Starving The SEC Won’t Fix Wall Street

Ezra Klein has a pretty silly post up about the Wall Street regulation bill and the SEC’s funding. He argues that since the SEC failed miserably in the years leading up to the crisis, it’s absurd to see them getting more funding in its aftermath. Like bloated banks, Ezrak says, bloated regulators are just getting bigger, even after Congress passed its Wall Street overhaul. It’s not a good argument.

Ezra is unquestionably correct to note that the SEC failed miserably during the Bush years. And there should be no question that the agency’s failures were far beyond mere budgetary inadequacies. You can’t blame the Madoff missteps—which were repeatedly brought to the agency’s attention by whistleblowers, only to be ignored—on insufficient funding. On Madoff, at least, the SEC was slapped in the face with egregious fraud, and failed to do anything about it. The SEC’s leadership spent years implementing a hands-off approach to regulation and enforcement, and the Madoff scandal was a direct result.

I’d actually go further in criticizing the agency than Ezra does (at least in his post). It’s not just that it failed miserably in the years leading up to the crisis—it’s still getting things wrong now. The SEC has ended some high-profile abuses, but it isn’t coming down very hard on the people it accuses of malfeasance. The Goldman Sachs settlement was pathetically small for a case that could have sunk the entire firm. The action against Barclays for illegally laundering money from Iran basically lets the bank off the hook. Bank of America executives who lied to their shareholders about their bonuses went unpunished. The proposed settlement with Citibank over its $40 billion lie on its subprime exposure is an absolute disgrace.

But complaining that the SEC is getting some bloated new budget is still totally wrong-headed. The SEC’s job is to police all of corporate America for financial fraud. The supposedly outrageous new budget that the agency will receive next year is . . . wait for it . . . $1.2 billion. That’s roughly 6 percent of the 2009 bonus pool for financiers who work in New York City alone.

During the Bush years, SEC Chairman Christopher Cox systematically curtailed the SEC’s budget in order to prevent regulatory enforcement and fraud prosecution. The agency’s budget was virtually unchanged from 2004 through 2009, despite an explosion in the size and scope of Wall Street’s activities over that time-frame. Cox was also straightforwardly incompetent and irresponsible—he refused to take part in the Bear Stearns bailout negotiations because he didn’t want to leave a birthday party.

The problem is not that the SEC is so bloated it can’t get anything done. The problem is that political appointees at the agency are making decisions that are very bad for the economy thanks to political motivations. If we want the basic functions of law enforcement to be fulfilled, we have to put cops on the beat. The $1.2 billion budget for next year is 20 percent higher than last year’s budget, and it will go toward putting more rank-and-file regulators to work looking for fraud and abuse. Does anybody really want to see fewer cops on the beat after what happened in 2008?

When a regulatory agency is starved for funding and lead by an astonishingly inept laissez-faire ideologue, the result is going to be failure. That doesn’t mean that a better-funded agency with different leadership can’t get something right. Reasonable funding alone won’t solve things—people at the top still have to make good decisions. But securing decent funding levels is still a necessary step. The alternative, which Klein appears to be backing, is regulatory nihilism in which failures committed by people who don’t believe the government can ever do anything right prove that the government can never do anything right.

That’s not to say that regulators alone should be relied on to protect the economy from financial calamity. Empowering regulators is a necessary step for economic security, not a sufficient one. We also have to structure markets so that epic frauds and financial calamities are much more difficult to create. That means breaking up the big banks, enacting hard, Congressionally-binding caps on leverage and creating strong barriers against the types of financial business that different firms can engage in (Glass-Steagall, or something like it).

Congress failed to adopt any of these serious structural reforms with its Wall Street overhaul, instead taking the Obama administration’s advice and simply granting regulators broader powers to cope with trouble when it arises. That’s not going to work. But continuing to starve the SEC isn’t going to improve things either.