Rep. Scott Garrett (R-NJ), who chairs the House Financial Services subcommittee that oversees the Securities and Exchange Commission, says he finds the idea of giving financial regulators more funds “troubling,” since the agencies failed to prevent the 2008 financial crisis. “It’s only in government, especially in Washington, where you have agencies that failed in their core assignments in the past, and yet they are rewarded with more authority and bigger budgets,” Garrett said.
Actually, it’s only in Washington where one can, with a straight face, blame the federal government’s regulatory agencies for being ineffective after implementing conservative policies rendering their effectiveness impossible. Conservatives spent years pulling the threads out of the financial regulatory framework and appointing regulators who actively ignored their agencies’ mission. This led to the massive financial regulatory failure that caused the U.S. housing and financial crises. And now these same conservatives are using that failure to deny the agencies funding.
Before examining this sleight-of-hand deregulatory gambit by conservatives in the new 112th Congress, let’s first set the record straight for Rep. Garrett. Last week’s final report from the Financial Crisis Inquiry Commission, which was charged with investigating and explaining the causes of the 2008 financial crisis, laid out a wide-ranging indictment of the risk-taking, predatory lending, and outright fraud that occurred on Wall Street over the past decade. The FCIC’s ultimate conclusion was that “this financial crisis was avoidable,” but not avoided, largely because conservative financial regulators were convinced that the free market had the capability to police itself.
Earning particular ire in the FCIC report are two of the prominent financial markets regulators: the Securities and Exchange Commission and the Commodity Futures Trading Commission. The SEC is charged with policing securities and markets fraud, while the CFTC regulates the futures and options markets, including that for derivatives, those complex financial instruments at the heart of the financial crisis.
These two agencies undoubtedly dropped the ball in the run-up to the financial crisis, failing to both keep up with the latest financial innovations and to enforce the laws already on the books. But they were also hamstrung by the practical implications of conservative economic doctrine, which says that regulatory agencies are burdensome and unnecessary, since the market can self-regulate.
This philosophy led to the appointment of regulators who had little to no interest in actually regulating. Take former SEC Chairman Chris Cox. Under Cox, the SEC ignored warning signs that big investment banks like Bear Stearns were taking on too much risk, and then censored internal reports detailing that failure. Republican SEC Commissioner Paul Atkins actually told a reporter that “It is difficult for regulators to question people who are in the business of taking risk—that’s what a financial institution is all about.”
During the George W. Bush administration, the SEC also did away with two key financial market safeguards: The debt-to-net capital rule was eliminated in 2004, allowing investment banks like Merrill Lynch to leverage up to 40-1, while the “uptick rule” governing the sale of stocks “short,” was eliminated in 2007, allowing speculators to hammer an already wobbly stock market.
Meanwhile, conservatives in Congress, led by former Sen. Phil “mental recession” Gramm (R-TX), prevented the CFTC from policing credit default swaps by attaching the Commodity Futures Modernization Act of 2000 to an unrelated appropriations bill and passing it on a Friday night before Congress recessed for the Christmas holiday. In its report, the FCIC identified to the CFMA the derivatives that it shielded from regulatory oversight as being “at the center of the storm” when the financial crisis finally hit home.
The consequences of hewing to this conservative laissez-faire regulatory philosophy were widespread and devastating. The financial system teetered on the brink of collapse, requiring extraordinary intervention from the federal government to prevent a sequel to the Great Depression of the 1930s. Millions of workers are still unemployed, and millions of homeowners are facing foreclosure as a result of this mess.
In order to better protect consumers and taxpayers, and to provide the government with the necessary tools to protect against the next financial meltdown, Congress and the Obama administration approved the Dodd-Frank financial reform law in the summer of 2010. The law strengthens the abilities of both the SEC and the CFTC to oversee the financial system, and grants the CFTC the ability, for the first time, to police over-the-counter derivatives in a way that will make the market transparent and allow regulators to hold bad actors accountable.
To accomplish these tasks, however, the CFTC and SEC need additional funding. The outgoing 111th Congress anticipated this problem last year by allocating funding for the implementation of Dodd-Frank, but House Republicans are taking advantage of their new majority and refusing to open the purse strings.
The current continuing resolution under which the federal government is operating, which keeps funding consistent at fiscal year 2010 levels through March 4, did not include additional money for the SEC or CFTC. Due to budget constraints, the SEC has already put on hold certain aspects of Dodd-Frank implementation, including the creation of a new office meant to aid financial whistleblowers. The agency is also “failing to follow up on tips about potential wrongdoing and postponing examinations of money managers and brokers who are far from their offices,” since it can’t afford to send inspectors out of town. The CFTC is facing very similar problems.
Now back to Rep. Garrett and his conservative supporters of more Wall Street deregulation. The conservative attempt to deny the SEC and CFTC additional funds, at its core, amounts to deregulation by defunding. And congressional conservatives have found some powerful allies in their effort, including the U.S. Chamber of Commerce, whose president, Tom Donohue, has pledged to “starve to death financially” new regulatory rule-writing efforts.
Between 2000 and 2008, the regulatory agencies faced downward pressure on their budgets, with the SEC experiencing an overall budget reduction between 2006 and 2007, and the CFTC seeing the same between 2002 and 2003. During these years, the financial industry was exploding at a rate that would have made it difficult for regulators to keep up under the best of circumstances.
As Rep. Barney Frank (D-MA) said, current funding levels for the regulatory agencies “predate financial regulation, predate regulation of derivatives, and predate investor protection.” And conservatives would prefer to keep it that way, even if it means the next avoidable crisis leads to further economic turmoil.
Pat Garofalo is Economic Policy Editor for ThinkProgress.org at the American Progress. Center for American Progress Associate Director for Tax and Budget Policy Michael Linden and Center for American Progress Action Fund intern Kevin Donohoe contributed research.