(This guest post originally appeared at the author’s blog)
Nothing about it the single most relevant factor in the blow-up.
Until 2004 (quick refresher) our investment banks had a leverage limit of 12:1. After Paulson led the multi-year effort to sway the SEC to drop these rules entirely, allowing 5 banks to utilise unlimited leverage, all 5 became effectively insolvent within 4 years.
It’s the most important factor in explaining how this banking crisis was so devastating compared to previous blow-ups, and why it was so widespread — European banks were (and remain) even more leveraged than our own.
And, it’s the easiest part to fix. Just turn the rule back to pre-2004.
There are only 2 possibilities.
- Congress is completely, undeniably, captured by Wall Street and so they did not allow leverage limits to make their way into either the House or Senate bill? OR
- Congress is so flipping stupid that no one though to propose a leverage limit?
The obvious answer is ‘captured’, but the more I consider it, the second choice of ‘just plain stupid’ is not out of the realm of possibilities.
I wrote this short post Friday night; I read this morning that Blodget had a similar thought:
- Raise capital requirements, forcing the banks to use their tremendous profits to build big cushions against future problems instead of paying huge bonuses. Given the forced bailouts of last year, why on earth should banks be allowed to pay out normal compensation ratios for the next few years? Why shouldn’t they be forced to keep this money on hand for a rainy day?
- In a just world, the way out would be to finally make the bank bondholders pay for their stupidity, converting bank debt to equity and correcting the error made last time. In the heat of another crisis, however, the government will likely be terrified at the thought of rocking the boat and will fight tooth and nail to give bondholders another free pass. If this proves politically impossible, the government might actually have tolet some firms fail, or risk being run out of town. And because we have yet to create a system in which banks CAN fail in an orderly manner without taking the whole economy down, this could put us on a path to Japan (zombie banks) or another Lehman-like disaster.
MUST SEE Video: Ratigan annihilates Paulson for causing the financial crisis — Oct. 19, 2008
Stated again for the record, the problem was leverage on the part of our biggest banks. The SEC rule change in 2004 that allowed the Big 5 to dramatically increase their leverage is the single most important event in the entire sordid story. Were it not for this change and subsequent leverage hike from 12:1 to 40:1, our current crisis would not be so chaotic or expensive.
And it still galls me to this day that the person leading the argument that morning in front of the SEC is none other than former Treasury Secretary Henry ‘Hank’ Paulson. I will ask again: when will a journalist with a large audience make it a goal to expose this man and what he has done to imperil your children’s future? He personally helped to pass the rule change that led to this crisis, then he led the effort to solve it by giving $700 billion of borrowed money from your kids to failed banks including his former employer Goldman Sachs, from whom he received $600 million in severance when he headed to Washington.
Another irony seems apparent: Paulson and the other CEOs used the same logic in front of the SEC as they did in front of Congress in the fall of 2008. Paternal we’re-smarter-than-you fear mongering. “Trust us, we know what we are doing. It is imperative that you grant us an exemption to the leverage limits so that we can compete on an equal basis with European banks, otherwise the US banking industry could be wiped out by the Europeans. “Trust us, we know what we are doing. It is imperative that you grant us $700 billion with no oversight and no questions otherwise, the US banking system will be wiped out and your ATM cards will not work.”
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