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October 02, 2008

In 2000 SEC Testimony, Paulson Recommended "Self-Regulation" For Wall Street, Plus A Rule Change Now Blamed For Collapse

Back in 2000, when Hank Paulson was CEO of Goldman Sachs, he testified in front of the Security and Exchange Commission. Among other things, he lobbied the SEC to enact a "change to self-regulation" for Wall Street. He also urged them to change the "net capital rule" which governed the amount of leverage investment banks could use. The net capital rule was indeed changed in 2004, and is now blamed for the investment banks' collapse.

The Challenge of Technology and Change to Self-Regulation in the United States

The third area for re-examination and reform is the structure of broker/dealer regulation, a function now shared by the SEC and the self regulatory organizations ("SROs"), principally the New York Stock Exchange and NASD Regulation Inc.

[W]e and other global firms have, for many years, urged the SEC to reform its net capital rule to allow for more efficient use of capital. This is the single most important factor in driving significant parts of our business offshore, so that our firms can remain competitive with our foreign competitors risk-based capital standards must become the norm. The SEC has made it clear that risk-based capital rules can be implemented only when the Commission is confident that firms employing value-at-risk models have robust credit and risk management policies in place.

For these reasons we think it is time to seriously consider the creation of a single, independent SRO to adopt, examine and enforce a core body of financial responsibility, customer protection and margin rules. We hope and expect that there would be savings generated by economies of scale.

How did Paulson's recommendation to let investment banks borrow much, much more work out?

Here's a story from two weeks ago:

The Securities and Exchange Commission can blame itself for the current crisis. That is the allegation being made by a former SEC official, Lee Pickard, who says a rule change in 2004 led to the failure of Lehman Brothers, Bear Stearns, and Merrill Lynch.

The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults...

The so-called net capital rule was created in 1975 to allow the SEC to oversee broker-dealers...The net capital rule also requires that broker dealers limit their debt-to-net capital ratio to 12-to-1...

In 2004, the European Union passed a rule allowing the SEC's European counterpart to manage the risk both of broker dealers and their investment banking holding companies. In response, the SEC instituted a similar, voluntary program for broker dealers with capital of at least $5 billion, enabling the agency to oversee both the broker dealers and the holding companies.

This alternative approach, which all five broker-dealers that qualified — Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs, and Morgan Stanley — voluntarily joined, altered the way the SEC measured their capital. Using computerized models, the SEC, under its new Consolidated Supervised Entities program, allowed the broker dealers to increase their debt-to-net-capital ratios, sometimes, as in the case of Merrill Lynch, to as high as 40-to-1. It also removed the method for applying haircuts, relying instead on another math-based model for calculating risk that led to a much smaller discount.

Who murdered the American economy? It was the CEO, in the 13th Floor Conference Room, with the Prepared Testimony.

—Jonathan Schwarz

Posted at October 2, 2008 09:10 AM

I have NO idea what fascism looks like (was born slightly after the last egregiously overt instances).

But I always assumed that what it looks like to the common person, is that some thugs/interest groups break into your home and do you grave damage, or accost you on the street while the law looks on approvingly.

We keep waiting for jackbootery to crash our doors, but we're way too sophisticated for that; it's happening right now under the veneer of special circumstance emergencies. We're being aggressively accosted and pummeled -- the hits just keep coming.

Posted by: Labiche at October 2, 2008 09:46 AM

"haircuts?" (last sentence of quote)

Posted by: Bob at October 2, 2008 12:20 PM

Never mind--I followed your link:

The so-called net capital rule was created in 1975 to allow the SEC to oversee broker-dealers, or companies that trade securities for customers as well as their own accounts. It requires that firms value all of their tradable assets at market prices, and then it applies a haircut, or a discount, to account for the assets' market risk. So equities, for example, have a haircut of 15%, while a 30-year Treasury bill, because it is less risky, has a 6% haircut.

Posted by: Bob at October 2, 2008 12:24 PM

I'm starting to hate everybody.

Hating everybody is always a wise strategy.

Posted by: Jonathan Schwarz at October 2, 2008 02:28 PM

"Hating everybody is always a wise strategy."

On the theory that more is more, I'm extending it to hating everyone and everything.

Posted by: Donald Johnson at October 2, 2008 02:31 PM

ESPECIALLY the ones that say, "Trust Me".

Posted by: Mike Meyer at October 2, 2008 02:32 PM

I would like to hate everybody, but it makes getting through my day very difficult. So I have settled for hating everybody separated from the Watergate break-in and coverup by three degrees or fewer of separation. This makes it quite safe to hate Paulson, and therefore I find it appropriate.

Posted by: Aaron Datesman at October 2, 2008 03:21 PM

Buffett just invested $5bn in Goldman Sachs, Paulson's company and one that stands to get a big share of the 'rescue' bill. Obama supports the rescue bill. They're all in on this ripoff.

Obama may be slightly less likely to start a nuclear war than McPalin, but he is obviously part of the same gang of thieves and killers that runs things around here. Why not keep Paulson and Gates, shit, why not Mukasey?

Posted by: Dick Durata at October 2, 2008 05:25 PM

Its like Cuba, WE'll all have to wait until the bastards die of old age.

Posted by: Mike Meyer at October 2, 2008 05:47 PM

"Hating everybody is always a wise strategy."

I started hating my representative (Frank) but as the list of criminals grows ever longer, this tactic is much more efficient. However, I reserve a special fondness for the bottle of tequila I've been nursing.

Posted by: bluestateleftist at October 2, 2008 06:02 PM

I usually hate tequila the next day.

Posted by: seatech1 at October 4, 2008 03:35 PM