Mike Konczal is a fellow with the Roosevelt Institute, and is a blogger at the Rortybomb Blog and New Deal 2.0.


Thomas Frank on Porn and the SEC (my bold):

Now, if you’re looking for reasons why the SEC failed in the past they aren’t hard to come by. Start with political leaders who clearly didn’t believe in the mission; proceed to the agency’s grotesquely underfunded workplace where lawyers had to do their own filing, mail-sorting and photocopying; and arrive, finally, at the revolving door, which sometimes transformed SEC jobs into stations on the Wall Street career path and worked fairly predictable effects on enforcement.

This was an agency whose mandate, essentially, was to crawl out on an ice floe and die…What all of this overlooks is the highly advanced concept known as “change.” The purpose of federal agencies can be redefined and their personnel changed. Once upon a time, the SEC performed well; then it performed poorly.

And now that it threatens to perform well again, we are told it can only fail, that no federal operation can ever overcome the unalterable depravity of its employees.

I bring it up because I’ve been reading a lot about financial reform from the late 1970s. And it’s still a point right before the financial industry went big, and right before the efficient markets hypothesis took over, where people could still argue for the need for financial regulation over conflicts of interests, transparency and honesty without having an overwhelming burden of proof work against them.

I’m reading the 1977 version of The Transformation of Wall Street, Joel Seligman’s definitive history of the SEC. It’s been updated to take it through 2001, but I like this old version because it’s being written during a transformation time, when the agency was under assault by academic theorist and a brand new type of lobbying. You can see the old midcentury guard coming out in defense of the prosperity they helped build.

Check out this blurb: “Myths breed myths. The myth that the ICC and SEC are there to protect consumers against the villains created the counter-myth that they are there to serve the industry’s interests. Joel Seligman’s airing of the facts of the SEC history clears the mind of lots of rubbish.” – Paul A. Samuelson.

From the book, check out this completely un-ironic defense of how Wall Street has changed for the better after the New Deal:

During the last half-century, this nation’s system of corporate finance has been fundamentally transformed. Long gone are the days when new securities sales were doominated by private investment banks, such as J.P. Morgan and Company, when references to “bear raids” or stock market “pools” daily appeared in the nation’s press, when the New York Stock Exchange fairly could be described as a “private club,” when Senate hearings riveted the nation’s attention with revelations of fraudulent Peruvian bond sales, “preferred” stockholder lists, bribed journalists who “touted” securities, or stock price manipulation. Gone too are teh public utility holding companies, the least justifiable corporate structure to evolve during the 1920s’ “bull” market, “blank” corporate proxies, and the time when securities fraud usually was irremediable because of the deficiencies of state corporate law. In the past decade, fixed minimum commission rates, a way of life on the New York Stock Exchange since 1792, have been abolished. Efforts today are under way to supplant, partially or fully, the hardwood floors of this nation’s securities exchanges with an electronically linked national securities market system.

The principal actor in this transformation of corporate finance has been the Securities and Echange Commission. During and immediately after the New Deal period, the SEC earned the reputation as one of the most ably adminstered federal regulatory agencies….

Ten years later you get Oliver Stone’s “Wall Street.” And now we don’t even have a coherent language to criticize the private club of Wall Street as anything other than a symbol of national pride and an omniscient calculator of everything our country should value.

The book deals with the crisis the agency had from not taking on the fixed commissions of Wall Street. Even though they were shining a spotlight in a dark corner of the economy, the accusations of cronyism and cartelizing a business line for Wall Street was there, and the SEC didn’t react quickly enough.

But what’s fascinating is in the last 10 pages of the 550+ page book is a new challenge – an academic theory that postulated that the SEC was incapable of doing anything. That the omniscience of an efficient market made the job of forcing companies to disclose information to all its stakeholders and potential investors superfluous.

Jump forward to the end of the book,

Nevertheless, beginning in the 1960s, economic research on the investment process raised fundamental questions about the usefulness of the SEC’s corporate disclosure program. Several studies appeared to corroborate the “efficient market” hypothesis…For securities law, the crucial implication of the efficient market hypothesis was that securities prices theoretically would be the same regardless of whether most investors ever received or read mandator corporate prospectuses and reports. All that was necessary was that a “sufficient” number of investors act on available public data.

Similar fundamental questions were raised by what was called the “portfolio” theory. This theory suggested that since investment risk could be substantially reduced by diversification of an investment portfolio, the value of data concerning any individual security’s risks or potential rewards was substantially reduced.

Two libertarian economists, the University of Chicago’s George Stigler and the University of Rochester’s George Benston, attempted to corroborate a more sweeping hypothesis: that there was no value whatsoever to the mandatory disclosures required by the 1933 and 1934 Securities Acts….

Data errors in Stigler’s research and some highly debatable inferences he drew from his study “substantially invalidated” Stigler’s conclusion, in the words of Wharton School profressor Morris Mendelson and the opinion of others….In particular, Benston’s suggestion that there was little securities fraud before 1934 was ludicrous…

But the cumulative significance of economic theories such as the “efficient market hypothesis” and “portfolio theory” and the Stigler and Benston critiques did prompt the SEC…to publish a rationale for a mandatory corporate disclosure system that took into account the recent economics literature.

The report offered four grounds for doubting that market forces alone would result in the publication of sufficient, reliable and timely data. First, “very often there are significant motives for at least temporary concealment of adverse information on the part of corporate executives…second, the actual experiences of many financial analysts led them to believe that in the absence of requirements imposed by federal law they would be seriously handicapped in securing corporate data…

Third, even if analyst interest could prompt disclosure of adequate firm data, the vast majority of publicly traded securities were not followed by analysts. Finally, securities analysts sought information for themselves and their customers: “they do not regard themselves as surrogates for the universe of investors and hence do not feel under obligation to disseminate widely information which they secure.”

Though the important ideas of informational asymmetries, free-riding and short term manipulation are an obvious defense of the importance of the SEC’s mission, you can practically hear the priority being downgraded and budgets not kept in line as everyone focuses on the dubious relevance of the beautiful mathematics of martingale theory to the ugly rip-the-face-off-the-client world of Wall Street.

It’s kind of an amazing game of three-card monte. Libertarians simply claim that the SEC can’t do anything. The mission of the SEC is downgraded accordingly. The SEC fails, and libertarians take that as proof that the SEC can’t do anything. Rinse, and repeat.

Category: Legal, Regulation, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

12 Responses to “Thoughts on the SEC, 1977 Edition.”

  1. NotQuiteSo says:

    For what it’s worth, I doubt there’s an organization anywhere with thousands of employees that hasn’t had a porn problem. It’s funny to talk about $200,000 a year government employees who download so much porn they fill up their PCs, but it doesn’t really move the ball (though you have to wonder where that employee’s boss was).

    In the last 10 years the SEC has been flooded with resources (see http://www.sec.gov/foia/docs/budgetact.htm). It has also been disastrously influenced by deregulatory forces that included Arthur Levitt pushing back on derivatives regulation and initiatives like the Consolidated Supervised Entities program. But what explains Markopolos’ experience with the SEC? According to his book, he believes the SEC is over-lawyered, captured, innumerate, and complacent. What explains the misbehavior revealed in the SEC Inspector General’s Stanford report, where SEC staffers repeatedly came to the conclusion Stanford was a fraud and their local management repeatedly did nothing with it – and then allegedly solicited Stanford’s business when they went into private practice?

  2. Transor Z says:

    Mike, terrific post. Thank you for this. But IMO there’s a really important piece that gets lost when we place too much stock in analyzing things from a “history of ideas/intellectual history” perspective.

    In 1977, the World War II generation was in control. There was a completely different mindset re: compensation and proportionality between CEO and factory worker salaries. Indeed, the mindset was heavily rooted in the manufacturing model and it was still a time when you would be embarrassed (and hard to employ) if your resume had a series of one to two-year stints. So tracking the influence of EMH/Friedmanite views only goes so far. In 1977 people still participated in the Elks, Kiwanis, VFW, American Legion, etc. — so socially people were genuinely united around interests other than class status.

    Interestingly, the Bankruptcy Act reforms of 1978 is when swaps were first given super-priority status to help protect orderly markets. So the “seeds of destruction” go way back.

    Thanks again for a thought-provoking post.

  3. franklin411 says:

    Agreed, Transor. And the fact is that the Depression/WWII generation believed in government because they had seen it for themselves. It’s irrelevant whether one believes that the Depression was ended by the significant deficit spending of the New Deal or by the astronomically high deficit spending during World War II. Either way, a major government campaign restored economic prosperity.

    Then the 1950s and 1960s generation started to take over in the 1980s. This was what I like to call the “Spoiled Brat” generation. These people never knew what it meant to work. They never really knew what hunger felt like. They didn’t know what it meant to be told “no…because I’m stronger than you and that’s all there is to it.” They got fat and sassy off the government programs their parents created, and like good little brats, they insisted that they did it all themselves. They didn’t believe in government, because after all, look at how fat and sassy they were! And all on their own!

    If you have a few minutes, just take a look at the bios of some of these “anti-government” types. You’ll see that many, if not most, went to public universities back in the 60s and 70s, when tuition was free on the taxpayer’s dime. :)

  4. Wow!! What happened this afternoon?

  5. carping demon says:

    It kind of tickles me that so much of the statistics that is used to justify these financial escapades began as investigations into gambling. As far as I can tell from several decades of reading history, gambling was never considered a viable method for allocating resources. Rather, the contrary.

    Another great post; it’s why I read it every day and loved the book. Thank you.

  6. Dogfish says:

    Great post:

    “It’s kind of an amazing game of three-card monte. Libertarians simply claim that the SEC can’t do anything. The mission of the SEC is downgraded accordingly. The SEC fails, and libertarians take that as proof that the SEC can’t do anything. Rinse, and repeat.”

    That’s their philosophy towards government in general. Neutering the SEC allows extra profit from extra-legal activities; neutering (or forcing more upon it than it can handle) the government pushes as many services as possible out into cost-plus land (privatization of military under Cheney, mining and energy regulations… under Cheney, etc).

    Their greed is only exceeded by the size of their balls.

  7. carping demon says:

    Oh, come on. They want more than that.

  8. franklin411 says:

    Looks like a computer bug, Calvin. I put in a buy order at -900 and it was filled at the -450 price. :(

  9. schirimiester says:

    Was Maria actually hyperventilating there for a few minutes………….???????????????

    great comedy

  10. alfred e says:

    @f411: The spoiled brat generation????

    And so what exactly gives you the expertise to make that call???

    Were you alive back then????

    Do you have any concept of what living conditions were like and what it took to survive?????

    Or how you, oh blessed member of the “entitled generation” see fit to pretend you understand deeper things.

    Lots of luck on that on AH.

  11. alfred e says:

    “one” not “on ” as in f411 is “one”

  12. [...] measurement,Government Failure,business ethics — southwerk @ 3:13 am Tags: Mike Konczal Mike Konczal writing on the web site, The Big Picture, revisits the 1977 history of the SEC. I have long argued with my students and [...]