'I Think the SEC Was Distracted'

Outgoing Securities and Exchange Commissioner Paul Atkins talks about bailouts, hedge funds, and what he thinks the SEC should have been regulating.

Nick Gillespie & Matt Welch from the March 2009 issue

(Page 3 of 3)

For example, when Amaranth, which was a $6 billion hedge fund, a relatively small hedge fund, blew up, I guess it was the summer of ’06, it didn’t really cause a big problem for the marketplace. But it took a number of weeks, with about 300 people from the two institutions that wound up buying the book and business of Amaranth, it took all those people that amount of time to just figure out what this hedge fund had as far as their investments were and what the valuation of it was. And that’s because most of the investments were in what we call over-the-counter types of securities, and so they were not standardized. It took some doing to try to figure out what the value was.

So that was just an indication of what was going to happen later on with Bear Stearns and Lehman and everything else, because there was no type of standardized exchange trading of these collateralized debt obligations. And a lot of these were held, as we saw, not necessarily by hedge funds. It was really the regulated entities, the major institutions that caused the real crisis of confidence.

reason: Why wouldn’t the market, this fierce disciplining force, create a system to certify trading activity and valuation?

Atkins: Well, there were outside parties—accountants, accounting firms, and, of course, the ratings agencies. Those were there to sort of give comfort to other parties, and the marketplace itself was starting to work on ways to try to have some sort of increased transparency with respect to these particular obligations. But the SEC has a statutory obligation to look at investment banks on a risk-management basis, to say, “What exactly do you think you’re worth, and how do you think you’re relating to the marketplace in general?” Those sorts of questions could have and probably should have been asked a little bit more forcefully.

Not that the SEC would have outlawed any particular type of product; I think that’s a mistake, and unfortunately that’s being talked about by some people on Capitol Hill. It’s not the instrument itself that’s bad; it’s the way people either invested in them without knowing what the risks were or were not being clear on how to value them.

reason: The best way to arrive at a price is to let people fail. Yet we’re now in a climate in which nothing shall fail ever again. Aren’t you worried that we’re creating the mother of all moral hazards?

Atkins: Oh, absolutely.

reason: What is too big to fail, or what’s the sliding scale to say the government should intervene here but not here?

Atkins: Well, the trouble with Bear Stearns and Lehman and others was that they were so intertwined with some of these issues we’re talking about that they’re unstructured failures. With Lehman, it just was allowed to go bankrupt right away. That created such a jolt to the system because, again, you had clients and others who had assets there at the firm that were suddenly all frozen in bankruptcy proceedings. And that had a direct and predictable effect, I would argue, on the financial system.

reason: So anything of a certain size that had a lot of these opaque instruments is too big to fail?

Atkins: I would take issue with the whole argument “too big to fail.” I mean, that’s a banking term, where the banking supervisors have traditionally looked at major banks and have said, “Well, we can’t allow them to fail and so we will step in and either do a workout by government intervention and government taking over the bank itself to run it, or to find some sort of buyer,” or whatever. I think there were probably other ways that, especially in working with our counterparts abroad, where perhaps in the Lehman situation you could have had a smoother landing. The firm still would not have continued, but at least with respect to the customer assets, they would not have been just thrown into limbo, especially in the U.K. That’s not necessarily the U.S. government’s deal. It’s more the British government’s issue, but that was the thing that I think really precipitated the jolt to the system.

reason: Now, though, we’re in a situation where no company is allowed to fail. In the financial sector, in the airline industry, in the auto industry, in mortgages, it creates a moral hazard in the sense that investors no longer have to worry about losing it all. How bad is that to the system down the road, and what should the government be doing instead?

Atkins: With respect to some of the other institutions, again, ultimately it’s not necessarily the shareholders that come out ahead. Now if some are being artificially propped up, then I think that—

reason: How do you make a distinction between Goldman Sachs or Citigroup? Are they being “artificially propped up,” or is it good to be throwing $25 billion of taxpayer money into preferred shares?

Atkins: Well, I mean, we have the whole TARP [Troubled Asset Relief Program] issue right now, where clearly the government’s trying to come up with a reasonable solution. The problem is, looking forward to five years, 10 years from now, how all that will be unwound. And then, of course, the precedent that’s being set. I think, you know, the real moral hazard issue is there. And so has this made things better through this intervention or not?

reason: What does your gut say? Is the Paulson plan a good thing or a bad thing?

Atkins: It’s hard to put myself in their situation because I don’t have all the facts that they do. I think I would have preferred the way they started out, with the idea that was proposed by the House Republicans back when the bailout was being debated, to either insure assets or, as the original plan was, to buy assets.

The problem with buying assets—as people quickly found out, and was my misgiving in the beginning—was how do you set the price of particular securities that are not being traded and where there is no market price and anything that you do is liable to influence the market? That’s why I thought the insurance proposal was intriguing.

But to inject government capital, which is crowding out private capital, I think is in the long run not a good idea.

reason: A lot of people are saying we need a new New Deal. One of the things that FDR did was what he called “bold, persistent experimentation,” which meant that you never knew as an investor or as a business owner or as a worker what was going to happen next. We seem to be in a phase where Paulson literally is having meltdowns on TV, where his plan keeps changing. And then there’s a sense that when Obama comes in, there will be a new stimulus package, there will be a new bailout plan, etc. Is the uncertainty as bad as even a certain plan that is bad?

Atkins: A lot of commentators have talked about how the uncertainty is a problem, and I can certainly agree that that is one thing that makes it difficult for folks to plan. But on the other hand, you know, from the Treasury side, it’s been a dynamic situation with a lot of things blowing up that they had not anticipated. Like when Lehman Brothers failed, Baltimore Gas & Electric had problems because Lehman Brothers had been one of their major trading partners for energy futures and things like that. Who would have thought that a utility, which is supposedly one of the most stable types of institutions, would fall into that? That sort of collateral thing, and then AIG falling, I think had people really scrambling.

reason: You were talking earlier about how the important thing is to maintain confidence in the system. Is the real root problem fiat currency, where you have to believe in the paper because there’s nothing backing it?

Atkins: That’s one thing that I think people will be debating intensively here over the next few years.

reason: What’s keeping you up at night? What’s the next horror right around the corner?

Atkins: Ultimately, frankly, it’s what we’re talking about: currency. I mean, the on-balance-sheet and off-balance-sheet obligations that the government is taking on are now really, really large. When you look historically at other countries where debt obligations have crept up to 40 percent, 50 percent or so of GDP, how the ratings agencies look at that and how investors look at that becomes a bit problematic.

reason: Is it conceivable that the U.S. would become like Argentina? Argentina in 1900 was something like the fourth largest economy in the world, and it has never been like that again. Could the U.S. actually go into that kind of national receivership?

Atkins: Well, let’s hope not. I think we have a lot more going for us than Argentina did. But again, inflationary pressures have got to be a concern of everybody.

reason: Most of the financial crises that we’ve lived through usually come out at the end with a forcible spoon-feeding of medicine to a perhaps unwilling patient, whether it’s Paul Volcker raising interest rates to ridiculous degrees to beat inflation in the late ’70s and early ’80s, or in Eastern Europe, which went through any number of austerity programs.

Is there any austerity today? Are we missing the austerity that’s happening right now, or is it just the fact that we’re suffering higher unemployment, more foreclosures? Is that the medicine that is going to get us through to the other side?

Atkins: The austerity right now is the huge deflation that we have in assets. If the housing bubbles burst and asset values are declining, there’s plenty of austerity to go around, especially on the financial instrument side. But once we get through the deflationary thing, what’s going to happen with all the pent-up money that’s been put into the system? That’s going to be a big issue.

Comments

|2.10.09 @ 12:06PM|#

I realize H&R is the All-Stimulus-All-the-Time blog now, but we might pause the "Oh shit, Socialism!"-fest to notice that Hopey McChange's administration is asserting the same state secrets privilege Bush's did to fend off extraordinary rendition lawsuits.

|2.10.09 @ 12:17PM|#

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|2.10.09 @ 12:18PM|#

raj | February 10, 2009, 12:17pm

Threadwinner.

|2.10.09 @ 12:22PM|#

Helping out Eric with threadjack, Panetta asserted during his confirmation hearing that the Obama approach to rendition would be to obtain assurances from the receiving government that the prisoner would not be tortured.

Oddly, this is exactly what the Bush administration did.

|2.10.09 @ 12:23PM|#

Oops, clicked too soon.

It would appear, then, that Obama represents no hope and change on issues like rendition, while fulfilling our direst predictions on taking the country hard left on issues of government control of the economy.

|2.10.09 @ 12:23PM|#

[Engages in primal yell, similar to Kirk's expression of displeasure towards Khan.]

Fade to Gray|2.10.09 @ 12:27PM|#

"Oddly, this is exactly what the Bush administration did."

True, but Bush did it with a malicious heart. Obama does it with love.

|2.10.09 @ 12:32PM|#

There's not a backbone left in DC, is there? It's going to be just like the last Democratic administration--bitch about the preceding GOP presidency, then do the same stuff or worse to avoid appearing "weak." Obama won't make radical changes in the WoT because he's afraid that he'll be toast if any terror attacks happen even arguably due to any such changes. I don't see why he bothers--he's already broadcasting "One Termer" on all frequencies--why not make the most of the situation? Oh, right, the only important thing is to ensure passage of this stupid non-stimulus bill.

Spoonman|2.10.09 @ 12:59PM|#

Helping out Eric with threadjack, Panetta asserted during his confirmation hearing that the Obama approach to rendition would be to obtain assurances from the receiving government that the prisoner would not be tortured.

Surprise, cockfags!

robc|2.10.09 @ 1:20PM|#

Three years later hedge funds have imploded

I thought hedge funds had exploded. At least the ones that hedged housing/banks/the market as a whole/etc.

|2.10.09 @ 1:22PM|#

"Implosion" is the new "explosion," rob. Didn't you get the memo?

VM|2.10.09 @ 2:09PM|#

ProGlib @ 12:32

+11

between that and "OBAAAAAAAAAAAAAAAAAAAMAAAAA", he summed it up perfectly...

Alan Vanneman|2.10.09 @ 2:10PM|#

Um, wasn't this post supposed to be about Paul Akins? I wanted to note that it's funny that this "fierce libertarian's" main complaint about the Bush folks is that they didn't bail out Lehman Brothers. Moral hazard, anyone? Funny that libertarians on Wall Street sound so much like, well, Paul Krugman with a shave.

As for Obama and state secrecy, I wasn't expecting much, so I thought, but I was expecting a lot more than this. Does the CIA have video of him giving Bill Clinton a Lewinsky? And I gave money to the guy! Stone me now! (But not too hard. McCain, after all, would have been worse. But not by much.)

Reason sucks|2.10.09 @ 2:26PM|#

Fuck reason, and fuck its evil anti-liberty benefactors. You motherfuckers are on the List.

|2.10.09 @ 3:09PM|#

It would appear, then, that Obama represents no hope and change on issues like rendition, while fulfilling our direst predictions on taking the country hard left on issues of government control of the economy.

I hope you didn't chafe anything while posting that, Dean.

The likes of Bush and McCain have already taken us "hard left".

|2.10.09 @ 3:19PM|#

Thank you, VM. My anger is righteous and not founded in disappointment, for I expected little from Obama. Or from McCain, for that matter.

I will say this. I feel for the libertarians who risked all to believe in the Obama miracle. It's okay, after Bush such delusions are forgivable. Please, a table is open near the window, where indignation and rejection of the major parties is not only permitted, but encouraged. Welcome back to the limited government fold.

|2.10.09 @ 3:25PM|#

The likes of Bush and McCain have already taken us "hard left".

Naw, I would say they were more in the "drifting left" category on economic/regulatory state issues. Obama appears to be in the process of cranking the steering wheel over and mashing the gas pedal.

|2.10.09 @ 3:28PM|#

Who can doubt that phase II (probably next year, or just after the 2010 midterms) will be a sudden, critical, must-hold-off-a-catastrophe need for higher taxes to carry all this new debt and radically increased baseline spending.

It'll be the old "fiscal responsibility" racket, conveniently forgotten for spending bills, but resurrected for taxing bills.

|2.10.09 @ 3:28PM|#

I feel for the libertarians who risked all to believe in the Obama miracle.

Me, too. Mostly what I feel for them is contempt, though.

|2.10.09 @ 3:47PM|#

Naw, I would say they were more in the "drifting left" category on economic/regulatory state issues.

Yes, you would give that line. That's how folks know you're not actually a libertarian.

|2.10.09 @ 4:31PM|#

That's how folks know you're not actually a libertarian.

(1) Och, mate, I think you min to seh "nawt a TREW libertarian."

(2) DRINK! (like you needed an excuse today).

|2.10.09 @ 5:28PM|#

you min to seh "nawt a TREW libertarian.

Get your mouth off from around the GOP's collective dick, and it'll be easier to talk.

|2.10.09 @ 6:15PM|#

Nice, Eric.

Do us a favor, and find the last post I wrote that said nice things about the Republicans.

Although I will admit that I have a really hard time capturing a Scottish accent in pixels.

|2.10.09 @ 7:47PM|#

Bite me, Dean. You've been around here for a long time, and you're no more a libertarian than Glenn Reynolds and Eric Dondero are. You're also beneath my future notice.

|2.11.09 @ 12:03AM|#

With all due respect, Mr. Atkins is wrong about the SEC's attempt to regulate hedge funds. First they should have been regulated because their leverage posed a systemic risk as well a san investor risk, as demonstrated back in 1998 by th efailuire of Long Term Capital Management. Second,the court of appeals decision striking down the SEC rule was based on the fallacy that general partners of llimited partnerships do not owe fiducitary duties to llimited partners. The court cited no authority for that proposition and it is contrary to state likmited partnership statutes . The SEC should have appealed the ruling to the Suprme Court but did not do so. It was a clear case for reversal . t the decisionj not to appeal was political and ideological, and has proved to have been most unwise.