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The SEC and the Financial Crisis

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. Overview.

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The SEC and the Financial Crisis

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  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 SEC’s past, present, and future • Past and present will focus on SEC’s origins and purposes, culpability for current mess • Future will put SEC in context of broader U.S. financial regulatory structure

  3. SEC’s PastOrigins & Purposes • Origins of SEC • Great Depression: Swindlers selling worthless stock • SEC: Administrative Agency created after Great Depression as part of FDR’s 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)

  4. SEC’s 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)

  5. SEC’s FutureWill it Survive? • 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 • Treasury’s 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) • Challenges from the Current Crisis • Focus going forward on systemic risk, not fraud • Wither the Investment Bank

  6. 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

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