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Financial Services: Confidence Vs. Consequences

A Stout SEC Has Its Advantages, but the Costs Are Up for Debate

Brendan Hoffman/Bloomberg News File Photo
The SEC allows greater access to securities markets by mitigating risk, but critics say that its rules can hamper growth.

In his tea party manifesto, “Fed Up!: Our Fight to Save America from Washington,” Texas Gov. Rick Perry blasted the “federal alphabet soup” created as part of the New Deal, including the Securities and Exchange Commission.

“Undemocratic, unelected Washington bureaucrats were now (dubiously) empowered to dictate their own preferences to the American people,” wrote the GOP presidential front-runner.

Amid a frustratingly high unemployment rate, conservatives have labeled numerous federal regulations as overzealous or unnecessary. If the government would just get out of the way, they say, the power of free enterprise would be unleashed, the economy would be revived and jobs would be created.

But effective regulation of financial markets is what keeps those markets — not to mention the broader U.S. and global economies — afloat. Without a government hand, in the form of the SEC, the Federal Deposit Insurance Corporation and other agencies, millions of Americans would likely be too afraid to participate in the financial system.

Without the regulation, storing cash underneath the mattress might again be in vogue, and the U.S. economy would be deprived of its lifeblood — capital. Lending would dry up, as would investment, and job creation would shrink in everything from municipal utilities to high-tech startups.

Mercer E. Bullard, a law professor at the University of Mississippi and influential financial services analyst, says there is probably no way to actually quantify the overall economic benefits of the existence of U.S. financial regulatory agencies. But, he says, they “account for a big part of the difference between our economy and the economies of less developed nations.”

“The rule of law has played an integral role in the increase in wealth over the last two centuries, and securities regulation has played an integral role in facilitating capital formation,” says Bullard, who is also founder of Fund Democracy, an investor advocacy group.

But if these agencies are vital in promoting capital formation, critics also say they are limiting economic growth through overly burdensome rules as well as poor management.

There is also a growing partisan divide between Democrats who believe these agencies need more resources to adequately fulfill their missions and Republicans who are reluctant to go along because of deficit concerns or opposition to the Obama administration’s policies.

In the wake of the 2008 financial crisis and a series of recent scandals, confidence in the regulators and the broader financial system is still in serious doubt. And in the end that might be more harmful to job creation than is anything else.

Tarnished Reputation

In response to the 1929 stock market crash and several stock trading scandals, Congress enacted major securities laws in 1933 and 1934, including one establishing the SEC, with its mission being to protect investors; maintain fair, orderly and efficient markets; and facilitate capital formation.

Without the SEC, securities markets would be akin to the Wild West; and in a far riskier environment, there would be far less participation in capital markets.

“If there were no SEC, that would mean no expert enforcement at the federal level and you would see a significant increase in the amount of fraud in the securities markets,” says Bullard. “Investors would be less willing to commit their capital to riskier ventures and there would be a resulting contraction in the economy.”

No one has seriously suggested that the SEC be done away with. But critics of the heavy hand, as opposed to Adam Smith’s invisible one, see plenty of areas where the weight could be lifted a bit.

Most securities sold in the United States must be registered with the SEC, which can be a costly, complex process. With dismal economic numbers continuing to roll in, policy makers have begun taking a look at ways to allow some companies to forgo SEC registration and other rules in an effort to speed up capital formation and economic growth.

House Republicans are pushing a series of bills intended to help smaller businesses avoid some registration rules, and President Obama recently endorsed one of those proposals. The SEC also recently signaled a new focus on helping small businesses boost capital formation when it announced last month the formation of an Advisory Committee on Small and Emerging Companies.

But the agency has come in for significant criticism as of late. In July, the U.S. Court of Appeals for the District of Columbia Circuit struck down a controversial SEC regulation because the agency did not adequately consider a cost-benefit analysis. And its reputation is still severely tarnished for missing a series of major securities scandals, most ignobly Bernie Madoff’s Ponzi scheme.

Paul Atkins, an SEC commissioner from 2002 to 2008 and a visiting scholar at the conservative American Enterprise Institute, says the SEC needs to change the way it does business.

Atkins says that there is a disturbing lack of transparency at the agency, and that it has become increasingly politicized in the cases it takes on and the rules it issues. And for an agency that oversees the financial industry, he says, it is overrun by lawyers at the expense of economists, leading to burdensome and unnecessary regulations.

“The SEC has a role to play. If you have it grounded in costs and benefits, then the marketplace and the taxpayers know what they’re paying for. Ultimately, it’s investors and taxpayers that bear the brunt of what a government agency does,” says Atkins.

Pricing an Overhaul

Throughout the year, lawmakers have clashed over how much to fund key financial regulatory agencies as well as whether they need a fundamental retooling.

The SEC has requested a 23 percent budget increase to update its technology so it can keep up with the rise of high-speed traders and hire the raft of employees needed to carry out new responsibilities under last year’s financial regulatory overhaul, known as Dodd-Frank.

“The key issue today is the issue of adequate resources,” says Kurt Schacht, managing director for standards and financial market integrity at the CFA Institute, a global association of investment advisers.

“They at least need a fighting chance,” Schacht says. “We criticize them for missing things like Madoff, and at the same time we try to cut off the life source of their capability.”

But GOP lawmakers say that regulators need to be more efficient in a time of fiscal constraint, and they are reluctant to spend more money absent major structural changes.

At a House Financial Services Committee hearing last month on GOP proposals to overhaul the SEC, freshman Republican Francisco “Quico” Canseco of Texas complained that the SEC’s budget had tripled over the last decade, yet the agency was “asleep at the wheel” during some of the headline-grabbing scandals of recent years.

“The old-fashioned solution is to throw more money at the problem and hope it goes away. But more money doesn’t solve inefficiency,” he said. “Only a serious reform can fix the SEC.”

Democrats have countered that the agency simply cannot do its job without additional funding, particularly because Congress increased its workload under the Dodd-Frank overhaul.

The law gives the SEC new authority to oversee credit-rating agencies, hedge funds and private investment advisers, as well as a role in regulating the $600 trillion over-the-counter derivatives markets.

Rep. Barney Frank, a Massachusetts Democrat and co-author of the law, has charged Republicans with pinching pennies in an effort to undermine the overhaul, a claim backed up by the words of the Senate’s top Republican.

At a breakfast with reporters in June, Senate Minority Leader Mitch McConnell of Kentucky endorsed spending bills crafted by House Republicans that would freeze the SEC’s budget for the next fiscal year and sharply cut funding for the Commodity Futures Trading Commission, which has also been tasked with regulating derivatives.

“The less we fund those agencies, the better America will be,” he said. “Anything we can do to slow down, deter or impede their ability to engage in this kind of oppressive overregulation, which is freezing up our economy, would be good for the country.”

Bullard says efforts to take on overregulation are legitimate. But he says the new political climate is “scary” in the way that first principles seem to be up for debate.

“There are the critics who make reasonable arguments at the margins as to the appropriate scope of regulation, and then there are the newer critics to the fundamental concept that securities regulation creates national wealth and enhances national power,” Bullard says. “The latter group I believe is a threat to our standard of living, not to mention a threat to our capitalist democracy.”

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