US Securities and Exchange Commission admits to failure in overseeing investment banks

27 September 2008

The chairman of the US Securities and Exchange Commission (SEC), a longtime proponent of deregulation, yesterday acknowledged that failures in a voluntary supervision programme for Wall Street's largest investment banks had contributed to the global financial crisis. He shut the programme down abruptly, saying the oversight programme was ''fundamentally flawed from the beginning.''

Companies have often sought greater autonomy and lesser government interference in their operations. This has increasingly led to calls for greater deregulation of the financial sector, a sentiment often shared by the regulators themselves. However, with the ongoing financial crisis gobbling up decades-old financial institutions and resulting in billions of dollars in losses, the rationale of such a ''hands-off'' approach is being questioned.

''The last six months have made it abundantly clear that voluntary regulation does not work,'' SEC chief Christopher Cox said in a statement. The programme ''was fundamentally flawed from the beginning, because investment banks could opt in or out of supervision voluntarily. The fact that investment bank holding companies could withdraw from this voluntary supervision at their discretion diminished the perceived mandate'' of the program, and ''weakened its effectiveness,'' he added.

Additionally, according to a report by the SEC's internal watchdog, issued yesterday, the agency had failed to adequately supervise investment bank Bear Stearns and limit the amount of risk it took on. Bear Stearns, starved of cash as customers and other banks doubted its solvency, was sold to JPMorgan Chase & Co in an emergency sale brokered in March by US officials. (See:  JPMorgan Chase acquires Bear Stearns for $2 per share)

The SEC's inspector general found the agency became aware of numerous potential red flags prior to Bear Stearns' sale. These included its concentration of mortgage securities, high leverage, shortcomings of risk management and lack of compliance with international capital standards. But the agency "did not take actions to limit those risk factors," said the audit requested by Republican Sen. Charles Grassley of Iowa.

Bear was part of the SEC's Consolidated Supervisory Entity (CSE) programme, in which five large investment banks volunteered to be monitored for capital and liquidity levels. Merrill Lynch & Co, Lehman Brothers Holding Inc, Goldman Sachs Group Inc and Morgan Stanley also participated. All five have now collapsed or reorganized, and the SEC said on Friday it was ending the CSE programme. (See: Goldman Sachs, Morgan Stanley surrender investment bank status  and Lehman Brothers heads for Chapter 11 as Barclays walks away)