SEC Chairman Chris Cox: "Market Ripe for Fraud and Manipulation"
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TILA violations SEC Chairman Chris Cox testified this morning at the Senate Banking Committee hearing in regards to the potential Wall Street Bailout plan that was proposed over the weekend. Cox said that his agency has more than 50 investigations open on subprime mortgage cases. However, Cox said that he's also trying to "ascertain" if anything illegal went on in the risky-mortgage market that contributed to the current crisis.
If Chris Cox was truly uncertain as to whether any illegal activity and lending was going on amongst Wall Street firms and mortgage lenders that led the way to the financial crisis, then why would he later say in his testimony, "This market is regulated by absolutely no one [. . .] It is a market ripe for fraud and manipulation."
The only thing that's left to ascertain is to pinpoint where this type of "illegal activity" originated, and why it was allowed to spiral as out of control as it did.
Interestingly, Cox does mention credit-default swaps (CDS). CDSs are unusual or creative financial instruments where the risk of default on credit is passed among lenders and investors, much like the game Hot Potato. This type of creative financial packaging became popular after the Gramm-Leach-Bliley bill gutted Glass-Steagall and the subsequent passage of the Commodity Futures Modernization Act. Cox believes, and is most certainly correct, that CDSs allowed a forum for the shorting of corporate debt without the oversight imposed on cash markets.
Unfortunately, Cox doesn't mention fraud or manipulation in mortgage documents like TILA forms or the presence of both in the Alt-A/Option ARM loan market. Fraudulent claims and ambiguous language were littered throughout Truth in Lending documents. For instance, whenever a loan failed to state that it was a negative amortizing loan -- when it was that type of loan -- it was in explicit violation of the Truth in Lending Act.
The reality is that the fraud and manipulation Cox is aware of, suspects, and/or turned his head away from could have been prevented: A Republican-led Congress chose in 2000 not to extend regulation to OTC derivatives markets. One of the most influential proponents of not regulating OTC derivatives was Alan Greenspan, then chairman of the Federal Reserve. Greenspan said, "OTC transactions in financial derivatives are not susceptible to - that is, easily influenced by - manipulation.” Nobody questioned Greenspan when he made this claim. Nobody questioned Greenspan when he said on October 9, 2006 that the housing market would soon rebound from its slight slump, "I suspect that we are coming to the end of this downtrend, as applications for new mortgages, the most important series, have flattened out [. . .] There is a good chance of coming out of this in good shape, but average housing prices are likely to be down this year relative to 2005. I don’t know, but I think the worst of this may well be over."
Without proper oversight, the people responsible for this mess were able to do and say whatever they felt looked and sounded good, whether their claims were accurate or a series of mistruths.
I think it's safe to say that the next time broad claims like Greenspan's, Ben Bernanke's, Hank Paulson's or anybody pushing a heavily deregulated industry goes unquestioned, consequences are likely to follow again.