Financial Oversight – What is too Little and too Much?

By Randy D. Lewis, CFA, MBA
Senior Analyst, EquityNet Research
December 21, 2009

“Sweeping overhaul” was the term used to describe a new financial oversight bill that narrowly passed the House (223-202) last week, and many players in the industry, from investment managers, brokerage houses, to even investor relations professionals, are chiming in with their thoughts – and unfortunately fears. It should be noted that there are no changes as of today. Laws must be approved by both houses of Congress and the President. But many feel this is moot with partisan domination across the board.

I will try to stay philosophically and politically neutral here, and readers should keep in mind, this is only one man’s opinion, but one whose subject matter should be addressed. I consider myself largely non-partisan, for those interested.

Like most financial professionals, I am pro-business with a preference for laissez-faire or “hands-off” government. I am of course a free-market proponent, where entrepreneurs should be rewarded for the risks they take. I also feel that our government is reactionary, and often over-reacts to concerns that later cause more problems down the road. After all, when legislation has to be written or altered, it is an admission that our former or present way of doing things didn’t work.

However, like many in my chosen field, I was rattled by last year’s financial crisis. Many, including myself, saw it coming long before it happened. You did not have to be a business grad to see the simple warning signs. Furthermore, it is hard to argue that Wall Street greed plays no part. In fact, some feel that is the only problem. As on a lot of issues, I am somewhere in the middle. Yes, I think Wall Street is greedy. But I also think that that is the way our capitalist system is set up. Companies need money, and the capital markets are there to provide it for them – and smart investors should be rewarded.

Ok, so what does our government have planned for us? Following is a partial list in plain English – and admittedly not all details are included – of the proposed financial regulations (source: Los Angeles Times) with my thoughts.

1) The allowing of federal officials to seize and dismantle large financial institutions that are teetering on bankruptcy.

To me, this sounds risky. The obvious question is who determines what “near bankruptcy” means? The government? This seems largely subjective in nature and could potentially give the government license to overstep its bounds. If enacted, there should be clear, objective indicators (with the help of the financial community) of what this means.

2) Authorization of the government to break up large financial institutions whose collapse could pose a risk to the overall economy.

Again, totally reactionary and subjective, but could serve a purpose if implemented properly. Conservatives always fear that once the government steps in, there is potentially no limit to its regulative zeal. This is certainly a concern.

3) The creation of the Consumer Financial Protection Agency to regulate loans and credit products.

Sorry Republicans, but I am for this in some form. Frankly, I blame both sides for this mess. Not to sound haughty, but consumers have proven themselves incapable of not understanding the financial decisions they make, grabbing at shiny nickels, and buying things they cannot afford. And it is MY money that has to bail them out. Mortgage brokers and lenders, on the other hand, preyed on these people with questionable sales tactics and esoteric products. And again, MY money has to bail them out too.

I saw this coming years ago when a mortgage-broker friend of mine kept prodding me to refinance with an ARM – or worse. “Alan Greenspan has a ‘neg am’ loan,” she said. I told her pointblank that her industry was going to be heavily regulated within five years. I might have been off by a year or two, but the point is, look where we are now.

4) New regulation of hedge funds and derivatives trading.

The secrecy behind private funds has bothered investors for years. But investment managers are against the current proposal for fear the government is stepping in where it has no experience. Sounds familiar.

According to the CFA Institute:

“The House legislation makes several improvements, but it does not address a big concern of investors: the gap in regulation of U.S. and offshore private-fund vehicles (e.g., hedge funds and private equity and venture capital firms). The House proposes that only hedge funds with assets of more than $150 million be required to register and provide information to the SEC.

“The House bill seems to acquiesce to industry pressures and has removed oversight of a large segment of private investment managers and funds.

“The Senate has the opportunity to close these gaps in regulatory coverage. It should act to ensure that the vast majority of investment management industry be subject to some level of regulatory oversight. The most investor-friendly approach advocated by the Investors’ Working Group and others is to require all private fund managers, regardless of size, to register with the SEC and disclose positions to regulators on a real-time basis.”

I have to concur with my colleagues that industry professionals should be used whenever possible. Perhaps I am naïve when it comes to politics and legislation, but, as the institute alluded to, I have always wondered why lawmakers can’t seem to get it right. I guess this is why partisan politics makes me queasy. My final question regarding financial oversight is this: Is it possible to create laws and agencies that a) treat everyone fairly; b) actually protect the public and economy; and 3) do not overstep their bounds in the interest of free enterprise?

Randy Lewis, CFA, MBA is founder and senior analyst at EquityNet Research, a boutique investment, industry and economic research firm. He is also founder of The GSL Group, LLC, a company focusing on private business valuation and advisory.