Inspector General Kotz gets expert help on his SEC audit

Using expert consultants is common in business and government. SEC Inspector General David Kotz used one on his report that slams the agency for missing numerous red flags that foreshadowed the collapse of Bear Stearns.

He retained Albert S. “Pete” Kyle, a specialist in capital markets and a finance professor at the University of Maryland. Kyle, a Rhodes Scholar at Oxford, was a staff member of the Brady Commission, which investigated the stock market crash of 1987.

Kyle’s academic background and resume take up 14 pages of the combined 158 pages in the two-part SEC report issued last week. Two of his publication titles, among dozens mentioned: “A Theory of Futures Market Manipulation” and “Prospect Theory and Liquidation Decisions.”

The SEC definitely needed some help. The agency’s failure to perform its oversight mission was “undisputable,” the report said.

Those overseeing risk management of mortgages at Bear Stearns “had numerous shortcomings,” the report said, “including lack of expertise by risk managers in mortgage-backed securities at various times; lack of timely formal review of mortgage models; persistent understaffing; a proximity of risk managers to traders suggesting a lack of independence; turnover of key personnel during times of crisis; and the inability or unwillingness to update models to reflect changing circumstances.”

The report also said that Bear Stearns’ board members didn’t comprehend the firm’s risk exposure. The company was highly leveraged, with a debt to net capital ratio of about 33 to 1 prior to its collapse, more than twice what has since become a safety guideline. J.P. Morgan Chase bought Bear Stearns in March.

In other words, conditions were perfect for a Category 5 financial storm, a credit crisis that crippled Bear Stearns and still threatens the world economy.

Inspector General Kotz’s own background is in law, not finance. He joined the SEC in December, moving from the Peace Corps, where he served in the same capacity. The 1990 Cornell Law School grad was an attorney in three different law firms before beginning government service with the U.S. Agency for International Development.

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