Several federal officials, including Barney Frank, the chairman of the House Committee on Financial Services, and Treasury Secretary Geithner, have called for an overhaul of the financial regulatory system. They argue that a major reason for the severity of this recession is the lax oversight and the vaguely defined enforcement responsibilities of existing government regulators. Without strict oversight, bankers proceeded to engage in reckless lending policies that caused many banks to collapse.
The solution that officials like Geithner propose is a “systemic risk” regulator, an agency or group of individuals, that, ideally, has the clairvoyant ability to predict future market shocks and deflate asset bubbles before they threaten economic stability. Before rushing to add another layer of bureaucratic labyrinth to the existing regulatory structure, the public should evaluate how current regulators have fared during the current crisis.
During this crisis, it is the individual decision-makers who bear the blame. The government can create as many regulatory agencies as it wants, but if the individuals who lead or work for those agencies fail to use the power already granted to them, then the federal efforts are for naught.
After analyzing the regulatory response, Americans can conclude two things: Some of the regulatory structures set up after the Great Depression have worked extremely well; and, when regulatory oversight has failed, it was not because of the structure of the agency or a lack of mission — it was because the individuals at those agencies did not perform adequately.
For example, Christopher Cox, the former Securities and Exchange Commission chairman, always appeared a step behind markets, and the SEC lost credibility with traders. The SEC’s main purpose is to protect shareholders from companies that fraudulently misrepresent their financial position and to investigate irregular stock trading activity. In 2007, Cox repealed a regulation known as the “uptick rule,” which limited the activities of investors who “shorted” the shares of certain companies. In a short sale, the trader receives the company’s stock as a loan from a broker, sells it on the open market, waits for the stock’s value to fall and buys it back at a lower price. The trader pockets the difference as profit. In the current economic crisis, short sellers have forced companies like Lehman Brothers, Merrill Lynch, Wachovia and Citigroup into financial distress or collapse by shorting their stock prices to extremely low levels — sometimes zero. The uptick rule only allowed short-sellers to bet against a company’s stock after it rose slightly in value, thus preventing the rapid decline in share price that forced many firms into bankruptcy. After repealing the uptick rule at the worst possible time, Cox never pushed for the reinstatement of this law. But the “uptick rule” at least might have slowed the banks’ collapses, as their share price would not have fallen so quickly, thus giving regulators more time to act.
In contrast to the SEC, the Federal Deposit Insurance Corporation deserves praise for its proactive takeover of failing financial institutions and its rapid sale of these institutions’ assets to stronger banks. Current FDIC Chairman Sheila Bair has been the most outspoken in favor of proactive bailouts. The FDIC is responsible for protecting the bank deposits of ordinary Americans. It takes deposits of failing banks and sells them to healthier rivals. Because of her forward-looking interpretation of the FDIC’s mandate, Bair’s efforts have saved billions in deposits. The sales of Wachovia to Wells Fargo and Washington Mutual to J.P. Morgan Chase, orchestrated by the FDIC after their deteriorating financial position became clear, is an example of federal regulators using existing authority with speed and forthrightness.
The would-be collapses of Wachovia and Washington Mutual would have been catastrophic. Without the FDIC quickly organizing their takeover by rivals, a situation similar to the bank-runs of the early 1930s might have occurred.
Perhaps modern-day regulators should take a page from John Pierpont Morgan, the founder of J.P. Morgan Chase, who was so feared and respected by traders that his very words moved markets. Short-selling, the trading activity that most directly brought down Lehman and forced the sale of Merrill Lynch, also was used to wreak banking havoc during the Banking Panic of 1907. J.P. Morgan would have none of it. When asked how he would deal with the short sellers, who, like today’s, were shorting shares of major banks and forcing them into bankruptcy or collapse, Morgan declared: “[They] shall be properly attended to”. Within weeks, the Panic subsided, and Wall Street resumed its normal course of business.
Andrew’s column runs biweekly Thursdays. He can be reached at a.golden@cavalierdaily.com.
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