Crimes of the regulators

January 4th, 2009

Bernard Madoff, image courtesy of New York Magazine

Why did the FSA and SEC turn a blind eye to the “elephants in the room” that nearly brought down western capitalism — the massive, unregulated and offshore “shadow banking system” that grew up in the credit bubble years and widespread apparent fraud in the banking sector? Instead of bothering to tackle such things, the regulators preferred to focus on easier targets: small-time wrongdoers like crooked intermediaries or IFAS.

At last, it seems some light has been shone on this conundrum.

Michael Lewis, author of the best-selling Liar’s Poker, and David Greenhorn, president of US hedge fund manager Greenlight Capital, recently argued that the regulators became so obsessed with ensuring “financial stability” that they had a deliberate policy of ignoring — and possibly of covering-up — the really big and scandalous frauds (see The End of the Financial World as We Know It, published in the New York Times on 4th January 2009.)

If true, this would represent not only a dereliction of duty by the folk at Canary Wharf, but also a scarily short-termist approach. When corrupt entities such as Madoff’s hedge fund and other corrupt or ill-managed institutions such as HBOS do blow-up, the fall-out is far greater than if the regulators had stepped in to cauterise the problem at an earlier stage.

Lewis and Einhorn’s main thesis is that the revolving door sydrome is largely to blame. People working for the regulator will be eyeing higly paid jobs on Wall Street further down the line. they are hardly going to be offered these if they rock the boat too much.

Here are some selected quotes from Lewis and Greenhorn:-

One of the great social benefits of the Bernie Madoff scandal may be to finally reveal the SEC for what it has become.

Created to protect investors from financial predators, the Commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors ….

[The SEC] seldom penalizes serious corporate and management malfeasance — out of some misguided notion that to do so would cause stock prices to fall, shareholders to suffer and confidence to be undermined. Preserving confidence, even when that confidence is false, has been near the top of the SEC’s agenda.

IT’S not hard to see why the SEC behaves as it does. If you work for the enforcement division of the SEC you probably know in the back of your mind, and in the front too, that if you maintain good relations with Wall Street you might soon be paid huge sums of money to be employed by it … A casual observer could be forgiven for thinking that the whole point of landing the job as the SEC’s director of enforcement is to position oneself for the better paying one on Wall Street.

At the back of the version of Harry Markopolos’s brave paper [”The World’s Largest Hedge Fund is a Fraud”, submitted to the SEC in November 2005] currently making the rounds is a copy of an e-mail message, dated April 2, 2008, from Markopolos to Jonathan S. Sokobin.

Sokobin was then the new head of the Commission’s office of risk assessment, a job that had been vacant for more than a year after its previous occupant had left to — you guessed it — take a higher-paying job on Wall Street.

At any rate, Markopolos clearly hoped that a new face might mean a new ear — one that might be receptive to the truth. He phoned Sokobin and then sent him his paper. “Attached is a submission I’ve made to the SEC three times in Boston,” he wrote. “Each time Boston sent this to New York. Meagan Cheung, branch chief, in New York actually investigated this but with no result that I am aware of. In my conversations with her, I did not believe that she had the derivatives or mathematical background to understand the violations.”

… The problem within the SEC] is systemic. The new director of risk assessment was no more likely to grasp the risk of Madoff than the old director of risk assessment because the new guy’s thoughts and beliefs were guided by the same incentives: the need to curry favor with the politically influential and the desire to keep sweet the Wall Street elite.

Short URL: https://www.ianfraser.org/?p=959

Posted by on Jan 4 2009. Filed under Blog. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry

You must be logged in to post a comment Login