classical economics
for analysis,  forecasting
and policy design

Abolish the SEC!
By Wayne Jett
© September 30, 2008

    Decisions by lenders to clutch capital reserves closely rather than lend to traditional customers are severely disrupting business. Lenders cannot be faulted; they act upon survival instincts. Dancing in their heads are visions of naked short sellers devouring capitalizations of Bear Stearns, IndyMac, Fannie Mae, Freddie Mac, Lehman Bros., Merrill Lynch, AIG, Washington Mutual and Wachovia Bank. Financial firms trust neither the SEC nor Treasury secretary Henry Paulson to save them from similarly ugly fates in lawless U. S. financial markets.
    Were the SEC capable of honest, independent action, the agency would never have allowed naked short sellers to run rampant in pillaging U. S. stocks during the past ten years. Having gorged upon illicit gains from stock manipulations of all kinds, destroying many smaller companies in the process, predatory hedge funds and investment banks are more ravenous and ruthless than ever. On September 16, global credit markets seized as the LIBOR doubled and the overnight rate on Fed reserves trebled.
Some Pigs More Equal
    Market manipulators refused to pause even when the SEC issued long-delayed limits on naked short selling effective September 18. That very day, Morgan Stanley and Goldman Sachs shares were taken sharply lower by naked shorting while the broader DJIA rose 500 points.
    MS and GS picked up phones, called SEC and complained. Hearing from someone with “juice,” SEC acted, barring all short sales of financial firms on an emergency basis effective September 19. Typically of SEC conduct on this highly lobbied subject, however, on the next trading day staff and commissioners opened a window for naked short sellers to drive through, exempting options market makers from the ban on short selling. After a second strong up-day on September 19, equity markets have been sharply lower since.
    WaMu and Wachovia were taken down in broad daylight with the SEC doing nothing, while media provided cover by claiming investors placed hopes in Paulson’s diversionary plan. Fear is instilled in lenders globally, and they will not resume providing credit until reassured of a lawful financial and commercial environment.
Paulson’s Policy Empire
    The SEC under domination of Treasury secretary (and “economic czar”) Henry Paulson has almost zero credibility remaining. The agency shields Wall Street players from criminal prosecution by the U. S. Department of Justice. Paulson is Wall Street’s bulwark against constructive policy reform.
    Just this past weekend, dissident congressmen negotiated express suspension of FASB Rule 157 as a provision of Paulson’s “bailout” legislation. But the provision was revised in the bill that went to the House floor to a mere grant of SEC “discretion” to suspend Rule 157. This is no different from status quo – the cunning hand of Paulson again evident. Dissidents were alert, though, and won the floor vote 228-205.
    Neither Treasury secretary Paulson nor the SEC can be trusted to establish integrity in U. S. financial markets. The SEC ought to be abolished as Paulson himself has proposed. Authority for regulation and prosecution of crimes in the financial markets would be better placed in the DOJ than in a separate agency. Certainly Paulson’s proposal to place regulation of Wall Street and authority to “stabilize” markets in the Federal Reserve ought to be rejected soundly. Wall Street already dominates the Fed, and that is itself a concern deserving reform.
“Progressives” Lead?
    Legislation urgently needed from Congress ought to do at least these two things:
    (1)    stop all failures-to-deliver shares sold short, and require pre-borrowing plus immediate delivery of shares to buyers; and
    (2)    suspend immediately FASB Rule 157 and restore pre-existing accounting rules for all audits.
    Leaks to the press Tuesday from SEC and FASB sources said both organizations would oppose changes in Rule 157. No surprise in this, of course, since both organizations were directly culpable in adopting and keeping the rule even after its disruptive effects were evident in light of manipulative gaming of the ABX sub-prime index.     Later Tuesday, SEC announced and issued “clarifications” of Rule 157, giving rise to hopes they amounted to relief of substantive importance. SEC said FASB would issue its own clarifications later in the week. Moves by both SEC and FASB resulted only from intensive pressure by the Senate and House to resolve the issue that turned some House votes against the bailout bill.
    Still later Tuesday, several “progressive” House Democrats who had voted against the bailout bill Monday announced their own proposal of a bill to resolve the credit crisis without funds to buy mortgage backed securities as proposed by Paulson. Pete DeFazio (D-OR) and Marcy Kaptur (D-OH) held a press conference and released a draft bill that would (1) require SEC to replace Rule 157 with economic value standards; (2) require SEC to block naked short selling permanently; (3) require SEC to restore the up-tick rule permanently; (4) require FDIC to implement a “net worth certificate” purchasing program to provide capital to member banks with capital needs and ability to re-pay; and (5) increase FDIC account insurance limits from $100,000 to $250,000.
    The DeFazio-Kaptur bill would likely attract more votes from the majority of 228 “no” votes on Monday’s bill than would a revision of Paulson’s plan, if allowed a floor vote. However, Speaker Pelosi has shown no interest in permitting any bill to reach the floor without her support. Pelosi did not require Democrats to vote for the Paulson bill as a matter of party loyalty though, which led to its failure.
    Many Democrats are now off the reservation so far as supporting Wall Street’s slush fund. They and some “yes” Democrats may press the Speaker to advance this bill that would likely be embraced by a public incensed and outraged by the Paulson-Bernanke actions of 2008. Many House Republicans likewise prefer some or all of this bill’s provisions to those of Paulson’s proposal.
    Tuesday’s market rise stemmed from leaks and hopes related to these events. Watch whether legislation deals with naked short selling and Rule 157 effectively. If not, credit availability will not improve and markets will be displeased. The Senate will rush a vote on Paulson’s Wall Street desires on Wednesday evening, but House dissidents are unlikely to be swayed without meaningful reform on these two items. This is the closest semblance of progress in quite some time. ~