Crisis Poses Big Test for Markets' Regulator

Former SEC officials and Democratic lawmakers this week criticized Cox for being "behind the curve" and for deferring to leaders at the Federal Reserve and the Treasury, which released a regulatory blueprint earlier this year that would have diminished the agency's authority. Sen. Jack Reed (D-R.I.) said yesterday that the SEC had "woefully underperformed" under Cox's reign but rejected calls for his ouster.

"There's been no one thinking rigorously or looking ahead at how things fit together," said former commissioner Harvey J. Goldschmid, now a law professor at Columbia University, who has exhorted the agency to devote more resources to risk assessment.

For his part, Cox yesterday stressed the steps he has taken: new rules that ban some short sales and require additional disclosure of hedge funds' trading positions, as well as information-sharing pacts with banking overseers. He recently called on Congress to give the agency more authority over credit-rating agencies, which frequently underestimated the risks of many debt products and contributed to the market downslide, and over holding companies that own investment banks.

Four years ago, securities watchdogs agreed to monitor risk and liquidity at five broker-dealers controlled by holding companies, making monthly visits to assess risk and ensure that investor assets were protected. The Fed led oversight of the holding companies themselves.

Today, only two of those banks remain standing, and one of them is negotiating a sale. Bear Stearns and Lehman Brothers collapsed, Merrill Lynch is to be absorbed by Bank of America, and Morgan Stanley is in talks to be acquired. Only Goldman Sachs remains relatively strong.

SEC officials said they had been urging investment banks all along to strengthen their balance sheets. Unlike other federal authorities, securities regulators do not have the power to influence interest rates, loosen borrowing capacity or set monetary policy. The five banks had a combined liquidity pool of $158 billion in February 2007. One year later, they had $232 billion, a 47 percent increase. In particular, Bear Stearns increased its liquidity from $5.5 billion to $17.4 billion in that time, the officials said.

"They sent people in to do it, but they didn't discover the terrible risk position the banks had," said former SEC chairman David Ruder. "Neither did the banking supervisors. Nobody figured it out. My opinion is that the SEC probably could have done a better job if they had more experience and more money. And even then, they would have needed to be smarter than the people they were regulating."

Joel Seligman, president of the University of Rochester and author of a history of the SEC, said, "There's a lot of fault to go around" among Washington regulators. "It's fair to say Cox is now in a storm that is probably the most serious since the 1930s. A lot of people have been finding their way. It is important that he is now at the table."

Special correspondent Heather Landy in New York contributed to this report.