How Did We Get Here?
In an about face, former SEC Chairman Christopher Cox reported said that Voluntary regulation of investment banks does not work.
That voluntary regulation he referred to the SEC's program of voluntary supervision for investment bank holding companies, the Consolidated Supervised Entity program, which was put in place by the SEC in 2004.
Cox responded that "The failure of the Gramm-Leach-Bliley Act to give regulatory authority over investment bank holding companies to any agency of government was, based on the experience of the last several months, a costly mistake.”
The $58 trillion notational market in credit default swaps is "another similar regulatory hole that most be immediately addressed to avoid similar consequences," Mr. Cox testified.
A credit default swaps buyer "is tantamount to a short-seller of the bond underlying the CDS," Mr. Cox said. CDS buyers do not have to own the bond or other debt instrument on which the CDS contract is based, meaning they can "naked short" the debt of companies without restriction, he said.
"This potential for unfettered naked shorting and the lack of regulation in this market are cause for great concern," he said, asking for authority to regulate the products.
An explanation of the morass we find ourselves in was provided by Fred Rosenberg, a securities expert from New Jersey. He indicates that the current financial collapse began with the sub-prime mortgages used to induce individuals with insufficient assets and income to purchase homes at inflated prices. The sub-prime mess could never have developed had local lenders simply kept and serviced their own mortgages using local credit standards that had evolved over years of economic growth.
Unfortunately, the subprime mortgage mess and the collapse of Fannie and Freddie, AIG, Merrill, Lehman, etc. are directly traceable to the complex financial instruments created by wall street’s financial eggheads who promised reduced risks with increased returns on pools of risky loans. In effect, Fannie and Freddie’s guarantees spurred a torrent of high risk mortgages originated by aggressive, fee driven banks and financial institutions whose new business model rejects direct lending and servicing in favor of originating doubtful loans that were subsequently pooled, packaged and sold off to satisfy the gluttonous appetite of the of these disastrous financial alchemists. It is easy to see the connection to home owners induced by half-truths and promises to execute trillions of dollars in mortgages when the profit in the repackaging was astronomical.
Like our securities clients, mortgagors were induced into taking on a misunderstood risk founded upon the premises that housing prices would increase perpetually thereby creating a cushion for both the homeowner and the financial industry. As housing prices ballooned, home equity became a second source of income eating up all remaining equity, and the reserves established to protect against disaster and deflation were vaporous and illusory and with the contraction in the housing market, defaults were inevitable and predictable.
Thus, the retail sales “channel” for products or services in the financial and banking industries has driven our economy over the levees intended to contain turmoil. The financing markets and the stock markets today are unrecognizable by historical standards and risk management cannot be achieved when it is the newest, most exotic, and least understood instruments, and excessive executive compensation and bonuses, that have changed the game substantially.