New Financial Inquiry Commission: Pecora, Part Deux?

If you're a politician and need to find cover, form a commission. That said, the financial melt-down of the past two years begs a more thorough approach to not only discover what happened, but to help create solutions that can improve regulation while not limiting innovation.

On May 6th, Congress passed the Fraud Enforcement and Recovery Act of 2009, which established the "Financial Crisis Inquiry Commission." The commission will examine the causes of (1) the U.S. financial crisis and (2) the collapse of each major financial institution that failed or would have failed but for the receipt of government assistance, and will be fashioned after the famous Pecora Commission of the 1930s.

The Pecora Commission hearings were conducted by a subcommittee of the Senate Banking and Currency Committee between 1932 and 1934. They sought to expose banking practices deemed "detrimental to the public welfare," to reveal "unsavory and unethical methods" used in the sale of securities and to lay the foundation for remedial legislation.

The work of this committee set the stage for the Banking Act of 1933, which established the FDIC; the Securities Act of 1933, which laid out disclosure and anti-fraud rules; and the Securities Exchange Act of 1934, which created the Securities and Exchange Commission. Talk about results!

I doubt that "Pecora 2" will be as effective as its predecessor, but here is what the new rounds of hearings are likely to cover:

• fraud and abuse in the financial sector
• capital requirements and regulations on leverage and liquidity
• lending practices and securitization
• the availability and terms of credit
• the quality of diligence undertaken by financial institutions
• derivatives and unregulated financial products and practices
• compensation structures

The current legislation directs that the Commission will have ten members -- none of them, thankfully, current government officials. Six members will be appointed by Congressional Democrats and four by Congressional Republicans. Like the 9/11 Commission, this one will have the authority to subpoena witnesses and documents, hold hearings, and take testimony.

If the Commission is not politicized, there could be a lot of good that comes out of it. But don't hold your breath -- the group has until December 15, 2010 to deliver its final report.