Cox Testimony Shows True Cracks in Regulatory Foundation

One of my immediate/knee-jerk reactions to the Senate Banking Committee hearings related to SEC Chairman Christopher Cox's role. Reading the mainstream business press, I can't help but get the sense that he's the odd man out; the Fed and Treasury, led by Bernanke and Paulson, are spearheading the government's response, and Cox and the SEC seem like they're along for the ride.

So, I went back and re-read the transcript of Chairman Cox's testimony several times. As I did, I found myself highlighting far more passages than I underlined when reviewing either Bernanke or Paulson's testimony to the Senate Banking Committee.

Cox's points are far more chilling than any of the other insights I've gleaned from these hearings because they highlight the fundamental holes -- some gaping -- in the country's current financial oversight scheme. These problems are structural, sort of like finding out that your home's foundation is seriously cracked in three different places.

Here's one crack, as reported by Cox: "The $58 trillion notional market in credit default swaps -- double the amount outstanding in 2006 -- is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market."

Here's another: The Gramm-Leach-Bliley Act (or GLBA) did not give regulatory authority over investment bank holding companies to anyone. This was, Cox (under)stated, "a costly mistake."

Regulatory authority -- or, more accurately, the lack thereof -- was a primary theme of Cox's testimony. He asserted that "first and foremost, the SEC is a law enforcement agency" and then detailed all of the current and pending enforcement activities related to the credit crisis. Reading that assertion and then pouring over the laundry list of pending enforcement actions, one gets the sense that the SEC is a highly reactive organization; it cleans up messes that it can't prevent. As we all know, these enforcement actions take years to complete. These dénouements finally appear as small paragraphs nestled deep in the Journal, and readers enjoy a twinge of scandal nostalgia: "Oh, yeah, remember all that backdating a few years back?"

But later in his testimony, Cox sheds light on why this is: a lack of regulatory authority. The SEC's program of supervision for investment bank holding companies, the Consolidated Supervised Entity program, was voluntary.

"There is simply no provision in the law that authorizes the CSE program, or requires investment bank holding companies to compute capital measures or to maintain liquidity on a consolidated basis, or to submit to SEC requirements regarding leverage," he explains. "This is a fundamental flaw in the statutory scheme that must be addressed, as I have reported to the Congress on prior occasions."

Any of Cox's Congressional critics (including those running for president) ought to fully disclose how they responded to these reports before calling for Cox's head. Cox may or may not be along for the ride, but he certainly understands the road that got us here. And that understanding is vital as we chart our journey to higher ground.