SEC’s Loose Rules: WHO wanted looser capital requirement?
Answer: Follow the money back to 2004 - when the fix was in.
In 2004 the SEC Commissioners decided to loosen capitalization requirements -- after only 1 hr. & slight discussion. The 5 largest investment banks had urgently asked for an exemption to hold larger amounts of riskier assets... increasing leverage by taking on more debt - $30 to every $1 of equity - greatly increases profits, too... IF nothing caused the markets to fly off the shelf that is. The banks wanted to swap older objective rules with their own subjective computer models to measure financial risk.
Henry Paulsen of Goldman Sachs headed the banks’ effort & Chairman Donaldson led the charge for him. He succeeded & was named Secretary of the Treasury by Pres. Bush in 2006. No wonder the President was letting him hang out there to take the heat.
One Commissioner - Harvey Goldschmid, law professor at Columbia (Democrat) – raised concerns (“We said these are the big guys that clearly will be involved here, but that means if anything goes wrong, its going to be an awfully big mess...” – a twitter can be heard). They did have one letter from Leonard Bole, a software consultant from Indian, warning the computer models proposed would not work to determine risk. Bole stated the models could not correctly anticipate market turbulence. The Commissioners simply ignored it.
Annette Nazareth, Director of SEC’s Market Regulation Division, also backed the banks. (1) Her staff explained that their proposed computer models would track variable risk, replacing previous strict capitalization requirements. Annette assured the Commissioners it was okay (“we have very, very broad discretion & will be meeting with these firms on a monthly basis… so, hopefully, we’ll have a lot of early warnings & ability to restrict activity that we think is problematic”).
Again, Goldschmid pointed out he was uncomfortable with the risk - “This is going to be much more complicated – compliance, inspection, understanding of risk – more than we’ve ever had to do.” Then he caved in reliance upon staff’s explanation.
They reassured the Commissioners the changes were not only for the better, but necessary. Staff explained they had hired mathematicians & auditors to review everything, “So we’re going to going to depend on the firms, obviously the front line. They’re going to have to develop their entire risk framework… we’ll be reading that first & they’ll have to explain that to us in a way that it makes sense… then we’ll do the examinations of the process in addition to approving their models & their risk control systems.” Ultimately they would have to rely on the firms to police themselves!
WHAT?!! Voluntary self-supervision??! What a novel regulatory concept!
(1) Annette Nazareth: J.D. Columbia Law - Held various positions in major NYC/DC law firms & government. She is married to Roger W. Ferguson, Jr., former vice chairman of the Board of Governors of the Federal Reserve and current CEO of TIAA-CREF. Reference: SEC Meeting 4-28-04 - Final Item #3 on the agenda: Alternative Net Capital Requirements for Broker-Dealers that are Part of Supervised Facilities and Supervised Investment Bank Holding Companies (Division of Market Regulation). Explanation | NYTimes Video