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Cox Says Role of Independent SEC Remains Critical

SEC Chairman Christopher Cox last week testified before the House Committee on Oversight and Government Reform about lessons learned from the credit crisis. Cox said the crisis makes clear the need for a strong SEC and that its mission is more important than ever before. Cox's testimony is posted on the SEC's Web site.

Cox quoted a former SEC chief accountant who said the crisis would never have happened if honest lending practices had been followed. He said the "nearly complete collapse" of lending standards by banks and other mortgage originators flooded the market with near-worthless mortgage paper. The bad loans were securitized and marketed as a way to diversify and reduce the risk, but the result was to spread the problem to a broader audience, according to Cox.

Cox also pointed to the credit rating agencies' contribution to the crisis by sometimes helping to design the securities so that they would qualify for higher ratings. The ratings gave false comfort to investors and skewed the computer risk models and regulatory capital computations, he said. In his prepared statement, Cox outlined the things he would do differently knowing what he now knows. He said that every regulator wishes he or she could have foreseen the complete meltdown of the U.S. mortgage market. There were early signals, he noted, with the deterioration of housing prices and the rise of credit spreads on mortgage-backed securities in late 2007. Unfortunately, no one used a risk scenario that contemplated such a total collapse.

Second, Cox said he would have liked to have questioned all of the assumptions behind the Consolidated Supervised Entities program for investment bank holding companies. He would have wanted the Division of Trading and Markets to challenge its reliance on the Basel standards and the Federal Reserve's 10% well-capitalized test. These standards neither provided adequate warning of the Bear Stearns crisis, nor did they prevent the failure of many other banks and financial institutions.

Cox said he also wished he would have worked "even more energetically" with Congress to close the most dangerous regulatory gaps, including the repeal of the swaps loophole in the Commodity Futures Modernization Act. Congress specifically prohibited the SEC from regulating swaps, he said, and that regulatory black hole has caused great damage. Cox has formally asked Congress to close the regulatory gap involving credit default swaps.

Another area in which Cox wished he had acted more aggressively was in the municipal securities market to improve disclosure. The market entails many of the same risks as other parts of the capital market, he said, but neither the SEC nor any federal regulator has the authority to demand more extensive disclosure. Cox added that he has asked Congress to provide the SEC with the authority to require disclosure equal to corporate disclosure requirements.

Voluntary regulation does not work, he said. Recent experience has shown that regulation must be mandatory and it must be backed by statutory authority, according to Cox. He said it was a fateful mistake in the Gramm-Leach-Bliley Act not to give the SEC or any other regulator the statutory authority to regulate investment bank holding companies.

Cox said the lessons for legislators is that they should eliminate the regulatory gap for investment bank holding companies, recognize each regulator's core competencies and ensure that securities regulation and enforcement remain independent. An independent SEC will remain important in the future, he said. Cox also called communication and coordination among regulators a top priority for regulatory reform. Coordination is difficult under the current fragmented regulatory scheme where financial products and services are treated differently under different statutes, he advised.

Cox said the jurisdictional split between Congressional committees "threatens to forever stand in the way" of rationalizing the regulation of banking, insurance and securities products. He knows from experience how difficult it will be to challenge the status quo and recommended the appointment of a select committee with representation from each of the existing standing committees in order to cut across jurisdictional boundaries. "Government intervention, taxpayer assumption of risk and short-term forestalling of failure must not be a permanent fixture of our financial system," he said.