May 27, 2009

Obama and Treasury May Strip SEC Down: Lynn Turner’s Ten Cents

The battle over the SEC’s future is heating up. Last week, the Treasury Secretary received this letter from 14 pension plans regarding the importance of maintaining the independence and oversight of the SEC.

Below is some interesting commentary from Lynn Turner regarding the latest developments in this battle:

This Bloomberg article highlights the efforts of Treasury Secretary Geithner, Larry Summers and the Obama Administration to strip the SEC of some of its powers. Changes being discussed include taking away the SEC’s regulation of mutual funds. Also perhaps giving a new consumer products commission some of the SEC’s powers.

About three years ago, the Treasury’s Paulson Blueprint Report, one from the Business Roundtable – as well as other reports – recommended that the SEC be weakened, with less protections afforded to investors in an effort to make the US capital markets more competitive and attractive to business. Those efforts seem to be in full swing again. There was a meeting last week in Washington DC between those individuals and others including Paul Volcker, Arthur Levitt and Elizabeth Warren to discuss the issues cited in the article.

The Federal Reserve is the Problem; Not the Solution

The financial meltdown – as the recent Frontline documentary aptly highlighted – was caused by banks making a lot of bad loans and Wall Street firms taking on huge risks and bets when they insured those loans through trillions of dollars of credit derivatives. The Fed stood idly by despite 1994 legislation that permitted the Fed to prevent these unsound lending practices. The Fed was the regulator for some of the biggest institutions that would have failed without taxpayers bailing them out. But then again, the Fed has never protected investors – and strongly advocated for legislation that allowed the creation of banks that became too large to fail and stopped any regulation of derivatives.

Now Treasury Secretary Geithner – who as head of the NY Fed oversaw these very banks that needed bailouts – and who was involved with the decisions on Bear Stearns, Lehman Brothers and AIG, is now proposing to give the Fed even greater powers while stripping those powers away from the SEC. Geithner speaks in the Bloomberg article of enforcement – but the Fed has a terrible enforcement track record and has never protected consumers and investors.

That is specifically why I understand the Congressional Oversight Panel has said the government needs to create yet another government agency to protect consumers – because the Fed and other banking agencies (which are captives of the industry) have refused to do so depite legislation such as the ’94 Hoepa Act and Truth-in-Lending laws. You don’t need the fingers on one hand to count the number of banking executives – whose major banks have required taxpayer-subsized bailouts – that have been targeted by the Fed for their unsound lending practices.

What is the Treasury’s Case?

What the Treasury has not done is make a case as to what problems they are seeking to fix with this change in powers. And explain why – other than for political reasons and due to their close ties to the banking industry – they would make changes to the SEC’s powers. On the other hand, the mutual fund industry has attracted large sums of money away from what use to be deposits at banks during the past two decades. And with those investments, mutual funds have invested in the commercial paper of many public companies, replacing bank financing in some instances. It appears what may be occurring is an effort on the part of the banking industry to get the government to decide “winners” and “losers” and try to bring those deposits back. But it will be costly for investors in terms of their future returns.

What people seem to forget is that there was one and only one money market fund that went under: the Reserve Primary Fund. That fund had invested heavily in Lehman debt in the prior year. Perhaps if the credit rating agencies had properly rated Lehman’s debt, that would not have happened – but that is another issue. (Also as Frontline documented, Geithner failed to understand the major issues associated with Lehman debt when he – along with Paulson and Bernanke – decided to let them fail.) In addition, the Reserve Primary Fund had a few very large institutional investors who withdrew their money, thereby forcing the fund to “break the buck” and create a liquidity issue. (Professor Mercer Bullard, a former SEC Staffer, gave some excellent testimony before the Senate Banking Committee on this issue a few months ago.)

However, this is but one fund. At the end of 2007, according to the ICI 2008 Fact Book, there was $3.1 trillion in money market funds invested in the US, up from $1.3 trillion ten years earlier. There were 38.8 million individual money market accounts. Having just one fund go under in this very severe downturn is a real statement on how well these funds – and the mutual fund industry generally – have weathered the storm.

At the same time, literally over a hundred banks have required a government-backed bailout with actual cash investments, as well as insurance of their debt. Dozens of banks have now failed this year – and without hundreds of billions of taxpayers dollars, other banks (including many deemed to big to fail) would have as well. Clearly mutual funds have turned out to be a safer and better deal for investors.

The Bottom Line: Let Investors Decide “Winners,” Not the Government

Why one would want to strip regulation of money market funds from the SEC and place it with the banking regulators or another agency is highly suspect and questionable. It clearly appears to be a play by the banks to recapture lost deposits, deposits they lost because their product was of an inferior quality to what mutual funds have offered. The government should not interject themselves into this fight between banks and mutual funds, but rather let the customer – the investing public – decide which is the best product. We need less of the government deciding who the winners and losers are, not more.

As the Bloomberg article notes, the current Chairman of the SEC has curiously been excluded from the negotiations and has argued against any changes through the mainstream media.

SEC’s Unpopularity: All-Time High?

Although I’m not convinced this type of survey has been conducted frequently enough so that we can really tell that the SEC’s unpopularity is at an all-time high, I would be surprised if that wasn’t the case given the phenomenal amount of negative publicity that the SEC has received during the past year.

As noted in Michael MacPhail’s blog, a recent Persuasion Strategies survey of potential jurors captured their opinions of six federal agencies. The SEC was the most negatively-viewed agency of the six, with 55% of respondents expressing an unfavorable opinion – compared with 46% expressing an unfavorable opinion towards the oft-despised IRS.

I completely agree with what Tom Gorman wrote in his “SEC Actions Blog” in his piece entitled “Remaking The SEC For Tomorrow” and couldn’t have said it better. The mission of each Division needs to be rethinked, including whether their focus should be broadened or even new Divisions need to be created (think asset-backed securities)…

– Broc Romanek