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One Year After the Meltdown, Wall Street Takes Some Lashings

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In remarks delivered on Monday at the nation’s first capitol, New York’s Federal Hall, President Obama marked the first anniversary of the collapse of Lehman Brothers—an event that launched the meltdown of the nation’s financial sector in the last months of the Bush presidency.

Unfortunately, there are some in the financial industry who are misreading this moment. Instead of learning the lessons of Lehman and the crisis from which we’re still recovering, they’re choosing to ignore those lessons. I’m convinced they do so not just at their own peril, but at our nation’s. So I want everybody here to hear my words: We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.

For all of Obama’s language, however, it is hard to see much difference so far between the regulatory posture of his administration and that of his predecessor. In both cases, the prescription for Wall Street’s ills seems to come from the wizards of Wall Street—a group of economists, lawyers and bankers huddled around a group of core financial institutions and the Federal Reserve. Obama may talk a tough game, but the medicine he prescribes looks an awful lot like sugar water.

The day after Obama spoke, the denizens of Wall Street unfolded their papers to some unpleasant news. It came from Jed Rakoff, a federal judge in Manhattan, who disapproved a proposed settlement between the Securities and Exchange Commission, the Bank of America, and Merrill Lynch in a blistering 12-page opinion. Rakoff’s incisive words offer a careful guide to much of what ails Wall Street today. “Oscar Wilde once famously said that a cynic is someone ‘who knows the price of everything and the value of nothing.’ The proposed Consent Judgment in this case suggests a rather cynical relationship between the parties: the SEC gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger; the Bank’s management gets to claim that they have been coerced into an onerous settlement by overzealous regulators… And all this is done at the expense, not only of the shareholders, but also of the truth.”

Rakoff, a highly respected student of Wall Street antics who teaches a seminar in securities law at Columbia Law School, had tough words for all the parties involved, starting with the SEC, which he said had failed in its most basic duties of oversight. The $33 million settlement that the SEC crafted “does not comport with the most elementary notions of justice and morality, in that it proposes that the shareholders who were the victims of the Bank’s alleged misconduct now pay the penalty for that misconduct.” Rakoff reviewed and dismissed the unconvincing arguments offered by SEC lawyers that the settlement would furnish a proper deterrent and would result in more prudent corporate management. “Absurd” was his well-chosen rejoinder.

In his opinion, Rakoff blew the lid off the unspoken conspiracy that drives the Wall Street world. The outer pockets of acceptable corporate conduct are constantly charted by lawyers who pass their careers between stints at the SEC, large corporate law firms, and key financial institutions. The heaviest remuneration in this process flows from the financial institutions themselves, and it rewards those lawyers who give corporate decision-makers the most freedom in calling their shots. Increasingly, this entire interplay has been about compensation—the nine-figure compensation packages for corporate executives, with their golden parachutes and bonus packages paid even in the event of gross mismanagement, the $750-dollar-an-hour rates of the corporate powerhouse attorneys who advise them. This golden regime of wealth generation is Wall Street’s precious and guarded secret.

The lawyers play a key role in this culture of irresponsibility, and Rakoff handed them some well-deserved lashes. When the bankers noted that they had simply relied on advice of their lawyers in issuing false statements—what is known as an “advice of counsel defense”—Rakoff responded: “If that is the case, why are the penalties not then sought from the lawyers?”

Rakoff’s opinion puts on paper the obvious but unstated truths that fill the cocktail and dinner party conversations of New York’s elite: regulators don’t regulate, and the financial industry calls its own shots.

For a deeper understanding of the problem, it’s worth investing some time in “Better Regulate Than Never,” by Eliot Spitzer in the current New Republic. Spitzer parses the collapse of the regulatory regime over the last decade—noting that it’s not that deregulation occurred in a formal sense, but rather that the regulatory institutions suddenly lost the appetite and will to perform their jobs.

Our market has been–and will continue to be–undermined by regulators who are intellectually or ideologically unwilling to confront powerful market players. Too many of our regulators have been tarnished by the culture of Washington, where the constant movement between government and the private sector has created a fear of disrupting the status quo. It is an environment where stringent enforcement–the very type we needed–jeopardizes future confirmations, alienates potential clients, and engenders social ire. This cozy world isn’t exactly corrupt. Rather, it perpetuates an insidious process of socializing the regulators and the regulated alike. Everyone emerges accepting a way of doing business that ultimately fails the public and the economy. Groupthink has prevailed, leading to an ideological conformity that forecloses challenges and alternative theories.

Effective regulation requires a more intellectually nimble regulator–a regulator that won’t be duped by all the cosmetic changes offered by firms. After all, trading vehicles will be renamed, leveraged assets will look slightly different, but the underlying issues that jeopardize the economy will remain the same: excess debt, leverage, and lack of integrity.

There may be no better demonstration of these forces than the settlement that Judge Rakoff sank. But another case worthy of more study involves former Governor Spitzer himself. When he began to chastise the Bush Administration over its failure to enforce restrictions on the financial markets, the regulators did not react by taking another look at the conduct he identified. Instead, they trained their guns on Eliot Spitzer, opening up a massive fishing expedition designed to embarrass him and drive him from office. And when the erstwhile “sheriff of Wall Street” had bagged Spitzer as his kill without ever bringing a high-profile regulatory case involving the financial sector, he retired, taking a $3-4 million per annum partnership at a major law firm that serves, unsurprisingly, precisely the corporate actors Spitzer was criticizing. This is the “cozy culture” of Wall Street that Jed Rakoff has just shaken up. About time.

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