Who's More to Blame: Congress or the SEC?

Join the Fool as we assess blame for this financial meltdown -- March Madness bracket style! Below is one of four second-round matchups you can vote on … enjoy!   

The case for Congress, by Rich Smith
I've said it before and I'll say it again: It's Congress's fault.

Last week, you agreed with me that Congress is at least more to blame for the financial meltdown than are Moody's (NYSE: MCO  ) or McGraw-Hill unit S&P. This week, let's review why Congress bears more blame than the SEC.

Reason No. 1
The SEC works for Congress.

Reason No. 2
Actually, we don't need a reason no. 2. Here's why:

Established by Congress in the wake of the last Great Depression (hereafter to be termed "the Lesser Depression"), the SEC acts as Wall Street's anti-fraud cops. When IBM (NYSE: IBM  ) spends a little too freely "competing" for foreign contracts, it's the SEC that steps in to put a stop to the hanky-panky.

Allegations of insider trading ahead of a big acquisition by General Electric (NYSE: GE  ) ? That one belongs to the SEC as well. Steve Jobs finagling the dates on his Apple (Nasdaq: AAPL  ) options again? Bernie Madoff robbing people blind? You know who to call: the SEC.

"Please hold. Your economy is very important to us ..."
Problem is, if you do call the SEC, there may not be anyone left to answer the phone. As our nation's economy boiled up and boiled over these past few years, Congress found $320 million to fund a bridge to nowhere -- but froze the SEC's budget from 2005 through 2007, and approved only a piddling increase in 2008. After inflation, this worked out to a budget cut of about 7% over the past four years -- and the loss of 80 employees at the SEC enforcement division.

Don't blame the SEC for this mess. Blame the people who picked the SEC's pockets to line those of their campaign contributors, who gutted Glass-Steagall, and who left investors to fend for themselves.

Blame Congress.

The case for the Securities and Exchange Commission, by Eric Bleeker
In the previous round, I emphasized that while the SEC may have a useful purpose, in the end, they just don't have any clue how to do their jobs. So to that end, it's worth bullet-pointing a couple of the agency's notable failures:

  • It ignored repeated warnings from Harry Markopolos that Bernie Madoff was running a Ponzi scheme. Mr. Markopolos sent the SEC letters demonstrating that there weren’t high enough options volumes for Madoff to possibly execute his split strike options strategy. Markopolos describes the SEC as "untrained in finance … lawyers without any financial industry experience."
  • In 2004, the SEC altered its net capital rule to allow five banks -- Bear Stearns (now a part of JPMorgan (NYSE: JPM  ) ), Lehman Brothers, Merrill Lynch (now a part of Bank of America (NYSE: BAC  ) ), Goldman Sachs (NYSE: GS  ) , and Morgan Stanley -- to triple the amount of leverage they employed from 12-to-1 to 40-to-1. Notice a common theme with those five banks? Yup, three of them don't exist anymore.

However, aside from these glaring examples that have been the subject of media scrutiny, it's also worth noting what the SEC didn’t do.

Inadequate disclosures of counterparties
While accounting rules determine what type of financial information companies must reveal, the SEC has the ability to require greater disclosure if current financial information is deemed inadequate. Where could this have been used? Well, for starters, the SEC could have (and should have) looked into requiring disclosure on how intertwined companies' market risks and leverage were.

Secondly, the SEC was eerily quiet when legislation was being passed that reduced oversight on dangerous derivative contracts. The continued ignorance about potential dangers indicates that Mr. Markopolos was right: The SEC is an organization that's good at checking paperwork to ensure that I's are dotted and T's are crossed, but it lacks the financial experience necessary to prevent sophisticated fraud.

Blame the specialists: the SEC
So, while I feel that Congress is generally a fine choice to blame in this whole mess, forgive me if the SEC's ineptitude shocks me a bit more. Most members of Congress are generalists by nature and shouldn't be expected to know the ins and outs of the financial world. However, the SEC is supposed to be an advocate that alerts Congress to potential dangers and protects investors from fraud.

Yet in this mess, they've not only sat idly by while measures were passed to de-fang them, but also took proactive measures that hurt investors. They're the Los Angeles Clippers of government, going above and beyond their ability to be incapable.

Vote now!
Now it's your turn. Who do you think is more responsible for the mess: Congress or its financial watchdog, the SEC? Make your pick below.

Check out the Fool's entire 2009 March Madness bracket here.

Fool contributor Rich Smith owns shares of Moody's. Eric Bleeker doesn't own any shares of the companies mentioned. Moody's and The McGraw-Hill Companies are Motley Fool Inside Value picks. Apple and Moody's are Motley Fool Stock Advisor picks. JPMorgan Chase is a former Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


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