Kaufmann Takes Aim At Corruption

Dani Kaufmann, one of the pioneers of the governance agenda at the World Bank, discusses the role that corruption played in the financial crisis:

There are multiple causes of the financial crisis. But we can not ignore the element of "capture" in the systemic failures of oversight, regulation and disclosure in the financial sector. Concrete examples abound.

First, the way Freddie Mac and Fannie Mae spent millions of dollars lobbying some influential members of Congress in exchange for, among other things, lax capital reserve requirements for these mortgage giants.

Second, how AIG's "small" derivatives unit located in London managed to obscure its accounts, be governed by lax regulatory oversight, and take inordinate risks that effectively brought down AIG's empire of 100,000 employees in 130 countries, accelerating the global financial crisis...

Third, how giant mortgage lenders such as Countrywide Financial switched regulators so to fall under the lax oversight of the Office of Thrift Supervision, which was funded by fees paid by the regulated banks (and which also supervised AIG's derivative unit).

Fourth, how in April 2004, during a 55-minute-long meeting at the Securities and Exchange Commission, the largest investment banks persuaded the SEC to relax its regulatory stance and allow them to take on much larger amounts of debt.

Finally, Madoff's giant Ponzi scheme, some of which appears to be plain fraud, though system-wide irregularities also point to subtler forms of corruption and capture. Years ago the SEC knew that Madoff, who had served on the commission's own advisory committee, had multiple violations and was misleading it in how he managed the funds of his customers. Yet the SEC failed in unmasking the Ponzi scheme.

Worse yet, more governance challenges are yet to come, as fiscal stimulus packages present all kinds of opportunities for the ethically challenged. Kaufmann recommends far-reaching measures to improve transparency as an antidote. I agree with that but doubt that's enough.

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Posted by Ryan Hahn on February 2, 2009 in Moral hazard, Prudential regulation, Stimulus policies | Permalink | TrackBack (0)