Page 182 - untitled
P. 182
THE CDO MACHINE
ing to be an awfully big mess,” Goldschmid said at a meeting. “Do we feel secure
if these drops in capital and other things [occur] we really will have investor protec-
tion?” In response, Annette Nazareth, the SEC official who would be in charge of the
program, assured the commissioners that her division was up to the challenge.
The new program was housed primarily in the SEC’s Office of Prudential Supervi-
sion and Risk Analysis, an office with a staff of to within the Division of Market
Regulation. In the beginning, it was supported by the SEC’s much larger examina-
tion staff; by the staff dedicated to the CSE program had grown to . Still,
only “monitors” were responsible for the five investment banks; monitors were
assigned to each firm, with some overlap.
The CSE program was based on the bank supervision model, but the SEC did not
try to do exactly what bank examiners did. For one thing, unlike supervisors of
large banks, the SEC never assigned on-site examiners under the CSE program; by
comparison, the OCC alone assigned more than examiners full-time at Citibank.
According to Erik Sirri, the SEC’s former director of trading and markets, the CSE
program was intended to focus mainly on liquidity because, unlike a commercial
bank, a securities firm traditionally had no access to a lender of last resort. (Of
course, that would change during the crisis.) The investment banks were subject to
annual examinations, during which staff reviewed the firms’ systems and records and
verified that the firms had instituted control processes.
The CSE program was troubled from the start. The SEC conducted an exam for
each investment bank when it entered the program. The result of Bear Stearns’s en-
trance exam, in , showed several deficiencies. For example, examiners were con-
cerned that there were no firmwide VaR limits and that contingency funding plans
relied on overly optimistic stress scenarios. In addition, the SEC was aware of the
firm’s concentration of mortgage securities and its high leverage. Nonetheless, the
SEC did not ask Bear to change its asset balance, decrease its leverage, or increase its
cash liquidity pool—all actions well within its prerogative, according to SEC
officials. Then, because the CSE program was preoccupied with its own staff reor-
ganization, Bear did not have its next annual exam, during which the SEC was sup-
posed to be on-site. The SEC did meet monthly with all CSE firms, including Bear,
and it did conduct occasional targeted examinations across firms. In , the SEC
worried that Bear was too reliant on unsecured commercial paper funding, and Bear
reduced its exposure to unsecured commercial paper and increased its reliance on se-
cured repo lending. Unfortunately, tens of billions of dollars of that repo lending
was overnight funding that could disappear with no warning. Ironically, in the sec-
ond week of March , when the firm went into its four-day death spiral, the SEC
was on-site conducting its first CSE exam since Bear’s entrance exam more than two
years earlier.
Leverage at the investment banks increased from to , growth that some
critics have blamed on the SEC’s change in the net capital rules. Goldschmid told the
FCIC that the increase was owed to “a wild capital time and the firms being irrespon-
sible.” In fact, leverage had been higher at the five investment banks in the late
s, then dropped before increasing over the life of the CSE program—a history
