Financial Crisis: Deep Down, We All Knew This Was Coming

The question that keeps coming to mind amidst the current financial meltdown is this: why is anyone surprised?

I take no pleasure in asking that question. Along with lots of other people, I've watched over the past few weeks as my modest stock holdings shrink into nearly meaningless positions.

But the question remains: given the myriad warnings that came via Enron -- and the years-long neglect of any meaningful efforts to have serious policing of Wall Street -- why are we surprised to find out that the financial engineers have robbed us blind? The warnings from the Enron meltdown could scarcely have been more clear. Indeed, two key lessons were obvious: financial regulators needed lots more funding, personnel and support; and derivatives markets that operate without proper regulatory oversight and reporting pave the way for financial engineers to privatize profits and socialize costs.

First, the lack of regulators. A key problem with today's financial markets, as it was when Ken Lay and Jeff Skilling were piloting Enron into the dirt, is simple: we have too few cops patrolling Wall Street. That lack of oversight can most easily be understood by looking at the budget of America's single most important financial regulator, the Securities and Exchange Commission.

In 2001, the SEC's budget was $437.9 million. In March 2002, the General Accounting Office issued a report which said that the shortage of money and manpower at the SEC had forced the agency to "be selective in its enforcement activities and have lengthened the time required to complete certain enforcement investigations." So what has happened since then? Precious little. Yes, the agency has a substantially larger budget today than it did during the Enron era. For 2008, its spending authority is $906 million. And for 2009, the agency's budget is projected to increase slightly, to $913 million.

But here's the number that defies explanation: this year, the number of enforcement personnel, the people who go after the financial engineers, is expected to decline. You read that right. Despite the trillion dollar meltdown now underway, the number of SEC enforcement personnel will decline from 1,209 in fiscal year 2008 to to 1,177 in 2009. In all, the SEC expects to have 3,771 employees for 2009.

How does that compare to other federal agencies? Well, for comparison, the Smithsonian Institution budget for 2009 includes funding for 4,324 employees. That's not a slap at the Smithsonian. It houses a myriad of the nation's most treasured objects. But the SEC actually guards the nation's treasure. And yet, Congress treats it like a bastard stepchild. Congress currently doles out more than five times as much money for corn subsidies ($4.9 billion in 2006, the most recent year for which data is available) as it does for the SEC.

It's not just about funding. It's also about rigorous accountability for the regulators themselves. Over the past few weeks, it's become obvious that the SEC was largely co-opted by the companies it was supposed to be regulating. On September 25, the agency's Inspector General, David Kotz, issued a report which that it is "undisputable" that the SEC "failed to carry out its mission in its oversight of Bear Stearns" -- the investment bank the collapsed earlier this year and was taken over by JP Morgan. The report said that the agency missed "numerous potential red flags" prior to the company's collapse and failed to require the investment bank to rein in its risk taking. (The full text of the report is available at: http://www.sec.gov/about/oig/audit/2008/446-a.pdf.)

But what's more telling, according to the report, is the lax approach the SEC had in its handling of what was known as the Consolidated Supervised Entity program, a system set up to oversee the biggest Wall Street firms. There were six holding companies in the program: Bear Stearns, Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, Citigroup and JP Morgan. The report found that the SEC approved the inclusion of Bear Stearns in the program "prior to the completion of the inspection process." Thus, the SEC agreed to regulate Bear Stearns before it even knew if the company was in compliance with the standards it was supposed to enforce.