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Congress Is Blowing It On Financial Reform (Again): Where Are The Limits On Leverage?

Nothing about 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 utilize 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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Reader Comments (16)


World 'losing faith in debt-laden UK': Bank's warning over the nation's credit rating

Dec 14, 2009 at 4:23 PM | Registered CommenterDailyBail

Righteous Ratigan Attack On Leverage And Regulation Leaves CEA Chair Dr. Christina Romer Mumbling Nonsense (Clip Of The Week)
Dec 14, 2009 at 6:03 PM | Registered CommenterDailyBail
Dec 14, 2009 at 6:06 PM | Registered CommenterDailyBail
I think a pretty big part of this aspect of the problem is it requires people to say, "We fucked up", and there are few people willing to cross that line. The repeal of Glass-Steagall, and leverage limits are examples of huge failures by both "capitalists" and regulators, and they're all watching each other's backs, because they're trying to project an image of infallibility. Sure, the middle class is screwed, but that's no reason for accountability or bonus-cuts.

" 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?"

I think the "journalist" species is pretty much extinct, with the exception of Dylan Ratigan. If he can't do it, no one can.
Dec 14, 2009 at 6:53 PM | Unregistered Commentermark mchugh
I think the "journalist" species is pretty much extinct, with the exception of Dylan Ratigan. If he can't do it, no one can.

If we're talking TV, absolutely. Did you see that clip with the senator from Oregon? DR asks him about a windfall profits tax and the pol starts blathering on and on about blah blah blah. And DR says, Yeah, that's lovely, but what about the windfall profits tax? (Sheepishly, the senator says he'll look into it.)

99% of TV journalists would have listened to the blather and then went right on, as if some kind of rational give-and-take had just taken place.
Dec 14, 2009 at 9:49 PM | Unregistered CommenterJames H
To Mark and James...

"If ifs and buts were candy and nuts, we’d all have a merry Christmas”

You two yip yap like girls talking about the media like you both just had an original thought. The media spent eight years bashing Dubya day after day and you are just figuring out that the Katie Courics or this world are up to no good.

Way to go Mulder and Skully.
Dec 14, 2009 at 11:28 PM | Unregistered CommenterGobiasBestFriend
99% of TV journalists would have listened to the blather and then went right on, as if some kind of rational give-and-take had just taken place.


I had the same thought...ratigan holds people accountable to his questions in a way that no one else does...
Dec 14, 2009 at 11:49 PM | Registered CommenterDailyBail

Hijacked by Home Grown Financial AlQAEDA Terrorists





Two major billboards must be written and read. 1) The USFed is insolvent. 2) The USFed is dangerously over-leveraged. According to its latest report, the US Federal Reserve owns over $1 trillion of mortgage backed securities, equal to 45.6% of the entire portfolio. One year ago mortgage backed securities were under 1% of its total assets. Actually the number was 0.6%, to make a 76-fold increase in toxic mortgage bond assets on the USFed balance sheet. The credit market actually believes the USFed stepped in and helped the system. But in doing so, they killed themselves. Just like other major banks such as the Wall Street firms, the USFed is very highly leveraged. The USFed carries $2157 billion of debt on $52.8 billion of capital, producing a leverage ratio of 40.8 to 1 ratio. Think over-leveraged, insolvent, and dead, but not yet declared dead. They might actually resign their commission contract with the USCongress, and thereby force a USTreasury Default!!

Here is where the insolvency risk screams out in obvious manner. Its listed mortgage bonds are 19 times greater than its capital, equal to 5.3% in inverse. So therefore, if the true value of these toxic assets is actually 6% lower than their recorded book value, the US Federal Reserve capital is depleted, effectively rendering it insolvent. It stands to reason that if Fannie Mae is insolvent, if Freddie Mac is insolvent, and if monetization supports their bonds, while the market shuns them, then the true value of the mortgage backed securities with their brand is less than 94.7% of their book value. Therefore one might safely conclude that on a strict accounting basis, the USFed is effectively insolvent. My simple guess is that the USAgency Mortgage Bonds on the official USFed balance sheet are worth perhap 30% to 50% less than cited on their books. That would leave the USFed insolvent by 15% to 25%.

One might wonder of motive for the USFed to offer big banks an interest yield on assets held on account. The reason might be to shore up its broken toxic balance sheet and fight off their own insolvency. The USFed remains liquid because banks continue to provide it with funding. Few if any questions come regarding the US Federal Reserve liabilities. The USFed is insolvent, just like the USGovt, just like the Social Security Trust Fund, just like the FDIC, just like US banks, just like US homeowners, and just like US leadership!!!

The Housing Collapse of 2010 Will Be Worse Than 2008

Judd Gregg: "We Don't Have The Money; It's All Borrowed"

Okay, first of all, ALL of the money was spent. They're not keeping anything around as it were. The amounts over and above what were spent on bailouts, were shipped overseas to meet debt obligations, equally serious for the stability of the United States. Large sums went to China for example, although also to debt holders in Europe.

That money has been spent, more has been printed, and that too was spent. In sum, America is working on borrowed money and borrowed time.
Dec 15, 2009 at 7:35 PM | Unregistered CommenterKen

626 billion for pentagon.. but we cant afford health care?
Source: Associated Press

(12-14) 14:32 PST WASHINGTON, (AP) --

Congress is knocking nearly $1 billion off President Barack Obama's request for Afghanistan's security forces and instead devoting the money to buying more mine-resistent vehicles for U.S. troops there.

The move comes as top House-Senate lawmakers are putting the finishing touches on a $626 billion Pentagon spending bill that Democratic leaders hope to clear for Obama's signature by Friday. Passage of the politically popular measure has been held up for weeks because Democratic leaders want to attach other controversial items to it.

The measure contains $128 billion to support Obama's February request for military operations in Iraq and Afghanistan. The president has yet to request funds for his recently-announced troop increase in Afghanistan, and there is no money in the bill for that.

The package contains about $465 million to develop an alternative engine for the F-35 Joint Strike Fighter, the Air Force's multimission fighter of the future. The administration said in June it would veto the legislation if it would "seriously disrupt" the F-35 program, an iffy threat at best. It has since backpedaled from the veto threat after the program won an impressive Senate vote.

The bill contains no funds for new F-22 fighters. Defense Secretary Robert Gates staked his reputation on killing the jobs-rich but well-over-budget program, which has its origins in the Cold War era but is poorly suited for anti-insurgent battles in Iraq and Afghanistan.

Details of the measure emerged from lobbyists and staff aides who demanded anonymity to discuss the measure before it becomes public.
Dec 15, 2009 at 7:36 PM | Unregistered CommenterKen
Moody’s Warns of Sovereigns’ Debt Troubles
US falls between Iceland and Jamaica. WASHINGTON is a circus.
Dec 15, 2009 at 8:17 PM | Unregistered CommenterKen
Dec 15, 2009 at 9:50 PM | Unregistered CommenterKen
the irs citi story is not that outrageous...

the law about not transferring tax-loss carryforwards is to prevent someone being purchased for tax credits alone...

that isn't what's happening here...
Dec 16, 2009 at 10:11 AM | Registered CommenterDailyBail
Pittsburgh Ponders "Fair Share" Tuition Tax To Fund Pensions

Instead of addressing pension problems escalating out of control, Pittsburgh Sets Vote on Adding Tax on Tuition.
The mayor of Pittsburgh calls it the “Fair Share Tax.” But to officials at the city’s 10 colleges and universities and many of their 100,000 students, it is anything but.

On Wednesday, the City Council is expected to give preliminary approval to Mayor Luke Ravenstahl’s proposal for a 1 percent tuition tax on students attending college in Pittsburgh, which he says will raise $16.2 million in annual revenue that is needed to pay pensions for retired city employees.

The tax would be the first of its kind in the nation, and other cities are watching closely as they try to find ways to close their own budget gaps.

“City officials see this as an untapped revenue source, and if Pittsburgh succeeds, I think you will see a lot of other cities immediately move to do the same,” said Terry Hartle of the American Council on Education, a lobbying group for universities. He added that if the Pittsburgh City Council approves the mayor’s proposal, the matter will surely go to the courts.

“This is a turning point for us,” said Joe King, president of the Pittsburgh firefighters’ union. He said that after Miami-Dade County in Florida, Allegheny County has the second largest number of seniors of any county in the United States and that in his union alone he has 900 retirees and 450 surviving spouses whose pensions need to be financed.

Let me tell you how it will be,
There’s one for you, nineteen for me,
‘Cause I’m the Taxman
If you drive a car, I’ll tax the street,
If you try to sit, I’ll tax your seat,
If you get too cold, I’ll tax the heat,
If you take a walk, I’ll tax your feet.
Dec 16, 2009 at 10:21 AM | Unregistered CommenterKen
No one mentions the 3-4 trillion dollar "war on terror" in Iraq, Afghanistan & American airports (for Israel) as a major fact in the financial problems. No one wants to be labelled "antisemite".

Senator Fritz Hollings, SC, said the war in Iraq is a war for Israel and EVERYONE in DC knows it but is afraid to say it------he is right!
Yes, the jews did it!!!

Mike, the antisemantic (who hates double talk and duplicity-----yes I'm a "hater")
Jul 21, 2011 at 7:46 AM | Unregistered CommenterMichael Volz

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