Financial Regulation Can Never Be Effective
A bit more than a decade ago, the former Attorney General of New York State, Eliot Spitzer, forced investment banks to separate their deal teams from their research analysts. As the Internet bubble inflated, Wall Street had used their research departments to lure investment-banking clients. The quid pro quo was straightforward. If a company gave the investment bank business, the analyst would provide highly favorable coverage whether the company deserved it or not. As a result many retail investors bought grossly overvalued stocks based on the favorable ratings of biased research analysts.
For a few years, Wall Street followed the technical requirements and spirit of the Spitzer settlement. However, as The New York Times pointed out on August 12, 2013, the spirit of the Spitzer reform is all but dead. A decade ago when I met Eliot Spitzer, he told me that he didn’t think his reforms would last. He likened his role to a highway patrolman running a speed trap. Although drivers might adhere to the speed limit shortly after passing the speed trap, they’d be back above the limit within a few miles if there weren’t several more rounds of traffic enforcement down the road.
In the last twelve months there’s been another burst of initial public offerings. While the law doesn’t allow Wall Street analysts to participate in the IPO process with their investment banking colleagues, The New York Times shows how research analysts get together in a separate but coordinated set of meetings with prospective clients. The technical requirements of the law may be intact, but the analysts are subjected to pressure to help their parent company win business.
Yesterday, I discussed the corrupting influence of Wall Street money on America’s legislative and executive branches of government. Today, The Times has shown how the amoral viewpoint of Wall Street undermines any attempt at reform. While most of us live our lives inside a moral framework that keeps us well away from violating the law, Wall Street thrives on operating at the edges of law and in a manner that defeats the purpose of the law.
Glass-Steagall, the financial reform act of the 1930s, was only thirty-seven pages long. By contrast, Dodd-Frank, our answer to financial excess, runs 2,319 pages. Our financial markets are more complicated than they were 80 years ago, and thus our laws are going to take up more pages. However, much of the expansion is due to the attitude embodied on Wall Street: unless something is explicitly prohibited, Wall Street is going to fashion a loophole. Glass-Steagall, which separated banking from investment banking, wasn’t really repealed by Congress in 1999. Rather, Wall Street riddled it with exceptions until the formal repeal was a mere formality. In fact, Citigroup was so confident that the vestiges of the depression era act would be repealed that it acquired Travelers, which owned Salomon Brothers, a year before Congress acted.
The implementation of Dodd-Frank is emblematic of how Wall Street approaches regulation and why the Spitzer reform is falling apart. Wall Street’s lawyers have bombarded the SEC with exhaustive comments designed to muddy the intent of Dodd-Frank. When the SEC responds with detailed regulations, Wall Street runs to its favorite politicians on the Senate Banking Committee and House Financial Services Committee complaining about the lack of clarity of the regulations. By the time regulations are issued, the intent of the law has been gutted.
The Spitzer reform separating Wall Street research from investment banking will probably be amended to prevent the practices cited by The New York Times. However, when Wall Street gets done commenting and using Congress to do its bidding, the resulting rules will probably be weaker rather than stronger.