Wall Street needs regulating
By Ted Kaufman
Last week's comprehensive and uncompromising report by bankruptcy examiner Anton Valukas on the demise of Lehman Brothers Holdings Inc. has put into sharp relief what many of us have long suspected: that fraud and potentially criminal conduct were at the heart of the financial crisis.
What lessons should we take from this 2,200-page report, which with meticulous detail lays bare "accounting gimmicks" designed to mislead investors and the public about the true state of Lehman's financial health?
First and foremost, we must return the rule of law to Wall Street. And that means we must undo damage wrought by decades of irresponsible deregulation; by financial institutions that are, as former FDIC chairman Bill Isaac says, "too big to manage and too big to regulate"; by a "wild west" attitude on Wall Street; and by the colossal failures by accountants and lawyers who misunderstood or disregarded their role as gatekeepers.
The rule of law depends in large part on making sure that institutions are manageable, and manageably sized; that Wall Street participants are interested in following the law; and that its gatekeepers, particularly the accountants and lawyers, are motivated by more than a paycheck from their clients.
Second, we must concentrate law enforcement and regulatory resources on ensuring that Wall Street plays by the same rules as Main Street. We must treat financial crimes with the same gravity as other crimes, both to restore the public's faith in our financial markets and to deter future misconduct that might trigger another crisis.
Third, we must help regulators and other gatekeepers not only by demanding transparency but also by providing clear, enforceable "rules of the road" wherever possible. That includes studying conduct that may not be illegal now, but that we should consider banning or curtailing because it provides too ready a cover for financial wrongdoing.
Over the past 30 years, we became enamored with the view that self-regulation was adequate, that "rational" self-interest would motivate buyers to undertake stronger and better forms of due diligence than any regulator could, and that market fundamentalism would lead to the best outcomes for the most people.
We were, of course, wrong — very wrong, it turns out.
Instead, the allure of deregulation led to the biggest financial crisis since 1929. And now we're learning, not surprisingly, that fraud and lawlessness were key ingredients in the collapse as well. Since the fall of 2008, Congress, the Federal Reserve and the taxpayer have had to step into the breach — at a direct cost of more than $2.5 trillion — because, as so many experts have said: "We had to save the system."
But what exactly did we save?
We saved a system of overwhelming and concentrated financial power that not only contributed to the crisis of 2008-09 but threatens to cause another if we fail to enact fundamental reforms. Just six U.S. banks control assets equal to 63 percent of the nation's gross domestic product; at the same time, oversight is splintered among various regulators who are often overmatched in assessing weaknesses at these firms.
And we saved a system in which the rule of law has been broken yet again. Big banks should not get away with conduct that would not be tolerated in the rest of society, such as the blatant accounting gimmicks used by Lehman and detailed in the examiner's report — despite the massive cost to the rest of us.
Who's to blame for this state of affairs, where major Wall Street firms conclude that hiding the truth is OK?
For starters, both Congress and the regulators, who came to believe that self-interest was regulation enough.
Then there are the accountants and lawyers, who are supposed to help ensure that their clients obey the law.
Finally, there is the SEC, which allowed investment banks to increase their leverage ratios by permitting them to determine their own risk level. When that approach was taken, it should have been coupled with absolute transparency about the level of risk.
What the Lehman example demonstrates is that when leverage increases, and accountants, regulators and credit-rating agencies fail to insist on transparency, we have a recipe for disaster.
The bottom line is that we need financial regulatory reform that is tough, far-reaching and untainted by discredited claims about the efficacy of self-regulation.