|“How Did the Regulators Miss This?”|
By Timothy H. Lee
Thursday, July 19 2012
Is that not our eternal lament?
We refer derisively to World War I as “The War to End All Wars,” because it obviously wasn’t. As British Prime Minister David Lloyd George reportedly observed, “This war, like the next war, is a war to end war.”
The same is true of the regulatory state, and unending attempts by some to expand it. Two new scandals – Barclays and Peregrine Financial Group – once again bring that into relief.
The tragic Peregrine tale stems from the collapse of the commodity brokerage firm and the attempted suicide of founder Russell Wasendorf, Sr., after $215 million in client funds disappeared. In his suicide note, Mr. Wasendorf admitted his misdeeds, and even provided a roadmap as to how the firm illegally diverted those funds.
Beyond that horrible personal tale, however, the matter once again highlights the limitations of government bureaucracy and the folly of enlargement as a cure.
Futures traders are now excoriating regulators for failing on multiple occasions to stop the Peregrine fraud, just as numerous agencies missed opportunities to stop the multi-billion dollar Bernard Madoff and Allen Stanford Ponzi schemes. Lauren Nelson of Attain Capital Management was incredulous:
“How did the regulators miss this? It’s very frustrating to be on the outside looking in, and wondering where the regulators have been when all of this has been going on.”
Since 1996, regulators at both the Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA) failed to stop Peregrine amid allegations of insufficient capital, inaccurate accounting and commingling of customer funds. Peregrine was involved in no fewer than 31 NFA arbitration disputes with customers since 1995, and 38 actions involving the CFTC or other industry regulators. As reported by The Wall Street Journal, regulators overlooked “incredible forgeries”:
“Last year, NFA regulators were notified by U.S. Bank of a nearly $200 million shortfall at Peregrine. The regulators subsequently received a fax purporting to show there was no fund discrepancy, but never followed up to reconcile the two reports. Investigators now believe the fax was sent from a number controlled by Mr. Wasendorf, according to people briefed on the investigation. The purportedly falsified bank documents Mr. Wasendorf may have fed to auditors appear to be ‘incredible forgeries,’ according to a person who had seen some of the documents.”
Meanwhile, the Barclays/Libor scandal reveals similar regulatory failure. As US and international authorities prepare for civil and criminal actions in connection with the rate-fixing revelations, the evidence suggests that regulators were actually aware of the behavior at the time it occurred, but did nothing.
According to documents released by the Federal Reserve Bank of New York, which current Treasury Secretary Timothy Geithner led at the time, regulators were aware in 2007 and 2008 of rate manipulation. In fact, Barclays employees themselves provided tips. Transcripts of conversations show that one Barclays executive told Fed official Fabiola Ravazzolo that, “[W]e know that we’re not posting, um, an honest Libor,” later adding, “[W]e are doing it because, um, if we didn’t do it … it draws, um, unwanted attention to ourselves.” Ms. Ravazzolo, however, concluded the conversation with a simple, “Have a great weekend. Bye.”
Later, a Barclays trader told another Fed official that, “[T]hree month Libor is going to come in at 3.53… It’s a touch lower than yesterday’s but please don’t believe it. It’s absolute rubbish… [R]ecently you’ve had certain banks who I know have been paying 25 basis points over where they’ve set their Libors…” The Fed official’s response? “All right, well thank you very much for your time.”
The Fed’s records admit that in 2008 these admissions were “circulated to senior officials at the New York Fed, the Federal Reserve Board of Governors, other Federal Reserve banks, and the U.S. Department of Treasury.”
So recall that the next time Geithner or President Obama scapegoat insufficient regulation, and demand even more layers of government bureaucracy.
As noted above, however, this is nothing new. In 2009, Securities and Exchange Commission (SEC) documents revealed that its regulators ignored multiple tips detailing Bernie Madoff’s $65 billion Ponzi scheme dating all the way back to 1992. What became the largest fraud ever committed by an individual came to an end only after Madoff’s own sons directly approached authorities in December 2008 and admitted fraud. Before that, we had Sarbanes-Oxley on the heels of Enron, Adelphia, Tyco and the 2000-2001 tech bubble. Its proponents claimed it would prevent similar misdeeds in the future. Less than a decade later, however, we witnessed Fannie Mae, Freddie Mac and the subprime housing debacle.
Such is the nature of oversized bureaucracy. The constant enlargement of bureaucracies and regulations aggrandizes government power and the Washington, D.C. metropolitan area, but somehow the promised benefits never come to fruition.
“How did the regulators miss this?” The answer is simple. ‘Twas ever thus.
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