Bill Black, Fraud, How Regulators Fail and Changing Wall Street

If you didn’t see this testimony from Bill Black at the Lehman earlier this week, it’s a must watch. Out of the normal ho-hum congressional testimony of nobody is ever to blame for anything, Black calls out Lehman for committing fraud (with Fuld sitting near to him), and explains that Federal regulators weren’t half as serious as they were during the S&L crisis:

A lot of this talk is about “regulators failing.” It’s true, regulators had the power to do a lot of what they needed to do, and they also face huge influence and incentives to do the opposite during a cycle. I think it is important to not forget that, and keep it in mind when thinking through a regulatory regime.

But it is also important to remember that they “failed” also in part to a specific ideology which said that they were superfluous at best, destructive at worst. Look at why Bill Clinton said he was wrong to accept the derivatives deregulation late in his term: he said he was wrong because everyone was sophisticated and there would be no spillover effects. He was influenced by the efficient markets hypothesis which told him that market competition could destroy any problems with market structure, fraud and incentives, and the Modigliani-Miller hypothesis, which told them that leverage just wasn’t that important because an efficient market will always balance it out in costs, ignoring that MM requires a lot of assumptions of what happens in a market and that a financial firm isn’t like any other firm.

It’s good we are getting a resolution authority. I like that we are getting a derivatives bill that will help undo the deregulation Larry Summers and Phil Gramm did around 1998-2000 (and that’s the strong language!). I think the CFPA can make a difference.

But stepping back, how do we get out of the current culture of Wall Street? The fraud, the conflicts of interests, the ripping the face off the client, the idea that hiding leverage would only upset yappers who don’t get how it really works?

I think a return to fiduciary responsibility, private rights of action, and a occupational concern for a job well done, over a narrow concern to maximize shareholder value at every turn (even blurring the lines of fraud) is one avenue. Senator Menendez will offer an amendment that gets stronger off-balance sheet and fiduciary requirements into the bill. I think a serious effort at investigating what kind of frauds happened, especially with a special prosecutor with a real budget and powers, is necessary for cleaning out the mess. But is there enough time left to get a good debate on it in the Senate?

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2 Responses to Bill Black, Fraud, How Regulators Fail and Changing Wall Street

  1. Pingback: Friday’s Caught On The Web - The Source - WSJ

  2. sneezy says:

    I read Black’s written testimony earlier today, and found this part interesting:

    The [Valukas] Report documents at least three major deficiencies in Lehman’s corporate governance that need to be addressed globally. First, it points out that Lehman, and many other Delaware corporations, have eliminated the fiduciary duty of “care.” This statutory change is the product of a naïve “law and economics” theory of corporate law that I addressed in an article (Black 2003). Judge Easterbrook and Professor Fischel are the leading proponent of the theory. They view managers as so pure that “a rule against fraud is not an essential or even necessarily an important ingredient of securities markets” (1991: 283). Alan Greenspan has admitted that he had a similar view and that events have falsified this naïve account. It is insane to withdraw accountability for negligence. Doing so encourages negligence. Congress should mandate that corporate officers and directors be subject to the fiduciary duties of care and loyalty. They will still, of course, have the very substantial protection of the business judgment rule.

    While restoring the fiduciary duty of care is no panacea, it seems to me that it would be a useful step. As for changing the culture of Wall St. — the way that people in the financial industry perceive their role in the economy and society — I’m afraid that that is probably a very long-term project.

    Rooting out real fraud, though, should not be as big a problem. While I am in favor of more regulation, I think that many of the problems in recent years could have been avoided by enforcing regulations already on the books, but that during the Bush administration, regulatory agencies were stacked with leadership that very deliberately chose not to use powers readily available to them. That can be solved by staffing the agencies with regulators who actually believe in the value of enforcing regulation.

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