How SEC rule-exemptions led to the Wall St collapse

Barry Ritholtz sez,
Special exemptions from the SEC are in large part responsible for the huge build up in financial sector leverage over the past 4 years -- as well as the massive current unwind

Lee Pickard, former director, SEC trading and markets division, spits out the blunt truth: The current excess leverage now unwinding was the result of a purposeful SEC exemption given to five firms.

The events of the past year are not a mere accident, but are the results of a conscious and willful SEC decision to allow these firms to legally violate existing net capital rules that, in the past 30 years, had limited broker dealers debt-to-net capital ratio to 12-to-1. Instead, the 2004 exemption -- given only to 5 firms -- allowed them to leverage up 30 and even 40 to 1.

Who were the five that received this special exemption? You won't be surprised to learn that they were Goldman, Merrill, Lehman, Bear Stearns, and Morgan Stanley.

As Mr. Pickard points out that "The proof is in the pudding – three of the five broker-dealers have blown up."

How SEC Regulatory Exemptions Helped Lead to Collapse


  1. Well the politicians always listen to the “captains of wall street”.
    The USA needs entirely new leadership. Get rid of those who do no useful labor but yet ride in Limos and can have you arrested…the wealthy “pay me cause I’m rich” types.
    Dems = Repubs = War + Prisons + Credit Ripoffs.
    Elect the hippies, they’ll do better…if your cops have not killed or imprisoned them all…

  2. 3 out of 5?
    The last two won’t be around for long, and I might just bet on that. A lot of others are doing just that, I think.

  3. Hey, Hey! Greed is good! The rallying cry of the 80’s and 90’s is earning us the end result.

    I was brought up by depression era parents who were dismayed by the removal of certain rules enacted to prevent this kind of thing. They have been proven totally correct in every qualm they had.

    Personally I haven’t participated in any of it, much to the scorn of my peers who now are paying for their investment savvy with sever heartburn and heart attacks as they watch their supposed wealth dissipate. And have to go through foreclosure because they thought future income would rise to meet future costs. And are stuck with the house they thought they’d flip like burgers, and are having to take on a third job flipping burgers to keep it. And are trying to sell off their F-250 trucks that they bought for the “resale value” while deriding me for buying an X-Box that supposedly had very little resale value but didn’t take an oil field to operate over its lifetime.

    In accounting, “thinking outside the box” is known as embezzlement, theft, larceny, bribery, pilferage and any number of other felonies. Too bad the creators of the mess aren’t going to face what you and I would get as an end result: prison time, heavy fines and a criminal record.

  4. Much as I’d like to slam Wall Street and the big brokerage firms, let me play Devil’s advocate for a moment and point out that two of the five firms mentioned have NOT collapsed, while other firms NOT subject to exemption HAVE collapsed (it happens every day). While correlation does not imply causation, I’d agree that regulatory exemptions did play some part in the collapse; the real question is, how much of part did they play? It’s not an all-or-nothing deal.

  5. That is sad. I assume since the government doesn’t regulate Boing Boing’s financial leverage, we’ll be seeing the end of Boing Boing any day now. Because without the government to stop us with regulation, we will all cause our own destruction – apparently. It is a sad day.

    Just think of all the other internet companies that have gone out of business because the government didn’t, in hindsight, force them to change whatever it was that made them fail.

  6. Was that supposed to be some sort of clever sarcasm? My experience has been that small businesses have lots of regulations on how they are run.

  7. KMoser:

    You are correct: it is not an all-or-nothing deal. This is merely an illustration of what kind of effect one may expect to see from an unregulated market. Other factors leading to the collapse of those big three involve dealings with sub-prime mortgages and derivatives thereof, a general stall of the IPO market due to companies being unable to meet the transparency and documentation demands of Sarbanes-Oxley legislation and regulation, a stall of the semiconductor startup environment in the United States and Europe, the incredible amount of money thrown away in the Iraq war, a fuel-economy loophole created for US automotive companies in clean air legislation that let them turn snowmobiles and electricity/sewer/pipeline utility vehicles – a tiny percentage of their overall sales in the late eighties – into the luxury vehicle class of the nineties and 2000’s, as well as a falling dollar versus the Euro / petrodollar due to the US FED printing money by pure fiat, a massive and unregulated and completely opaque Credit Default Swaps market (which contributed significantly to AIG’s collapse), and other factors. I’m not an analyst and this isn’t advice, it’s just my opinion. However, this particular “market correction” has been on its’ way for a year and a half, give or take, and has been building for decades.

    Those who fail to learn from history are doomed to repeat it, and not just in fifth grade.

  8. @#2: Find me an actual functioning hippie (i.e. not one that went on to try to be one of the “captains of Wall Street” nor one who did so many drugs s/he hasn’t got 2 brain cells left to rub together) and I’ll happily vote for him or her.

    @#7: Companies fail, that’s the way it goes. The problem is when companies fail that hold large chunks of other people’s money, and especially when they hold large chunks of other people’s money that said people put there to be (relatively) safe. The unfortunate reality is that the financial industry has become more complex even than medicine; many professionals in the industry apparently don’t really understand what’s going on, let alone the layman outside the industry looking in and trying to decide where to put retirement savings.

  9. bad news:

    debt-to-capital ratios (aka “reserve requirements”) have been eroded to ZERO (yes, ZERO) in Canada, UK, New Zealand, Australia, Mexico, and Sweden…

    This happened in a drawn out process in Canada, over the past decade or longer… I heard the occasional story on the news which horrified me in its implications but seemed to pass under the radar for the general media and public…


  10. Kmoser: I see the last two standing are already looking for arms to catch them.
    The got all the rope they asked for, and then hung themselves with it.
    It is IMO actually lol funny.

  11. Hey fennel they have done no such thing…the “reserve requirement” is zero because it is voluntary…check with the BIS if you want numbers as to what the actual reserve ratios are for the Banks in question.
    Your post misleads in that it implies that by having a “reserve requirement” of 10% the USA’s Banks must therefore be in “better shape” than those with no such legal requirement. Sad to say that this is not so….the USA’s Banks tend to ignore the spirit, while observing the letter, of the Law.
    In the UK Sweden Canada etc the Law is explicitly all “spirit” and the Regulators of Banking in those countries cannot be waved off by suspect bankers by their pointing to their meeting of the “required” reserve. Those Regulators have greater powers to knock the rotten fruit off the tree before it falls and konks people on their heads, so to speak.
    The word “eroded” implies that there has been a change in the Banks of the UK Canada Sweden etc. There has not.
    What is more interesting is what gets counted as Tier One capital, for the purposes of US “required reserves”, and how that has been changed over time,and what the actual numbers are taking the quality of such “qualified assets” into account, not what the Statute strictly requires.
    It is in the USA that the declines in the quality of what has been allowed to be counted as “reserves” have triggered the crisis. Lax regulation, in other words. Regulators whose hands have been tied by overly-strict definitions as to capital reserves required, etc….and by the too-loose rules as to the necessary quality of what is statutorily allowed to count as “reserves”. Tier two, tier three…what’s it really worth? Enough to leverage a Bank?

  12. @17,
    to clarify, what I meant to point out was that the reserve requirements have changed in Canada, dramatically, over the past several years, ending at a zero reserve requirement. And there have been correlative changes in the banking industry in Canada, namely, massive unprecedented (in Canada) profits posted by most major banks… in the billions, across the industry. Makes me nervous, as I watch the turmoil in the US banks.
    Definitely didn’t intend to imply that the US banks are in better shape than Canadians banks. Clearly not the case. Only meant to point out that Canada’s eradication of reserve requirement seems like a really, really bad idea, particularly in the context of the current inability of some large US institutions to guarantee their debts.

  13. if nothing else, I take some happiness in thinking it now a real possibility that I may live to see Cheney, his monkey and other conspirators dance the hemp fandago yet. All it cost was the world.

  14. Takuan “if nothing else, I take some happiness in thinking it now a real possibility that I may live to see Cheney, his monkey and other conspirators dance the hemp fandago yet.”
    You act all tough and macho now, but you know you’ll cry after he tosses the Emperor off the ledge and Luke removes his helmet as he dies.

  15. Dunno. I think that Obama fellow is Han, which makes Biden a Wookiee. The rest of the Dems are all Ewoks. Not the cool ones with the catapult either, but the ones that got stepped on by AT-STs.

  16. Fennel, a statutory requirement could tie a good Regulators hands.
    If the Bank can say, “Look I’ve got the 12% Reserve ratio”, it can then tell the Regulator to go pound salt, even if they are managing the Bank recklessly.
    With no statutory reserve ratio, the Regulator can pull the plug for more “nebulous” reasons…which is a good thing ,IF the Regulator is a good competent and suspicious one.
    I take the removal of the Reserve Capital requirements as increasing, not decreasing, the power of Canadian Bank regulators.
    And let there be no doubt that it is powerful and firm Regulation that has given the CDN banks greater strength than their US counterparts, with their ever-looser regulation and oversight.
    The statutory requirement if fulfilled may serve as a smokescreen to shield Bank malfeasance. A broader, if necessarily more vague, standard is preferable, again, so long as the Regulator is actually regulating.
    In the US it seems to have been some kind of “dumbshow” rather than Regulation, but the Banks own it all in the US now anyway. Look at the Reg/Law changes – they always get everything they want from this Administration. Regular folks do not count – they are all “living beyond their means”, whatever that means.

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