Markkula Center of Applied Ethics

Keeping the SEC on a Starvation Diet

By William K. Black

Consider these facts about the Securities and Exchange Commission (SEC):

1. U.S. (and world) stock markets have lost trillions of dollars of capital value.
2. The corporate frauds and abuses are a major cause of these losses.
3. The SEC has been starved for budget and personnel for decades.
4. SEC Chairman Harvey Pitt and the Administration cut key SEC staff in 2001.
5. Congress had to order Pitt and the Administration to rebuild the SEC.
6. The Administration is not complying, it is blocking most of the increase.
7. Why? It claims there's not enough money given the deficit.
8. Why is there a deficit? A massive tax cut and the stock market losses.
9. Even Pitt says this will harm SEC enforcement.

How much money are we talking about? The Administration says gutting the SEC budget increase will "save" $208 million. Let me repeat, trillions of dollars of market capitalization have been lost in the U.S. alone because of the inevitable collapse of a stock "bubble" that fraud helped inflate and by the loss of investor confidence produced by the wave of fraud by controlling persons ("control fraud"). A trillion dollars is a million times bigger than $1 million. We are losing hundreds of thousands of dollars as a society for every dollar we "save" by keeping the SEC on a starvation diet.

The administration is senselessly turning the scandals into a partisan issue. The SEC's budget has been kept absurdly low since 1980, under both Democratic and Republican administrations. The results have been disastrous. The SEC now reviews only a trivial percentage of security filings and its staff turnover has become so severe that it is a hollow organization. The old joke is that the function of financial regulators is to "bayonet the wounded." The SEC is unable to do even that; it scatters the ashes of the dead.

We have now run a real world experiment. Conservative economists have long preached that the markets are so efficient that control fraud would never be a serious problem. They claimed it would be spotted by the top audit firm and stock analysts. They claimed that rules against fraud were neither necessary nor even important because markets effectively excluded the fraudulent. They claimed that a vigorous SEC was a bad thing that helped incompetent competitors harass "entrepreneurs" like Michael Milken (the Drexel junk bond king) and his band of corporate raiders. Fine, we tried it their way. Does anyone like the results?

And for the historically minded, I would note that it was these same conservative scholars who thought it was a fine idea to deregulate and desupervise the savings and loan industry in the 1980s. The federal agency that (failed) to regulate the S&L industry was first starved for funds and examiners, denied permission to pay its staff competitive salaries and then run by deregulatory zealots. (All three things are true of the SEC.)

It is time for the U.S. to take seriously the advice we give constantly to developing nations. Fraud is the enemy of free markets. It erodes trust and can cause horrific losses that are vastly greater than the "take" received by the fraudulent. Vigorous, good government is critical to restraining fraud and making markets efficient. The problem isn't the advice we give; it's good advice. The problem is that we need to practice what we preach. A vigorous SEC is good for investors, business and workers.

Financial regulation is one of those "you can pay me now, or pay me (much more) later" situations. The largest recent scandals each cost investors more than the SEC's entire budget over its entire existence. If the administration wants to save money it should provide the SEC the entire amount authorized by Congress. It should also ask for a supplemental appropriation to beef up the Justice Department and the FBI because the need to allocate so much of our law enforcement resources to the war on terror is creating a critical weakness in our already grossly inadequate effort against major white-collar crimes.

William K. Black is an Assistant Professor at the LBJ School of Public Affairs, the University of Texas at Austin and a Visiting Scholar at the Markkula Center for Applied Ethics. He is a criminologist, lawyer, and former S&L regulator.

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