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Cox Calls for Government Exit Strategy From Market Intervention

SEC Chairman Christopher Cox discussed the importance of an exit strategy now that the government has gotten so deeply involved with troubled financial institutions. In remarks at a joint meeting of the Exchequer Club and Women in Housing and Finance, Cox said an exit strategy is critical if the financial institutions are ever to return to fully private ownership and funding.

Cox reviewed some of the events leading up to the market crisis, including bad lending practices and the securitization of bad loans that received top ratings from the credit rating agencies. He noted that Moody's alone has now downgraded over 5,000 mortgage-backed securities. As of September 2008, he reported that banks have experienced over a half trillion dollars of losses on U.S. subprime mortgages and related exposure.

Cox discussed the SEC's examination of the three major credit agencies which uncovered significant weaknesses in their practices, including conflicts of interest. The SEC has adopted a number of reforms to address the lack of transparency in the industry.

The Emergency Economic Stabilization Act and the Housing and Economic Recovery Act gave the chairman of the SEC a formal role on the oversight board for the Troubled Asset Relief Program and the government sponsored enterprises. In that capacity, Cox said he has considered how the government came to intervene to the extent that it has and how to ensure that the intervention comes to an end and is unwound as early as possible.

The amount of federal resources committed so far this year to support the financial markets, housing and financial institutions exceeds $6.4 trillion, according to Cox. In addition to the staggering amount of federal spending and the debt burden that it imposes, Cox said the government's role in the economy also poses concerns. The government is now a shareholder in many institutions and firms, he explained, and the recipients of federal funding and guarantees can expect additional scrutiny by Congress.

Cox said the government intervention will bring with it demands for compliance with Congressional investment preferences and corporate governance policies. He believes the demands will grow in direct proportion to the timeframe in which the investments and guarantees remain outstanding. These are good reasons for policy makers to develop an exit strategy for each of the federal interventions, in his view. Combining the roles of market regulators and market participants could threaten the integrity of the regulatory system, he warned, and will likely produce unintended consequences.

Cox emphasized the importance of ensuring that the measures that have been taken in the past month are temporary and will be self-liquidating. Government programs do not go away unless there is a plan to eliminate them, he said. If the exit plan is not strictly adhered to, the vast new federal roles will last forever, he said.

Cox said the objective in each instance should be to monetize the federal government's positions as quickly as possible. The government must constantly monitor its positions, the firms and the markets. The government must also be mindful about the size of its positions, he said, in order to minimize any disruption to the capital markets when it liquidates its positions. Cox said the liquidations should be regular and predictable in order to reduce market surprises and avoid depressing the market into which the government is selling.

The exit strategy with respect to Fannie Mae and Freddie Mac will require a resolution of the conflict in their current status, according to Cox. These GSEs must be returned to financial health, he said, or Congress and the taxpayers will have to bail them out at a much greater cost than has already been allocated. Cox said that Congress and the new administration must decide whether to continue the GSE programs in their current form or to consider alternatives such as privatizing and breaking them up into competing companies or creating a cooperative structure similar to the Federal Home Loan Bank system.

If the tough questions are addressed now, and sturdy plans are made for the future, Cox said the mortgage market, the financial services industry and the broader economy will be positioned for renewed growth and prosperity.