Linking the Fate of Mutual Fund Reform to the Bank Bailout Problems

News that the New York Fed urged AIG officials to keep the terms of their federal loan secret is putting more pressure on Treasury Secretary Timothy Geither to explain his actions. At the same time, it is also raising more questions about whether Fed Chairman Ben Bernanke and White House chief economic adviser Larry Summers, director of President Obama's National Economic Council, are the right people to hold these key positions as the nation tries to claw its way out of the recession.

These questions also shape the prospects of financial regulatory reform, including how the SEC deals with investor protection issues facing individual mutual fund shareholders.

In an interview, former IMF chief economist Simon Johnson, says Summers and Geithner can stay in their jobs, but they has to change their policies, specifically the idea that banks should be considered “too big to fail.”

While the “too big to fail” positions must be changed, Johnson is incorrect in thinking that the policy can be separated from the government official. In Washington, the man is the policy. Policy is an attitude, a way of thinking, and increasingly the method of making money and generating either campaign contributions, new jobs offers and lifetime financial security.

For example, when he was chairman of the New York Fed, Geither was offered the job as head of Citigroup. How could he ever be objective when the bank executives he regulates, sit on his committees, and offer him jobs which pay millions annually?

This is a rhetorical question. It also explains why banks are now paying out 40%-45% of the money they received from taxpayers and using it to pay themselves bonuses.

Then there is the question that the top people in the financial services-industrial complex have unique access to job-hopping opportunities which the average person can only dream of, especially when the official unemployment rate is 10%.

Take the case of current White House official, David Lipton, who used the financial services-industrial complex revolving door to move from U.S. Treasury to Citigroup and now, back to the White House.

Teetering SEC Reform
This takes us farther down the food chain to the SEC, which is the formation and trading part of the capital markets, but not the more –important policy, macroeconomic, national security side.

The SEC is considering a number of initiatives which would ideally benefit individual investors. This includes greater transparency, fee disclosure, adopting a fiduciary standard for financial professionals, and reducing 12b-1 fees, to name a few.

The problem is that SEC Chairwoman Mary Schapiro is indebted to Geithner for her appointment. At the time the Obama administration was screening candidates for the top SEC job, the choices were narrowed down to Schapiro, a career compliance and enforcement bureaucrat, and Sheila Bair, a more independent-minded candidate who had experience in both government and the private sector. Geither criticized Bair as not being “a team player.”

As a result, she was named to head the FDIC, a position which had less contact with Treasury and less control over shaping financial services industry regulations than the SEC.

Presumably, Geither believed Schapiro would be more of a “team player” than Bair. But what individual investors need now more than ever is someone who is not a “team player.”

The last SEC chairman who was an advocate for individual investors was Arthur Levitt (1993-2001.) Levitt was a former president of the AMEX and a senior executive at Shearson, Loeb, Rhodes, which exposed him to the plight of retail investors. Unfortunately, Schapiro does not have this experience and despite Shapiro’s long career at the Commodity Futures Trading Commission, NASD, and now, the SEC, she has not scored any major kudos from shareholders.

Being a "Team Player"
This takes us to the present critical debate over the need for reforming mutual fund company practices. In an interview, Schapiro said that a 12b-1 fee decision would be made by year-end 2009. Nothing happened. Nor have any other major announcements come out of that agency. The delay is disturbing since the SEC would not make any pro-investor decisions that would outflank bank and insurance company reforms, which are more closely linked to Geithner’s domain.

This means the fates of Schapiro and Geithner are tied together. So is the gathering populist revolt against Geithner and the Fed's “too big to fail” policy and the pressing need for fund reform. If Geithner feels the populist pressure, it will bode well for fund reform.

If not, fund reform will be almost meaningless. This should not be unexpected, since too many past chairmen of the SEC have used that position to buttress the industry they are supposed to regulate. Once again, shareholders will be on their own.