From Enron to the Financial Crisis, With Alan Greenspan in Between

Enron was only a prelude to the current market meltdown.

In the wake of the Enron bankruptcy—which was briefly the biggest failure in U.S. history—two key lessons were obvious: Financial regulators needed lots more funding and personnel, and derivatives markets that were allowed to operate without proper regulatory oversight and reporting paved the way for financial engineers to privatize profits and socialize costs.

Today, less than seven years after Ken Lay and his accomplices drove their once solid company into the ground, the United States is facing a financial disaster that makes Enron look quaint. The bankruptcy of Lehman Brothers Holdings, America's fourth-largest investment bank, involves a whopping $613 billion in debt. When Enron failed, it claimed assets of just over $63 billion.

The implosion of Lehman—along with the federal takeovers of mortgage giants Fannie Mae and Freddie Mac and insurance behemoth AIG—is symptomatic of the same lack of oversight that existed in December 2001 when Enron failed. And that lack of oversight can most easily be understood by looking at the budget of America's single most important financial regulator, the Securities and Exchange Commission, which oversees financial markets worth tens of trillions of dollars.

In 2001, the SEC's budget was $437.9 million. In March 2002, the General Accountability Office issued a report that said that the shortage of money and manpower at the SEC had forced the agency to "be selective in its enforcement activities and...lengthened the time required to complete certain enforcement investigations." So what has happened since then? Precious little. Yes, the agency has a substantially larger budget today than it did during the Enron era. For this year, its spending authority is $906 million. And for 2009, the agency's budget is projected to increase slightly, to $913 million.

But here's the howler: The number of enforcement personnel, the people who go after the financial engineers, is expected to decline. That's right. Despite the trillion-dollar meltdown now underway, the number of SEC enforcement personnel will decline from 1,209 this year to 1,177 in 2009. In all, the SEC expects to have 3,771 employees next year. For comparison, the Smithsonian Institution budget for 2009 includes funding for 4,324 employees.

That's not meant as a slap at the Smithsonian. It houses a myriad of the nation's most treasured objects. But the SEC actually guards the nation's treasure. And yet, Congress treats it like a bastard stepchild. Indeed, Congress doles out more than five times as much money for corn subsidies ($4.9 billion in 2006, the most recent year for which data are available) as it does for the SEC.

Those pitiful numbers lead us to the innumerable problems posed by derivatives, the same financial instruments that led to the chaos at Enron, which before it failed operated a huge—and almost completely unregulated—derivatives exchange business. According to the Bank for International Settlements, the global derivatives market is now worth some $676.5 trillion. That's $676,500,000,000,000. That's a fivefold increase over the value of derivatives that were traded in 2003. Further, that $676.5 trillion is 51 times America's current gross domestic product.

In 2002, the world's smartest investor (and my pick for president this year), Omaha billionaire Warren Buffett, issued his annual letter to the shareholders of Berkshire Hathaway. In it, he called derivatives "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

Few people heeded Buffett's warning. In fact, some of America's most important financial players dismissed him out of hand. In September 2002, Federal Reserve Chairman Alan Greenspan, Treasury Secretary Paul O'Neill, Securities and Exchange Commission Chairman Harvey Pitt, and James Newsome, chairman of the Commodity Futures Trading Commission, sent a letter to a pair of U.S. senators in which they declared that financial derivatives were not a danger. Instead, they said that derivatives "have been a major contributor to our economy's ability to respond to the stresses and challenges of the last two years." Further, they declared that a then pending Senate proposal to regulate derivatives could increase "the vulnerability of our economy to potential future stresses."