HOW THE SECURITIES & EXCHANGE COMMISSION OPENED THE FLOODGATES FOR ABUSE IN 2004

By Citizen Paul

Oct. 9, 2008 — If you’re still looking for the smoking gun that helps explain why our current financial crisis was allowed to happen, one of the most critical answers can be found in a little-publicized Securities and Exchange Commission ruling made in April of 2004. With the unanimous vote of all five members of the S.E.C, an exemption was granted to the investment banks of Wall Street that allowed them to speed down the road to ruin!

Runaway greed was unleashed with this little-known ruling. The damage that has been caused is still beyond measure or calculation.

At issue was a long-standing regulation, (the Net Capital Rule), that required investment banks to have a comfortable and responsible cash reserve on hand for the companies to weather downturns in the market and to guard against excessive debt loads.

Early in 2004, the major Wall Street players all put pressure on the S.E.C. to grant them an exemption – an effort led by Henry Paulson, then at Goldman Sachs and now our current Treasury Secretary. These are the same Wall Street players who are now lining up for bailout money, with their friend and former colleague, Paulson, running the 700 billion-dollar show.

No wonder the public is enraged.

Why did these companies bully the S.E.C. for this exemption at that time? The answer is the housing market, which was riding a bubble, held aloft in part because of the sub-prime mortgage market and the new and unregulated mortgage-backed securities that promised to make everyone rich.

Wall Street investment banks desperately wanted in, but this regulation was in their way!

On April 28, 2004, after less than an hour’s discussion, the Commissioners caved in to Wall Street and approved the exemption. These institutions would now be set free to use their billions of dollars in reserve – their safety net – to be invested in the reckless and uncertain mortgage-backed securities market. In the process, they would be putting their shareholders at great risk, as well as the stability of the entire industry.

The Commissioners reassured themselves that rules embedded in the exemption would allow them greater access to risky behavior on the part of the major firms. They reassured themselves that these firms would successfully self-regulate themselves – that the executives running these Wall Street firms would never allow their personal greed to steer their companies so deeply into dangerous debt that it would threaten their very survival of the institutions.

The commissioners forgot the lessons of the Savings & Loan debacle of the 80s, when deregulation led to massive abuses within the industry. Self-regulation didn’t work then, and, tragically, it wasn’t going to work this time around as well.

The S.E.C. established a seven-member commission at the same time to provide oversight, and to blow the whistle if they thought the huge Wall Street firms were taking on excessive debt and risk.

Former California representative Christopher Cox, a persistent enemy of regulatory oversight of the financial industry, was appointed by President Bush as the new S.E.C. chairman in 2005. One of his first orders of business was to gut the effectiveness of this particular commission as much as he could so his friends on Wall Street could do as they pleased without governmental review.

Earlier this year, another watchdog group within the S.E.C. warned about excessive debt and dangerous practices at Bear Stearns and other companies.

Deaf, dumb, blind and arrogant, Cox said in March: “We have a good deal of comfort about the capital cushions at these firms at the moment.”

Days later, Bear Stearns went belly up, and had to be acquired by JP Morgan Chase, with the assistance of American taxpayers to the tune of 29 billion dollars.

Wall Street firms have been tumbling ever since, weighted down by the gluttonous debt the S.E.C. exemption allowed them to accumulate.

The Securities and Exchange Commission was created during The Depression to restore a sense of trust and decency to Wall Street – investor confidence. That confidence has been dashed once again. The S.E.C. was sitting impotent and disinterested on the sidelines while this crisis brewed – history repeating itself once again.

Chairman Cox, running for cover, and away from his involvement in this disaster, issued a lame postmortem recently: “The last six months have made it abundantly clear that voluntary regulation does not work.”

The exemption oversight commission, that was never allowed to do its job in the first place, was quietly shut down earlier this month.

EPILOGUE:

We are in the opening weeks of what most experts now anxiously conclude will be a serious worldwide recession. We are once again paying the consequences for what happens when you excessively free up the Market Place so it can inevitably respond to its worst instincts. This time, the price will be steep, painful and prolonged. The monetary price we will have to pay as American citizens will make the Savings & Loan bailout seem like pocket change. It will be a price our children will be paying for a long time as well.

On the international stage, the price goes beyond huge amounts of bailout money or loan guarantees. The price concerns our very identity – our very soul as a nation.

For hundreds of millions of our fellow world citizens, America has always stood for integrity and honesty and the rule of common decency. That image, that ideal, has been shattered with this crisis.

We are now being seen as a country that tolerated lawlessness and unbridled greed at the very top of some of our most critical institutions.

If the leader of the Free World doesn’t live up to its own standards, who will?