,000 stocks listed in the Wilshire 5000.

What could be more outrageous? These instruments amount to nothing less than a crazy, gigantic game of liars poker played by companies like AIG, Wall Street firms, and hedge funds that can no more pay these stupendous sums (of a fraction of them) than fly to the moon. That did not stop them (and neither did the SEC) from greedily collecting and booking the premiums to goose their revenue, profits and stock price. We all know that AIG can't pay; and we all know that none of the other firms can even come close to paying. Christopher Whalen of Institutional Risk Analytics recently stated to Fortune magazine, "To be generous, you could call it an unregulated, uncapitalized insurance market. But really it is a gaming contract." But unlike these derivatives, gambling casinos are regulated, and there is reasonable assurance of getting paid the wager by the casino. Why on earth should these financial weapons of mass destruction be allowed to continue? Why on earth should these characters be allowed to put the entire financial system of the US and the world at risk - to collect premium dollars on bets they can never pay? These gamblers who want to place gigantic bets with money they don't have cannot be permitted to drag down the rest of the country and the world.

Incredibly, this is a progression of, but worse than, the fiasco ten years ago of the hedge fund Long-Term Capital Management that tanked - with its founder John Merriweather, and Nobel Laureates Robert Merton, and Myron Scholes aboard - that posed a systemic risk such that the Federal Reserve bailed it out ten years ago. The sequel? It is hard to believe, but Merriweather now runs another hedge fund called JWM Partners; according to a September 20-21, 2008 Wall Street Journal, the fund is down $300 million, which is one-fourth of investors' money.

Interestingly, the Commodities Futures Trading Commission suggested regulating these instruments, but that attempt was beaten back by Alan Greenspan and others, who actually supported legislation, along with Treasury Secretary Lawrence Summers and Senator Phil Gramm, that was passed in 2000 prohibiting federal and state governments from regulating them (former senator Phil Gramm recently called those talking of recession "whiners" - his wife sat on the board of directors of the colossally catastrophic Enron). Regulation? Not interested.

The SEC has stood virtually mute about CDS's over the years. Cox finally, belatedly said the other day that maybe they should be regulated, after the problem has fully metastasized into a full blown life-threatening cancer.

We need real enforcement of the fraud laws if our financial system is to survive, just like we need vaccines to prevent disease and chemotherapy to stop cancer. It is time to put someone in charge of the SEC with the will and the backbone to protect the consumer and the investing public from those reckless and even criminal elements that will stop at nothing to enrich themselves at the expense of our financial system.

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