Judgement, not more Regulation

If not for the fall from grace, he'd be a hero today. In fact, he'd also have every right to wag his finger at us smugly saying, "I told you so."

Prior to his downfall, Eliot Spitzer was the person Wall Street arguably feared the most. As the former Governor and Attorney General (AG) of New York, Spitzer developed a reputation for a vindictive and no-nonsense approach of taking white collared crime to task. Price fixing, investment bank stock price inflation, fraud, predatory lending practices and even excessive fees and compensation were some of the areas Spitzer actively pursued during his tenure as the AG--long before they became household topics in 2009.

Spitzer has finally broken his silence, granting an interview with Fareed Zakaria which was televised over CNN on March 22nd 2009, following his resignation as AG following his involvement in a prostitution scandal. It is evident from the interview that although the scandal has tainted his legacy, it has in no way diminished his expertise on financial regulation nor has it interfered with his clarity of thought. I found several of his responses to be deeply profound. Here are some of his views:

ON CAPITALISM AND THE FINANCIAL SERVICES:
"Recklessness, greed and a misunderstanding of what capitalism is all about, and a belief that financial services alone could generate wealth.

Financial services doesn't really generate wealth. Financial -- the capital markets are designed to raise money and then apportion it to industries that are creative, whether it's biotech or automotive, or anything else.

Financial services should be a conduit. Instead, we became enamored of the products themselves. And what resulted was this enormous bubble in assets, ginned up and supported by a financial services sector that, because of a series of improper incentives, got us to where we are right now."

ON REGULATION:
"...After the last round of scandals -- Enron, et al. -- we passed Sarbanes-Oxley. And we said, aha, we've solved the problem. Now we have another set of scandals.
There are enough laws, enough regulations on the books for smart, aggressive regulators and prosecutors to make all the cases. What was missing was judgment. And you can't legislate judgment. You can't regulate judgment. Either the people who are the regulators will walk into a bank and say "Your leverage is too great. We are going to take actions to pull it back," or "This type of investment is flawed," or they won't. You can't pass a law that says, you must use sound judgment... Bubbles have been there through history, through over-regulation and under-regulation. This is a question of judgment and of failure of judgment."

COMMENT: It is interesting to note that as the AG, Spitzer frequently invoked, what was long considered to be an obscure and dormant piece of legislation dating back to 1921 and known as, the Martin Act to bring action against a number of offenders. The tools are there, it's more a matter of regulators getting round to using them.

ON THE MEDIA
"And I think the media -- writ large. I mean, forget CNBC. I think the entire media -- print media, TV media, et cetera -- did not ask the hard questions as these deals were being structured, as the bubble was inflating.

We turned the Wall Street masters of the universe into these icons, who bestrode the universe and made no mistakes, when I think a more inquisitive attitude would have said, "Wait a minute, guys. This won't last."

ON THE GOVERNMENT:
"...there are many on Capitol Hill who are beating their chests so loudly, you know it's just a cover-up of their neglect and failure over the last decade. They sat there and watched and did nothing, as they clearly should have known that we were building a system that was a house of cards. And they enjoyed it and prospered from it, and there was a symbiotic relationship between them and Wall Street."

ON PRESIDENT OBAMA:
"And I think one of the largest, most difficult tasks that he has is to control the outrage that is brewing in the public -- sympathize with it and garner it, but use it to get good policy, not policy based upon anger...I'm worried that we will go to the other extreme and end up with rank populism. That could be just as dangerous."

ON THE POPULIST OUTRAGE:
"Yes, yes. The outrage is legitimate, but it is being fomented by sort of a faux populism by many on Capitol Hill who saw this coming, who knew this was going on. And so, I look at them and I say, "Come on, guys. You're supposed to be more mature. Express the anger, but then say, how do we solve it? Don't just throw more oil on the fire."

COMMENT: Is the outrage being formented? Presently, it's being directed at AIG which is paying out $160 million in bonuses despite taking taxpayer dollars. However, it is not alone in that regard and while $160 million is no small sum, it actually pales in comparison to what the other firms are recieving. Some suggest that the real welfare queen is actually Goldman Sachs. AIG is neither alone nor is it the most culpable. John Thain and Merrill Lynch win that prize.

ON EXECUTIVE COMPENSATION:
" I think I might go back to a very old tort theory of unjust enrichment -- contract theory, tort theory -- and say, you know what, guys? There's a theory in the law that says -- a couple of theories -- one impossibility saying, AIG just doesn't have the money to pay you. And absent the federal infusion, it wouldn't have it, so we can't pay.

And second I would say, unjust enrichment. You simply don't deserve it. It's an equitable argument. Some courts might go for it, some courts might not.

But as a practical matter, as the president of the United States, I think I would call the CEOs into the Oval Office. And I would say, "Guys, this is untenable. We're all going to have to suck it up a little bit and show the American people that we know what it means to be part of a community, and share the sacrifice. Let's see if we can't solve this without the legal wrangling."

ON THE FAILURE OF THE SEC
"Absolutely. The power of the federal agencies to do this stuff was unlimited.

And any time I hear the SEC say, we didn't have the power to do this or that, forget it. They had more people, more power, more money than was necessary. What they lacked was the creativity and the will."

ON THE PROBLEM
"I tried very hard not to vilify individuals, because it wasn't a mid-level executive who was the problem. It was the whole structure. And that's why the global deal was with all the banks."

ON HIS OWN FAILURE
" I never held myself out as being anything other than human. I have flaws, as we all do, arguably. I failed in a very important way in my personal life, and I have paid a price for that."

CLOSING COMMENTS:
Evidently, Spitzer himself excercised poor judgement in the events leading up to his resignation from office in 2008. Something he plainly admits. However, that should not distract us from the soundness of his reasoning, there is much we can learn from him.

I also want to leave you with another thought. It should be now obvious that regulators lacked the skills, conviction and judgement to take on the Financial Services. An effective financial regulator needs to have a sound knowledge base in law, finance and business. That is ironic because having gone to both law and business school, I have never encountered a single person aspiring to become a financial regulator. The regulatory/financial services compensation gap must be narrowed, by having such a huge disparity in compensation continue for so long is tantamount to putting Wall Street on the honor code system for decades. And it is pure fantasy to think society is better off this way. Until this changes, Wall Street will always be several steps ahead of the game and we can never safely say, it won't happen again.

The full transcript of the interview can be found here.

Better still, you can watch it here.