The End of Supervised Entities - Now What About Swaps?

The U.S. Securities and Exchange Commission [SEC] announced Friday a decision by the Division of Trading and Markets to end the Consolidated Supervised Entities [CSE] program, now that the five participants have collapsed or reorganized.

SEC’s Chairman Christopher Cox in his statement made it very clear that the CSE program was fundamentally flawed from the beginning, since investment bank holding companies such as Goldman Sachs (GS), Morgan Stanley (MS), Merrill Lynch (MER), Lehman Brothers (LEH), and Bear Stearns (BSC) could opt in or out of supervision at their discretion - thus significantly diminishing the effectiveness of the program, and practically leaving the SEC or any agency for that matter with no authority to regulate.

“The last six months have made it abundantly clear that voluntary regulation does not work,” SEC Chairman Cox said.

However, Mr. Cox in his statement pointed out that with each of the major investment banks that had been part of the CSE program now reconstituted within a bank holding co., they will all be subject to Federal Reserve’s statutory supervision authority. The Fed from this point forward will be able under the Bank Holding Company Act to impose and enforce supervisory requirements on those entities. Thus, noted Mr. Cox - “there is not currently a regulatory gap in this area”.

Friday’s announcement coincided with criticism by the SEC’s inspector general (Mr. H. David Kotz) of the agency for failing to properly supervise broker dealer risk assessments in a program run by the Division of Trading and Markets. The purpose of this program is for Trading Markets to assess the risks to registered broker-dealers that may stem from affiliated entities, including holding companies and to keep those involved informed of significant events that could adversely affect broker-dealers, customers and the financial markets.

“Trading and Markets [TMs] failure to carry out the purpose and goals of the Broker-Dealer Risk Assessment program”, said Mr. Kotz in his report, “hinders the Commission’s ability to foresee or respond to weaknesses in the financial markets. This may impact TM’s ability to protect customers from financial or other problems experienced by broker-dealers”.

Mr. Cox said the report’s major findings echoed the concerns he expressed to Congress this week. Unfortunately, he added, there is more work to be done. Mr. Cox also reiterated the fact that the approximately $60 trillion credit default swap [CDS] market still remains unregulated by any agency of the government. He urged Congress to take swift action to address the issue.

Chairman Cox concluded by saying that based on CSE experience, it is critical that Congress ensures there are no similar major gaps in SEC’s regulatory framework in the future.

Comments

[swaps:]

The debacle we are experiencing also proves that regulators don't even regulate what they are supposed to.
In Friday's Denver Post Jeff Wilson alleges the total value of all derivatives is $600 trillion. Excluding those, the estimated total wealth of the U. S. is $57 trillion. If 10 percent of the derivatives go bad, you do the math.

2008 Sep 27 12:19 PM

[Tom Armistead:]

Congress in their wisdom exempted credit default swaps from regulation by the SEC. They did not wish to stifle innovation.

After they are done posturing and pandering over the Financial Stability Rescue Plan, they could address the root causes of the problem.

CDS would be a good place to start.

2008 Sep 27 01:13 PM

[Rumpole:]

Tell me something, will the $700 billion bailout allow parties whose CDS obligations were triggered by the BSC, AIG, LEH, WAMU or other failures to dump them onto the taxpayer?? If so, I guess Paulson's successor will be back begging for more money from Congress except this time she/he will be prostrate rather than on one knee!

2008 Sep 28 02:38 PM

[barsell:]

Rumpole Nobody is going to dump anything on the government. The Fed banks will sit down at arms length with the debt sellers and negotiate the best deal. The debt will be bought at market price or better ie 50 cents on the dollar or whatever. The loss rate will already be washed out of the purchase price. Since treasuries go for 3-4 percent and these debts go for 6-7 percent the government stand to make a great deal of money provided however that Congress does not destroy the Feds negotiating position by imposing a lot of conditions such as mandatory equity and pay cuts for the sellers.

2008 Sep 28 06:01 PM