by Martin Fridson, CFA
In Bed with Wall Street: The Conspiracy Crippling Our Global Economy by Larry Doyle portrays the financial crisis of 2008-2009 as a failure of regulation and oversight. The author contends that while the industry's watchdogs focused on small firms' petty infractions, the leaders of major institutions escaped retribution for irresponsible practices that brought the global financial system to the brink of collapse.
This perspective is useful, even though it downplays the role of monetary policy and does not explain why the housing market got overheated in such countries as Spain and Ireland, which did not engage in the financial deregulation and promotion of low-income home-ownership that the author blames for the U.S. debacle. Unlike many other commentators on public policy, former Wall Street mortgage-backed security trader Larry Doyle cannot be accused of failing to offer concrete alternatives to existing practices. Unfortunately, there are no easy fixes for the problems he tackles.
To remedy the too-big-to-fail problem, which was left unsolved by the Dodd-Frank financial reform legislation, Doyle favors ring-fencing bank activities that do not involve deposit taking or lending. Surely he is right to maintain that a taxpayer-backed safety net cannot be justified for such business lines as asset management and security trading. To add backbone to the securities industry's self-regulation, Doyle wants to create a Financial Regulatory Review Board, staffed and managed by individuals passionately devoted to public service. (Good luck writing that standard into law!)
Doyle proposes these two measures as politically feasible alternatives to his ideal solutions: respectively, reinstituting Glass-Steagall's formal separation of investment and commercial banking and completely abolishing self-regulation. He apparently does consider it feasible, however, to achieve another of his proposed reforms - a constitutional amendment to override Citizens United v. Federal Election Commission. In that decision, the U.S. Supreme Court struck down restrictions on independent political expenditures by corporations.
Probing the intricacies of regulation, Doyle recommends placing the results of customer-broker arbitrations on the public record. This step, he argues, would deter future bad behavior by brokers. But there is a potential drawback. Currently, brokerage houses settle some arbitration cases on reasonably generous terms in order to avoid protracted legal battles, with the assurance that their concessions will not be publicized. By keeping things quiet, they avoid tipping off other potential claimants to the possibility of obtaining comparable awards. Removing the no-publicity condition could induce the brokers to fight those cases to the bitter end, with worse outcomes for the aggrieved customers.
Turning to the underlying causes of the financial crisis, Doyle devotes considerable space to questions surrounding the Financial Industry Regulatory Authority (FINRA), the brokerage industry's self-regulatory body. Did FINRA delay its revelations of a freeze-up in the auction rate security market until it divested its own $650 million auction-rate securities (ARS) portfolio? Is there any truth to rumors that FINRA invested with Ponzi scheme operator Bernard Madoff? In creating FINRA through the merger of the National Association of Securities Dealers (NASD) and the New York Stock Exchange's oversight unit, did NASD officials lie about financial aspects of the deal to their organization's member firms? Unfortunately, Doyle is unable to produce a smoking gun to substantiate any of these allegations.
The book's broader accusation, suggested by its title, involves alleged collusion between regulators and the entities they are meant to regulate. Doyle links this unholy alliance to the government's failure to prosecute individual executives of leading financial institutions for actions that precipitated the financial crisis. There was an "additional lubricant that greased the wheels," he contends: "Evidence indicates that the payoff for many legal eagles within the regulatory and judicial offices is a spin through the revolving door to a plum job at a law firm representing major financial clients or within the chief counsel's office of these institutions." Once again, there is no smoking gun; the limited evidence that Doyle presents is circumstantial.
Jed Rakoff, U.S. district judge for the Southern District of New York, disputes the revolving door thesis. He states that in his experience, ambitious federal prosecutors are eager to bring cases against high-profile suspects. Corporations usually settle criminal charges, but individuals' cases frequently go to trial, creating the possibility of a victory that can make a prosecutor's reputation. Rakoff maintains that this effect more than offsets any harmful impact of the revolving door. He ascribes the lack of high-level prosecutions instead to a variety of factors. They include the U.S. Securities and Exchange Commission's focus on Ponzi scheme prosecutions in the wake of the Madoff scandal and the U.S. Justice Department's pursuit of numerous insider-trading cases that fortuitously arose from audiotapes obtained in connection with the conviction of hedge fund manager Raj Rajaratnam.
In Bed with Wall Street's editorial lapses are commendably few and minor. Doyle incorrectly states that deposit insurance first appeared in the U.S. banking system in the 1930s. In the 19th century, several deposit insurance schemes were launched at the state level, only to fail after a few years. A list of brokerage houses that disappeared in the financial crisis mistakenly includes Countrywide, a mortgage lender. In an alphabetical list of several prominent financial institutions that have disappeared through mergers and acquisitions, Irving Trust appears after Kuhn, Loeb & Co. In addition, Doyle uses "enormity" as if it were a synonym for "immensity."
All in all, though, In Bed with Wall Street represents a worthy addition to the extensive list of books about the financial crisis. It draws attention to several significant incidents that were overshadowed by others that for some reason attracted greater media attention. Some comparatively unsung whistleblowers gain deserved exposure, and the author helpfully sheds light on the impact of lobbyists and campaign contributions on financial rule making. Whether or not one agrees with Doyle point by point, it is hard to argue with his plea for enhanced accountability and effectiveness in the regulatory arena.
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