Wednesday, February 10, 2010
Remake the SEC?
"To protect the financial system from the next potentially toxic innovation or the next Bernard Madoff, the [SEC] has turned to a college professor who warned back in 1993 that derivatives could cause major financial problems for financial firms. ... 'It's the low-probability catastrophic event that can kill a bank,' said [Henry] Hu in an interview. ... But the professor's out-of-the-box thinking is what attracted SEC Chairman Mary Schapiro to recruit him to run the agency's first new division in 37 years. ... His job, she said in an interview, is 'to help us really rethink risk management and help us attract different skill sets to the agency as we try to remake the organization.' ... In the back of everyone's mind are the twin breakdowns at the SEC that emerged in 2008. The agency was caught flat-footed in oversight of Wall Street firms that made risky bets on mortgage securities and missed the decades-long Madoff fraud. ... Mr. Hu is also advising Ms. Schapiro as the SEC plans for a possible regulatory overhaul by Congress that would give it more power to regulate derivatives. Mr. Hu is pushing for strong steps, saying the legislation should 'prevent a gaming of rules that really should apply to everybody.' ... When financiers dream up new products, he wrote, they have an incentive to downplay the risks and use them to generate short-term profits--as well as big bonuses", my emphasis, Kara Scannell at the WSJ, 25 January 2010, link: http://online.wsj.com/article/SB10001424052748703415804575023402762491286.html.
Even when the SEC appears to do right, I've learned don't trust it. Does anyone remember Howard Rubin's $377 million 1987 bath at Merrill Lynch? Why didn't the SEC learn from it? What's happening here? The SEC is bringing Hu aboard to "expert up" in its turf war with other federal regulatory agencies to determine which will regulate derivatives. I don't favor their regulation! Make it a felony for an institution holding federally insured deposits to use or issue derivatives. Further, no FDIC-insured institution should be permitted to lend to an entity using derivatives. If say, a Barrick wants to borrow money, let it issue bonds or commercial paper. Disagreeing with professor Hu, it's not the "low-probability catastrophic event that can kill a bank". It's the event whose probability is unknown. No economic event's probability is known ex ante. It is hubris to think otherise.