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Levitt: Leave the Markets Alone

Tuesday, 12 Aug 2008 10:55 AM

Former SEC Chairman Arthur Levitt has stern words of advice for the SEC and the Federal Reserve: Don't over-regulate the markets.

"A regulator can never, and should never attempt to control the animal spirits of the market," Levitt writes in The Wall Street Journal.

Levitt wants regulators to butt out of markets and stick to their narrowly defined functions.

"Financial markets are not the place to practice field surgery and experimental medicine, because they are too important to the vitality of the world economy," he continues.

According to Levitt, the Fed's responsibility is to prevent bank failures and bank runs. The SEC's duty, meanwhile, "is to investors, protecting investors' cash and securities, and working to prevent securities fraud."

Levitt acknowledges that "we are in the midst of a severe [economic] crisis," and that in the eye of this economic story, there are "increasingly loud calls for action, for someone to fix everything that has gone wrong."

But, he warns, "Quick fixes and knee-jerk responses generally do more harm than good, by creating new problems with every attempted 'solution.'"

As an example of his contention that the quick fix ignites new problems, and perhaps unintended consequences, Levitt cites the Bear Stearns meltdown.

The Fed and Treasury, he says, ensured that Bear Stearns shareholders would not benefit and would, in fact, be punished by the sale to JPMorgan Chase and the associated government credit support.

They were attempting to prevent Bear's shareholders from being rewarded for excessive risk taking — something academics and regulators call "moral hazard," he says.

Heavy-handed government intervention in the Bear Stearns collapse was unprecedented, says Levitt.

As a consequence, short selling ensued in several other financial institutions — Lehman Brothers, Freddie Mac and Fannie Mae, for example — because both shareholders and potential buyers knew they wouldn't be protected.

This rash of short sales "caused even more disruption," says Levitt.

Now comes the SEC, stepping into the wake of the broad spectrum selloff, with their unprecedented quick fix: a ban on short-selling imposed on 17 banks, Fannie Mae, and Freddie Mac.

That ban expires on Aug. 13.

"Let me assure you that this SEC action had absolutely no effect on anyone's ability to short any of these 19 institutions," says Levitt.

"Instead, it has created hidden problems in the back offices of investment and commercial banks across the Street (Wall) Street that are likely to manifest themselves in coming months."

Financial regulators are often in a lose-lose situation, Levitt admits.

When markets are heading upward, those who are regulated complain about over-regulation. When markets are heading downward, regulators are blamed for not doing enough to stop the slide.

Levitt believes both regulators and markets would benefit if his advice is taken:

"Regulators should stick to the basics — those things that are at the core of what has made U.S. financial markets strong: disclosure, transparency, fairness and accountability."

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Former SEC Chairman Arthur Levitt has stern words of advice for the SEC and the Federal Reserve: Don't over-regulate the markets. "A regulator can never, and should never attempt to control the animal spirits of the market," Levitt writes in The Wall Street Journal.Levitt...
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Tuesday, 12 Aug 2008 10:55 AM
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