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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

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

  • 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
sec s past origins purposes
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)
sec s present the current financial crisis is the sec to blame
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)
sec s future will it survive
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
u s financial regulatory structure should we move to twin peaks or a single regulator
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