March 31, 2008

President Bush: Announces Intention to Nominate Democratic SEC Commissioners

Due to this White House press release from Friday, the status of Luis Aguilar and Elisse Walter to become SEC Commissioners has been upgraded from "rumor" to "announced intentions." Once nominated - and if confirmed by the US Senate - they will fill out the Commission and both serve as Democratic Commissioners. Elisse's appointment in particular is timely given the potential merger of the SEC-CFTC and she is a former CFTC General Counsel (as well as a former Corp Fin Deputy Director). Here is a Washington Post article about the coming nominations.

If these two are indeed nominated, it will prove me wrong that this Administration wouldn't bother to fill the open Democratic slots - although these candidates have been "rumored" for months and nothing was done until now, so maybe I'm partially right?

Today's a Big Day: Paulson's Proposed Regulatory Overhaul

Today, Treasury Secretary Henry Paulson will unveil his final report that serves as a potential blueprint for a regulatory overhaul. This is the product of Paulson's Committee on Capital Markets Regulation that has been working on reform efforts for the past year - efforts that began well before the market went south and the housing market exploded. Here is the executive summary of the report - and here is the 212-page report.

The report breaks down proposals into short-, intermediate- and long-term:

1. Short-term - Take action now to improve regulatory coordination and oversight now in reaction to the credit crunch by:

- Empower the President's Working Group on Financial Markets (which would be expanded to add heads of banking regulators) to serve as the inter-agency body to promote coordination and communication for financial policy - and extend its authority over all of Wall Street rather than just financial institutions.

- Create the Mortgage Origination Commission set - and regulate - uniform minimum licensing qualification standards for state mortgage market participants.

- Ensure the Federeal Reserve the sole authority to draft regulations for national mortgage lending laws and clarify and enhance the enforcement authority for federal laws.

- Enhance the temporary liquidity provisioning process during those rare circumstances when market stability is threatened so that the process is calibrated and transparent; appropriate conditions are attached to lending; and information flows to the Federal Reserve through on-site examination or other means as determined by the Fed.

2. Intermediate - Eliminate some of the duplication of the US regulatory system

3. Long-term - Create an "optimal" regulatory framework, with an objectives-based regulatory approach, with a distinct regulator focused on one of three objectives— market stability regulation, safety and soundness regulation associated with government guarantees and business conduct regulation.

Here is a statement from SEC Chairman Cox, recognizing a need to integrate a reduced number of regulators; former SEC Chairman Arthur Levitt holds a similar view according to this NY Times article from Sunday (although Arthur doesn't like the idea of the stock exchanges taking on more self-regulation).

Competing Democratic Reform Efforts: Here is a WSJ op-ed from Senator Schumer from Friday (remember that Schumer put out a reform report with NYC Mayor Bloomberg in early '07). And Rep. Frank is ready to spring into action, as noted in this NY Times column.

My Ten Cents: Initial Reactions and a Bit of Cynicism

It's hard to evaluate the Treasury's broad plan without seeing it. I agree that we need regulators with the power to oversee a range of products that now stretch across the jurisdictions of too many agencies. So some change is definitely warranted. So without knowing the details yet, here's a stab at an initial reaction:

The plan for reform makes Sarbanes-Oxley look like a drop in the bucket in terms of the magnitude of change. And a lot of it sounds great on paper. Sure, we have too many regulators. Can you believe there are at least six regulators for financial institutions in this country? The Fed, FDIC, OCC, OTS, NCUA and a myriad of state regulators. Merging them and the SEC-CFTC is nothing new and has only been stopped in prior years due to political maneuvering on the Hill.

Then, the cynic in me digs in. It's easy to propose a lot of change for the sake of change in the face of a major crisis. But what's it gonna cost? There is no way that a new government agency - or even a merged one - is gonna hit the ground running. New people get hired and need to be trained. There is no institutional memory to guide them. It's true that the most ripe time to effect governmental reform is during a crisis (and during a Presidential election year) - otherwise folks argue for the status quo - but as many complain about SOX, it might not be wise to act too hastily when the chips seem down.

On the other hand, the new Grand Poobah role for the Fed seems like it would consist of little more than as an information gatherer until a crisis has developed. Being reactive rather than proactive is not gonna stop a reincarnation of the mess we are mired in today.

Much of the "meat" of the Paulson plan would seem to reflect the view that rules and agencies are no substitute for market discipline. But is market discipline really the right answer given what we are experiencing now? In my opinion, a lot of the blame for what is happening today is that Wall Street financially engineered itself into a hole. And it's a dark hole, with a bottom that no one can understand. You can create all the regulators you want, but none of them will ever be able to understand the complex morass of securitizations, resecuritizations, swaps, etc. that have grown to trillions and can't be explained. For me, this is the crux of the problem and can't be solved by regulation. "No doc" mortgages were being originated because there were plenty of places to go and immediately sell them.

A decade ago, I spent a year in the Corp Fin branch that reviewed the asset-backed securities that were registered with the SEC. Most ABS aren't registered and most of the complex instruments that have been created over the past 15 years have been traded over-the-counter. If you have ever read a resecuritization prospectus, you quickly realize that it's mostly mumbo jumbo. And I'm sure the asset-backed market has become much more "sophisticated" since my very limited experience with it.

I also fall back on some of my in-house experiences. Watching a room full of bankers conduct a PowerPoint presentation to explain how smart it would be for the company to issue "tracking stock" (this was fashionable about a decade ago when a dozen or so companies got convinced of the need to create securities for which there were no voting rights and - arguably - no fiduciary duties to the holders; not the best governance framework nor not a sound investment as it turned out). Or enter into synthetic real estate leases to keep debt off the books because a company is too highly leveraged. More mumbo jumbo.

And I would imagine that this is just a drop in the bucket. I haven't worked on Wall Street and I'm not privy to her dark secrets. But I think I know enough to give my ten cents in asking for some of those on Wall Street to change their philosophy and stop looking for fees at the expense of the financial health of this country. There has to be accountability at the top. As said so often during the Sarbanes-Oxley reform debates, you can't regulate ethics and morality.

I like the idea of what has happened in the United Kingdom. In the wake of the Northern Rock failure, the Financial Services Authority went out and conducted a post-mortem and issued a report saying "what they missed, what needed to be corrected and what they were doing about it." Hopefully, this is part of the Paulson plan that will be released today, but I doubt it. We need to know what went wrong before we fix it, right? Or maybe this crisis runs so deep that no one really knows the extent of what went wrong. Even if that's true, let's understand and learn from that as part of such a report to start...

The Bottom Line: Smarter people than me will offer more cogent arguments "for" and "against" various aspects of the numerous proposed reforms. And I'm grateful for that. All I ask is that if new governmental agencies are formed, please avoid the cartoonish names that are mentioned in the Paulson plan. The "Business Conduct Regulator" sounds like it came from the Flintstones...

- Broc Romanek

Posted by broc at 07:19 AM
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