All Cox' Fault?

Looks like the GOP has found a scapegoat for the financial meltdown. John McCain said today that he would fire Chris Cox as the chairman of the SEC. Now, Presidents don't have the power to do that, but clearly that showed a lack of trust in Cox on the part of the Republican nominee, and now CNBC is reporting (no link) that Cox will resign at the end of President Bush's term. In a way, McCain got what he wanted. And expect lots of articles about how lax SEC oversight was the proximate cause of this mess.

But how true is that? McCain tried to lay the blame at Cox' feet for the practice of naked short selling, which is when you can bet on a stock to go down without owning it, sort of like playing the ponies without owning the horse. This isn't exactly the best thing for the market, and Andrew Cuomo is launching an investigation to see if it's fully compliant with current law.

New York on Thursday began a probe into possible illegal short-selling in the stocks of Wall Street companies such as Goldman Sachs Group Inc and Morgan Stanley, Attorney General Andrew Cuomo said.

Cuomo said on a conference call with reporters: "I want the short-sellers to know today that I am watching. If it is proper and legal then there is nothing to worry about." [...]

The New York State prosecutor said his office also would look back into illegal short-selling that may have occurred in stocks of Lehman Brothers Holdings Inc and American International Group Inc, two companies at the heart of the crisis.

In the past week, Lehman has gone bankrupt and the insurance giant was rescued by the U.S. government.

Cuomo has asked the SEC for a freeze on short-selling.

But to suggest that this is why the markets are in turmoil is crazy. It's like blaming the guys betting on the horse for the horse carrying 200 extra pounds and stumbling to the finish line. The banks lent money to people who couldn't pay them back, and then hid the debt in all sorts of tricky new assets and securities that they tried to shovel out the door. That's the main problem, and no change in short-selling would alter that. The other problem is leverage, which may or may not be the SEC's fault.

As we learn this morning via Julie Satow of the NY Sun, special exemptions from the SEC are in large part responsible for the huge build up in financial sector leverage over the past 4 years -- as well as the massive current unwind.

Satow interviews the above quoted former SEC director, and he spits out the blunt truth: The current excess leverage now unwinding was the result of a purposeful SEC exemption given to five firms.

You read that right -- the events of the past year are not a mere accident, but are the results of a conscious and willful SEC decision to allow these firms to legally violate existing net capital rules that, in the past 30 years, had limited broker dealers debt-to-net capital ratio to 12-to-1.

Instead, the 2004 exemption -- given only to 5 firms -- allowed them to lever up 30 and even 40 to 1.

Who were the five that received this special exemption? You won't be surprised to learn that they were Goldman, Merrill, Lehman, Bear Stearns, and Morgan Stanley.

You can credibly charge Cox with failing to conduct meaningful oversight and indeed encourage over-leveraging, but that's not what McCain said.

He talked about short selling, which is perfectly legal, thanks to the masters of the universe like Phil Gramm, who encouraged and supported the casino-like atmosphere on Wall Street that led to this mess.

If you want to know what happened to blow up the financial markets, it's relatively simple. The banks let anyone buy a house, securitized the mortgages, and over-speculated and over-leveraged themselves, so that investors were buying worthless pieces of paper that they thought were valuable. The fixes are also simple:

Reform One: If it Quacks Like a Bank, Regulate it Like a Bank. Barack Obama said it well in his historic speech on the financial emergency last March 27 in New York. "We need to regulate financial institutions for what they do, not what they are." Increasingly, different kinds of financial firms do the same kinds of things, and they are all capable of infusing toxic products into the nation's financial bloodstream. That's why Treasury Secretary Hank Paulson has had to extend the government's financial safety net to all kinds of large financial firms like A.I.G. that have no technical right to the aid and no regulation to keep them from taking outlandish risks. Going forward, all financial firms that buy and sell products in money markets need the same regulation and examination. That will be the essence of the 2009 version of the Glass-Steagall Act.

Reform Two: Limit Leverage. At the very heart of the financial meltdown was extreme speculation with esoteric financial securities, using astronomical rates of leverage. Commercial banks are limited to something like 10 to one, or less, depending on their conditions. These leverage limits need to be extended to all financial players, as part of the same 2009 banking reform.

Reform Three: Police Conflicts of Interest. The conflicts of interest at the core of bond-raising agencies are only one of the conflicts that have been permitted to pervade financial markets. Bond-rating agencies should probably become public institutions. Other conflicts of interest should be made explicitly illegal. Yes, financial markets keep "innovating." But some innovations are good, and some are abusive subterfuges. And if regulators who actually believe in regulation are empowered to examine all financial institutions, they can issue cease-and-desist orders when they encounter dangerous conflicts.

The SEC could have handled reform 2, but that's about it. There are also reforms that we can do to ensure that people stay in their homes, which would be novel, protecting ordinary people instead of the executives who caused this. AND, we could actually tax hedge fund managers on their income the way we do any other income-generating American, increasing federal revenue and having the people at least somewhat responsible for this mess partially finance the bailouts, as they are no longer creating public wealth.

This remains a scary time. China could decide that holding US dollars doesn't make any sense and divest, which would lead to what Michael Bloomberg has called a next wave crisis.

But you'll see that short-selling, which actually doesn't affect the market as much as claimed, because on the way down you have to buy the stock to cover the sale, isn't on anyone's reform list. The bottom line is that simple regulation that is actually implemented is much cheaper and more efficient than bailing out everyone on Wall Street with phantom money that is just created out of thin air and ends up becoming debt for our children and grandchildren. John McCain is out of touch with what is needed to soothe the markets, but it sounds manly to "strike forth" and fire a guy you decide is responsible. The responsibility lies with Republican love of deregulation, not any one person. You can scapegoat Chris Cox all you want, but it's a smokescreen.

...funny, too, how McCain can stand up to Chris Cox but not George Bush.

In private late Tuesday evening, the McCain campaign circulated a draft statement on the Wall Street crisis that attacked the Bush administration for a slow and "inconsistent" response, and charged that executives at several financial firms had made "misleading and false" statements.

But the criticism never appeared. After being circulated not only among McCain aides but also major campaign donors who have worked in the investment industry, the language was softened.