Here’s when things went south: the SEC removed safety nets for big financial institutions. The new regime allowed big financial institutions to spend all the money they normally kept on hand for safety, in case the pension plans or 401(k)’s bets didn’t pan out.
There’s a NYT article describing the full effects, and here’s a portion of the SEC speech. Comments in red:
Speech by SEC Chairman:
Opening Statement at April 28, 2004 Open Meeting
by Chairman William H. Donaldson U.S. Securities and Exchange Commission.
. . . The final item on our agenda today is a recommendation from the Division of Market Regulation that we adopt rules and rule amendments establishing a framework for voluntary group-wide supervision of broker-dealer holding companies. There are two parts to this framework, which we proposed last October.
Translation: Large investment banks who have a broker dealer component can decide for themselves if they want to opt out of the ordinary regulatory regime, and instead go for a regime where they are loosely monitored to by SEC markets staff.
First, the rules would create a group-wide supervision program for large broker-dealer holding companies, called “Consolidated Supervised Entities” or “CSEs.” Participation in this program would enable the broker-dealer within the CSE to use an alternative risk-based approach to satisfy the Commission’s regulatory capital requirements, instead of using the current net capital rule.
Translation: The money held in reserve for 401(k)’s, pension plans, company investments is now freed up to use as leverage in other investments, like the securitized mortgage market.
In addition, a CSE that does not already have a principal regulator may be able to rely on the Commission’s group-wide supervision to satisfy some European Union regulatory requirements.
Translation: The Europeans lightened up on the net capital requirement, that’s Eastern Europe built out all those condos.
The CSE rules begin to respond to industry comments that regulatory capital requirements should be linked more closely to the firm’s internal risk management procedures.
Translation: The investment banks use their own way to determine if they’re putting their client’s money at risk, and the regulators should rely more on the internal review of the i banks.
Additionally, for a CSE that does not already have a principal regulator, the rules may help it avoid overlapping or conflicting regulatory mandates in the different countries where it operates.
Translation: This voluntary regulation lowers the bar to the European standards.
The second part of the framework would implement the Gramm-Leach-Bliley amendments to the Securities Exchange Act of 1934. A broker-dealer holding company could elect to be treated as a “Supervised Investment Bank Holding Company,” or “SIBHC,” if it is not affiliated with a bank or thrift. This would permit the SIBHC to become subject to group-wide supervision by the Commission, which, in turn, may enable the SIBHC to satisfy some European Union regulatory requirements and thereby avoid inconsistent or redundant obligations.
Translation: This voluntary regulation lowers the bar to the European standards.
This rulemaking is an important step towards modernizing our regulatory approach to make capital requirements more risk sensitive. I believe that the CSE proposal, in particular, helps us move from a command-and-control regulatory model to a more efficient and goal-oriented approach.
Translation: The goals of the investment banks is aligned with the goals of the regulators on behalf of the US public, and so the US regulators should defer to the investment banks goals.
Additionally, given the rapid and ongoing convergence of different kinds of financial services providers into consolidated entities with operations in multiple jurisdictions, and the globalization of competition, it is critically important that we formalize our program for supervising the large broker-dealer holding companies to ensure that firms are supervised on a group-wide basis and to avoid regulatory gaps in their oversight.
Translation: We are going to regulate the big banks all in one place to avoid having any subunits fall out of regulatory scrutiny.
If we do this wisely, and we and our fellow regulators listen to and learn from each other, we will help the investing public by using the best available tools to manage risks to the health of our markets wherever they arise, and by allowing the market for financial services to continue to evolve. At the same time, we will help the financial services industry by removing regulatory obstacles that tilt the playing field or impose needless costs.
Translation: We are going to learn what the investment banks say they do, and believe them. And we are also going to let them just copy each other.
Nevertheless, there are real challenges for the Commission as we move towards formal consolidated supervision of broker-dealer holding companies. It is incumbent on the Commission and the staff to build expertise with the approaches taken by other financial services regulators, and to determine whether their techniques and philosophies can be adapted to improve the way we regulate the industries under our supervision. As the distinctions among the players and services in the financial arena become more and more artificial, there will have to be greater coordination of regulatory efforts, and cooperation among regulators, both domestically and internationally.
Translation: The global financial world is not segmented by market, and so everyone should have the same risk management, which is the low, almost non-existent European version.
In this regard, I would like to commend the Division of Market Regulation on their consultation and cooperation with the Federal Reserve, the Department of Treasury and other financial services regulators in developing the recommendations the Division brings to us today.
As always, my thanks to Annette Nazareth for her leadership and advice and to the members of the Market Regulation staff for their hard work on these complex and thoughtful proposals. I particularly want to acknowledge some of the people who were instrumental in developing the recommendations before us today: Bob Colby, Mike Macchiaroli, Caite McGuire and Tom McGowan.
http://www.sec.gov/news/speech/spch042804whd.htm
Wow…
Dig, 20/20 hindsight.
These people knew better, and I wonder why they did this?