Sen. Richard Durbin (D-Ill.) (WDCpix)

During George W. Bush’s ill-fated push to privatize Social Security, conservatives condemned the use of surplus retirement taxes to help offset the deficit. But few Democrats or Republicans decry the government’s custom of padding its coffers with fees from an agency with a mission that’s more significant than ever: the Securities and Exchange Commission.

For two decades, the SEC has made more money in fees from the entities it regulates than it receives from Congress through the budget process – about $350 million more in this year alone. With the agency taking heat for its Bush-era enforcement lapses, most notably the failure to stop Bernie Madoff’s infamous fraud, lawmakers and advocates are debating the right amount to spend to ensure stronger financial cops on the beat.

Illustration by: Matt Mahurin

Sen. Dick Durbin (D-Ill.), chairman of the appropriations panel that funds the SEC, unveiled a bill Wednesday that would give the agency $1.13 billion for the next fiscal year – an increase of $100 million, or nearly 10 percent, above the Obama administration’s request.

Debating budgets for financial regulators may sound “as dry as dust,” Durbin acknowledged at a hearing of his subcommittee last month.

“But if you step back for a moment and translate their work into the real world,” he added, “you realize that their oversight … protects the savings and futures of American families, and ensures that economies in countries around the world will view our economy and the way we run it with respect.”

Given those stakes, the argument for beefing up enforcement spending at the SEC appears easy to make. Yet the tight fiscal times pose challenges; Sens. Chuck Schumer (D-N.Y.) and Richard Shelby (R-Ala.) won approval in April to give the agency an extra $20 million in 2010, but appropriators in the House have signed off on only half that number.

The money makes a real difference for SEC officials, who have seen their technology budget shrink by more than half since 2005 and their numbers of investigative attorneys remain more than 11 percent below 2004 levels, according to a recent Government Accountability Office study.

“It’s an ongoing problem the agency has dealt with,” Barbara Roper, director of investor protection at the Consumer Federation of America, said in an interview. “In the past couple of decades, there hasn’t been a careful review of the resources the agency needs to do its job effectively, what the real funding level of the agency should be.”

SEC Chairman Mary Schapiro told Senate appropriators last month that the White House budget request for 2010 would not allow her to hire more staffers than the agency has already brought on board this year.

Schapiro is seeking to add 1,000 positions for 2011 – nearly as many people as now work in SEC enforcement – which still would leave the agency smaller than the Federal Deposit Insurance Corporation.

The FDIC supervises about half as many financial institutions as the SEC.

Bill Black, who served as a senior banking during the 1980s savings-and-loan (S&L) scandal, offered a blunt assessment of the consequences of years of inattention. “Congress probably doesn’t know how” to appropriately arm financial fraud monitors, he said in an interview.

“I don’t mean this in an insulting way,” continued Black, now an associate professor of economics and law at the University of Missouri-Kansas City, “but to know what makes enforcement effective, it pays to know what’s going on at an institution, what goes on at the SEC. And they simply had not conducted meaningful oversight for most of the decade.”

After the S&L crisis, as Schumer and Shelby noted in their legislation, strike forces in 27 cities were set up to monitor financial fraud, backed by 1,000 FBI agents. Black recalled training federal prosecutors during that time on in the ins and outs of complex cases as well as serving as a free expert witness for the government.

Since Schapiro took the helm, the SEC has moved rapidly to restore its tarnished enforcement record. The agency has targeted 23 Ponzi schemes so far this year – with Allen Stanford’s alleged $8 billion fraud topping the list – and charged Angelo Mozilo, former CEO of Countrywide, with insider trading.

But the SEC is hardly the only agency with a checkered past to overcome.

Regulators at the Office of the Comptroller of the Currency and the Office of Thrift Supervision also have fallen down on the job of monitoring the health of the nation’s banks, advocates say. Recent weeks have been even harsher for the agencies, with the OTS on the brink of elimination under the Obama administration’s financial reform plan and the OCC losing a Supreme Court case in which it sided with the banks it policed – and against states that sought stricter consumer protections.

Unlike the SEC, the OCC and OTS are funded by fees they levy on banks. And though the SEC can face a rough road to securing more money from Congress, that fate is better than an agency getting cash from its regulated entities, U.S. PIRG consumer program director Ed Mierzwinski said.

“It’s the worst of both worlds,” Mierzwinski said in an interview. “They’re never dragged before appropriators. They don’t have to fight for their money.”

Regulators did fight over which would attract banks’ business, however, as “charter shopping” and lax enforcement became more common.

So should a financial regulator seek its budget in the politicized climate of Capitol Hill or from the companies it oversees? The question could be a central one as lawmakers take up legislation this month on the administration’s proposal for a Consumer Financial Protection Agency.

Mierzwinski supports funding the new agency through a combination of congressional appropriations and user fees paid by regulated entities.

That mix also appeals to Ira Rheingold, executive director of the National Association of Consumer Advocates. But ensuring proactive enforcement involves more than providing an independent revenue source, he added.

House Financial Services Committee Chairman Barney Frank (D-Mass.) introduced a bill late Wednesday that would fund the new consumer agency in a manner similar to the SEC, with Congress okaying a budget and the agency asked to “recover the amount of funds expended” through fees on the companies it regulates.
Those fees, like the SEC’s generated revenue, will go to the general Treasury – and potentially help balance the government’s books.
Still, ensuring proactive enforcement involves more than providing an independent revenue source, Rheingold noted.

“Moving forward, we need to recognize that these regulatory agencies – no matter how you structure them – may be captured, may be subject to political whims,” Rheingold said. “The way you build safety valves into the system is if you have multiple enforcement mechanisms.”

Frank’s plan would open up two potential enforcement paths. First, the new agency would have the authority to ban forced arbitration in banking contracts, allowing private citizens to pursue certain fraud claims in court instead of being forced into private dispute resolution.

The bill would allow states to set stronger limits on financial practices of national banks without the threat of federal preemption, taking the handcuffs off state attorneys general, such as New York’s Andrew Cuomo and Illinois’ Lisa Madigan, who have doggedly pursued fraud cases.

Some analysts have suggested using the financial overhaul bill to strengthen the SEC’s protections for whistleblowers who report alleged fraud, although this provision was not included in Frank’s draft.

In the end, however, the best way to help regulators elevate enforcement efforts may be a matter of cold, hard cash. The SEC’s budget for policing rule-breakers was lower last year than in 2005, and is still smaller than the amount of fees the agency sends, no questions asked, to the Treasury.

“If you look at what we’ve now spent on the bailout because we weren’t willing to spend money up front on proper regulation,” Roper of the Consumer Federation remarked, “the cost of poor regulation dwarfs the cost of actually funding these agencies.”

Did I say piece? Actually, the Daily Beast calls it a “wrenching saga” of how Penney lost her fortune.

Here’s Penney, describing the way she pondered her future, after learning she’d lost everything:

I began to think about my options: I’d have to sell the cottage in West Palm Beach immediately. I’d need to lay off Yolanda. I could cancel the newspaper subscriptions and read everything online. I only needed a cell phone. I’d have to stop taking taxis. And who could highlight my hair for almost no money? And how hard was it to give yourself a really good pedicure?

Then there is my jewelry. I’ve always collected nice watches and pearls. In the back of my mind I’d think, “Buy good stuff because if you’re ever a bag lady, you can sell it.” It might have been a rationalization then—but here I am now: The nightmare may be coming true.

Look, no one deserves to be ripped off, and everyone has sympathy for those in shock from losing their life savings. But Penney also talks in this piece about how she got involved with Madoff to begin with – and part of this story really should be about the networking among the wealthy and well-connected to get in on a piece of the Madoff returns. They didn’t succumb to a cold call from a broker. Madoff’s funds were an accessory available to only the selected few, as exclusive as a Birkin bag.

Again, from Penney:

I suddenly had a lot of money. I was in my late 40s, and I felt that I was just too old to have it in a plain old bank account. But I was a creative person, not a savvy investor, so I asked around and talked to my smartest friends with Harvard and Wharton MBAs. There appeared to be a secret society of Madoff investors. A friend who was older, wealthier, and more established somehow got me in. I’ve always had good luck, and I thought it was another stroke of good fortune to be invested with the legendary Bernard Madoff.

Every month I got detailed statements, and my money looked to be growing around 9 to 11 percent. It didn’t seem greedy because I knew people other people who were making 15 or 20 percent. I thought, “This is just a very smart investor.”

If anything comes out of this economic crisis, it will be that people with financial degrees from fancy schools often aren’t really all that smart, are they?

Anyway, back to Penney. She’s got more problems ahead than losing her Florida seaside cottage. The part that stuck with me is her freshly ironed white shirts. She’ll no longer be able to pay Yolanda, her domestic, to take care of that task. From Penney:

I wear a classic clean white shirt every day of the week. I have about 40 white shirts. They make me feel fresh and ready to face whatever battles I may be fighting in the studio to get the best out of my work.

How am I going to iron those shirts so I can still feel like a poor civilized person? Even the no iron ones need touching up.

Yolanda makes my life work. She comes in three mornings a week, whirlwinds around, and voila! The shirts are ironed, the sheets are changed, the floors are vacuumed. She’s worked with me for seven years and is a big part of my life. She needs money. She sends it to her family in Colombia. I have more than affection for Yolanda, I love her as part of my family.

On Friday, I tell her I have had a disastrous thing happen to me, but I don’t have the guts to tell her I cannot keep her with me any longer. I’ll wait till Wednesday.

I think I can help Penney here. Everyone I know gets those no-iron white shirts from Target. Then you don’t have to pay someone to iron them. You can even switch to t-shirts and those always go one sale there! Besides, Yolanda, it seems, has bigger problems on her plate than a lack of crisp, white shirts. I’m glad Penney at least acknowledges that.

But then she moves on. She’s not going to spend her golden years, it seems, dividing her time between her New York artist’s pad and the Florida cottage. She has “terrifying thoughts” about ending up in what she calls a state-run old people’s home, with “slow-eyed” attendants who drug you and strap you to your wheelchair.

I believe the proper term is “nursing home,” and millions of people who didn’t benefit from fraudulent returns end up being cared for in them. It’s sad, and it’s hard on their families, but often there’s no other choice. Some nursing homes are run well, and abuses occur at others, and in most cases there’s not enough money from the state, the federal government and the private sector to make them better.

But wasn’t this woman an editor at a national magazine? Did she ever think, back then, about applying her journalistic clout to afflicting the comfortable and comforting the afflicted? I don’t remember any nursing home exposes at Self magazine, although I’m sure I could have found tips on finding an eyeliner that didn’t run and losing those last five holiday pounds.

Maybe I’m being unfair. Penney noted that she was a divorced, single mother in the 1970s, and she worked lousy jobs to claw her way back into money and prestige. Good for her. Too bad those heady returns from the Madoff years, and her exclusive membership in the Madoff fraternity, seems to have clouded those memories, leaving her just like everyone else she knows. Another wealthy sucker.

From Smith:

If $50 billion really went poof in Bernie Madoff’s self-described Ponzi scheme, where did the proceeds go? This has to top what any dictator ever siphoned out of a banana republic. (Note that the Journal suggests that at least $17 billion has disappeared, so inflation adjusted, the Perons may be ahead). The story also suggests he was merely a very bad trader and merely lost the money.

In the case of other Wall Street operations that are now toast, the losses were the result of very big losses on positions and overpaying themselves bonuses in years that appeared to be good, but if the profits had been risk adjusted, were not so hot.

But a Ponzi scheme is all about fraud, all about taking as much out for yourself as possible (well, that is also the name of the game on Wall Street generally, but the rent-seeking is presumed to be on the back of an underlying legitimate activity) So where did the dough go?

And Madoff had to know this would blow up. Wonder why he didn’t flee to Panama.

More questions to look into today, as the biggest fraud in Wall Street history continues unraveling.

Clusterstock has the indictment, if you want to read the details. Madoff’s firm, Bernard L. Madoff Investments, ran more than two dozen funds for decades, overseeing $17 billion and promising high returns and low fees. But a few days ago, Madoff blew the whistle on himself, telling senior executives at his firm and the FBI, according to the indictment, that it was all one big lie, a giant Ponzi scheme. He was broke.

But what pushes this beyond a juicy Wall Street rip-off story is the sheer size of the swindle — possibly the largest fraud in Wall Street history — and its implications for other hedge funds and investors.

From the New York Times:

“We are alleging a massive fraud — both in terms of scope and duration,” said Linda Chatman Thomsen, director of the enforcement division at the Securities and Exchange Commission. “We are moving quickly and decisively to stop the fraud and protect remaining assets for investors.”

Andrew M. Calamari, an associate director for enforcement in the S.E.C.’s regional office in New York, said the case involved “a stunning fraud that appears to be of epic proportions.”

Those proportions have some concerned about how this will play out, beyond Madoff’s personal saga, according to The Times:

There was some worry on Wall Street that Mr. Madoff’s fall would shake more foundations than his own.

Calculated Risk supposes Madoff had about 10 to 25 hedge funds as clients, that they lost everything, and that some hedge funds will be taking some serious write downs soon.

Looks like Wall Street will be sorting through the wreckage of all this today, to see how much damage has been done. As if there weren’t enough to worry about, already.