Financial Reform: The Enforcement Vacuum

Shahien Nasiripour is on a roll these days. Today he makes a great catch:

In a paper on the financial crisis he presented last month at the Brookings Institution in Washington, Greenspan did not mention the word “fraud”, in any of its forms, even once in the 66-page presentation.

His prepared remarks this week, though, mentioned it three times.

This is an extremely important issue when it comes to regulatory reform, because the history of financial regulation in the US is a history of regulators completely missing fraudulent behavior — with the relationship between the SEC and Bernie Madoff, of course, Exhibit A.

Greenspan is absolutely right here:

“[I]t is one thing to promulgate rules, and quite another to successfully implement them. Rules to prevent fraud and embezzlement have failed as often as not. Parenthetically, in the years ahead, we will need far greater levels of enforcement against misrepresentation and fraud than has been the practice for decades,” he told the investigatory panel.

Greenspan also called for “enhanced” enforcement against “misrepresentation and fraud” going forward…

But the Fed isn’t equipped to handle it, Greenspan testified this week.

“The Federal Reserve, remember, is not an enforcement agency,” he told the panel…

“It’s not a group that can ferret out embezzlement, fraud, misrepresentation — and indeed, when we get such examples, what we tend to do is recognize that we don’t have the facilities.”

When one thinks about the successful enforcers of financial crimes, the names which spring to mind are the likes of Rudy Giuliani and Eliot Spitzer, not anybody at the SEC or within the federal regulatory apparatus. There’s a very real risk that any financial reform bill will make all manner of harmful behavior illegal — and that all manner of financial fraudsters will go ahead and do it anyway, with a low risk of being caught and prosecuted.

It’s far from clear to me where the real locus of enforcement is in any of the financial reform proposals floating around Capitol Hill. The SEC has proven itself incapable of aggressively investigating such things, even under Mary Schapiro. Shahien seems to think that maybe the Consumer Financial Protection Agency can fill the vacuum; I’m not sure. But someone certainly needs to.