The two issues everyone is talking about this week are (1) financial market regulation and what President-elect intends to do about it, and (2) editorials from the Washington Post and the New York Times opposing Obama’s intention to nominate Mary Schapiro as next Chairman of the Securities and Exchange Commission. There is a third related issue that no one is talking about: Barak Obama’s reliance on economists and shunning of finance/accounting types for advice.
This matters a great deal. Our system of financial markets can be likened to a fragile china shop chock full with expensive dishes and figurines displayed in the most unpredictable manner. A blind person wandering about is sure to bump a display and cause a dish or figurine to crash to the floor, irreparably broken and lost for eternity. President-elect Barak Obama is that blind person. He lacks any formal education in business or the economy or even in regulatory law. Nor does he have experience Thus he does not have the world view needed to govern the U.S. world of business. Consequently, there are a lot of highly educated people who are extremely fearful for the china shop.
My own take is that we’re heading for a disaster of unimaginable magnitude. This is how I get to that conclusion.
Fast forward to weekly event #1, a House Financial Services Committee hearing devoted to exploring what is wrong with the SEC and what should be done about it. At the current time, there is simply angry gnashing of teeth and politico posturing. Two comments from a Bloomberg News article bear repeating.
Whether the agency should be beefed up or dismantled will be a likely topic at meetings this year about the SEC’s future. “It would be a big mistake for the hearing to start focusing on throwing more money at the SEC, until the question has been answered about whether the agency is using the resources that it has adequately,” said Jacob Frenkel, a former SEC attorney now at Shulman Rogers Gandal Pordy & Ecker in Rockville, Maryland.
“The SEC will have to defend its existence,” said Donald Langevoort, a former agency attorney who teaches securities law at Georgetown University in Washington. The meeting is “a way of sending a message to the SEC of Congress’s anger and dismay that this happened, especially given all the things that have happened in the last six to eight months,” such as the collapse of investment bank Lehman Brothers Holdings Inc., he said.
Personally, I believe we are less in need of reform of the SEC, and more in need of a good SEC chairman. There are many, especially Ed Ketz of Penn State, who call Christoher Cox the worst chair in the history of the SEC. Having read his and other arguments, I wholeheartedly agree.
Obama, of the “I don’t know nothing, but I’m going to make the right changes,” seems to prefer changing the commission, and not changing the type of person heading the commission. What is this change likely to be? First of all, the House Financial Services Committee, like all committees, will be ineffective in coming up with its own plan, and will simply rubberstamp what Obama passes its way. Second of all, there are some preliminary signals, as reported on by Jim Hamilton’s World of Securities Regulation. There are three posts I wish to call atention to:
- President-Elect Obama Details Key Principles to Guide Federal Financial Regulation Reform – a key point mentioned is the need for one agency that integrates the functions of several existing agencies. A second key is to intervene before a problem (good luck with this one, it takes guts and politicians/regulators lack guts or else they’d never get elected/apointed.
- Obama Choice of Schapiro for SEC Chair Should Facilitate SEC-CFTC Merger – this seems to be what Obama has in mind with a one agency approach. The CFTC is the Commodities Futures Trade Commission, and is not nearly as high profile as the SEC. Obama/Schapiro believe that an agency merger will give the survivor sufficient clout to prevail in international negotiations for forming a global regulatory framework.
- Historic Securities Regulation Reform Coming in 2009; But Will it be Globally Integrated – relying on global allies is Obama’s answer for everything, terrorism, defense, and now securities regulation. His answer is driven primarily by the need to free up funds for domestic purposes. The wars in Iraq and Afghanistan are too expensive. Solution? Turn them over ot our allies, and save precious U.S. dollars.
I’ve been arguing for three months that Obama’s globalization push will have unintended consequences in the financial markets ares. The most significant problem will be in the adoption of IFRS and the ditching of U.S. GAAP. This will cause U.S. executives to run wild with repect to earnings manipulation. In effect, it will grant governmental permission to smooth income. Eventually this will cause a $five trillion charge to the economy. Secondly, there is no world-wide market system. There are many national markets that suffer the same ups and downs. However, there is no unified market, and there never will be as long as we have different countries and different cultures. Why, even Christopher Cox recognized this. Here are his comments from Monday, November 18, 2008:
“But it is unrealistic to think we could or should make [international securities regulation] identical, because of differences in national laws, economic conditions, and objectives. These differences are healthy and normal. It is entirely reasonable for a nation to view its responsibility to its own citizens and markets as paramount. The Securities and Exchange Commission is responsible for the protection of American investors, and it will never compromise that mission. Nor should any other national regulator. One of the reasons for the remarkable success of IOSCO is that it understands this very well.
“There is yet another reason that global consultative bodies should not aspire to become global regulators. As we have learned to our misfortune time and again, international agencies often are forced to regulate to the lowest common denominator. Of necessity, they must yield to the average rather than the highest standards of their members in order to achieve consensus. Worse, the tensions that every national regulator is bound to reconcile – of factions and stakeholders, not to mention of parliaments, legislatures, and executive authorities – are multiplied a hundredfold in international bodies. These are concerns that should be considered seriously before assigning the function of global systemic risk “czar” or any similar responsibility to an international body
So, Obama’s solution will essentially be to keep the economist foxes in charge of the henhouse. The difficulty with economists such as Paul Volcker and Austan Goolsbee is that they think in terms of mathematical theories and have no awareness of the nuts and bolts of the real world. To them, details are trivial and will work themselves out. A finance/accounting type, however, realizes that a devil lives in the details, and it is there job to root out the devil. The economist solution to the SEC problem is to put an economist in charge. Fast forward to criticism, the pace of which is quickening this week. I’ll cite three opponents to Obama’s choice to head the SEC, one Mary Schapiro.
- Dan Solin, Huffington Post - Mary Schapiro Should Not Be Confirmed as SEC Chief, and Mary Schapiro Will Protect Investors the Same Way Willie Sutton Protected Banks. He argues that she has ties to industry groups (not investors), her FINRA experience has been unimpressive (and even missed the Madoff scandal), and her desire to move to arbitration boards instead of judicial prosecution of securities violations will only lead to a disaster where investors are the last group protected.
- Steven Pearlstein, Washington Post – Obama’s SEC Pick Is No Joe Kennedy. He says, “For the top SEC job, Obama needed to mount a determined search outside the current establishment — someone willing to take no prisoners and question everything about the way the industry does business and the way the government regulates it, someone so capable of channeling the outrage the country now feels that he or she would have industry insiders quaking in their hand-made wingtips. Instead, what we got was someone who not only has been at the very center of a failed regulatory process for the past two decades, but has emerged from it well-liked and acceptable to everyone.” And finally, to the point, “The problem is that there is nothing in her record to suggest that she is likely to clean house at the agency and launch a brutal and sustained assault on Wall Street culture.“.
- Editorial, New York Times – Starting the Regulatory Work. The problem is clearly laid out, “The outlines of the challenge are clear. The decades-old ways in which the Treasury and other federal regulators have relied less on rules and enforcement and more on faith in market discipline to limit risk to the system have been a manifest failure. Anything less than a new rules-based regime would be inadequate to the task of restoring confidence and, eventually, reviving the economy.”. Schipiro will add to the problem, “Mary Schapiro, … is best known for her support of self-regulation and a greater role for principles-based regulation basically, the opposite of clear rules.”
My own criticism with the Schapiro nod for SEC chair really is an integration of there factors: (1) SEC reform push is led by economists with a disdain for accountants and accounting standards, Obama and Schapiro will follow their lead, (2) a reliance on globalism, and (3) reliance on principles. All of this leads inevitably to the adoption of IFRS as the accounting standard of the land. It will be a perfect storm, and a disaster of unimaginable magnitude.
Over and out – - David Albrecht