Agency’s ’04 Rule Let Banks Pile Up New Debt

I've long been impatient with people who assert that our chief problem is too much government regulation, and this is a perfect example of why.

Friday's Times has a long, meaty article detailing how a key SEC ruling in 2004 let investment banks throw caution to the winds by removing the rules about how much debt banks could take on. The reasoning was that the banks were grown-ups and would know how to watch out for their own best interest.

They used financial modeling software to assess risks. The author of that software wrote to the SEC saying that removing those regulations was a really bad idea - the software the banks would be using to "watch out for their own best interest" couldn't anticipate severe turbulence, as had happened in 1987 and 1998. The SEC never replied.

At the time, some regulators questioned whether investments would be secure enough. A senior staff member said the SEC would hire the best minds, including people with strong quantitative skills to parse the banks’ balance sheets. It never happened.

With cash reserve requirements removed, some banks ran up their debt to 33 times their actual amount of cash. Imagine if you had $10,000 of life savings and you took on debt of $330,000!

A good friend of many years, with whom I differed on several points, used to assert that government should just get off the back of business. He also objected to taxes in all forms. I wonder how he's reconciling that, now that taxpayers are bearing the brunt of the irresponsible businessmen who made those choices, and the other irresponsible people who failed to hire those quantitative experts.