Leverage: What Could Possibly Go Wrong?

“We’ve said these are the big guys but that means if anything goes wrong, it’s going to be an awfully big mess.” -Harvey J. Goldschmid, authority on securities law

“I’m very happy to support it and I keep my fingers crossed for the future.” -Commissioner Roel C. Campos

I yelled at my computer screen after reading this.

I don’t even know what to say.

The lone dissenter was a software consultant. Poor bastard was the only voice of reason. He probably got absolutely destroyed by the big five after this for daring to dissent.

Agency’s ’04 Rule Let Banks Pile Up New Debt, and Risk: “Many events in Washington, on Wall Street and elsewhere around the country have led to what has been called the most serious financial crisis since the 1930s. But decisions made at a brief meeting on April 28, 2004, explain why the problems could spin out of control. The agency’s failure to follow through on those decisions also explains why Washington regulators did not see what was coming.

On that bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.

They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.

The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary.

A lone dissenter — a software consultant and expert on risk management — weighed in from Indiana with a two-page letter to warn the commission that the move was a grave mistake. He never heard back from Washington.

One commissioner, Harvey J. Goldschmid, questioned the staff about the consequences of the proposed exemption. It would only be available for the largest firms, he was reassuringly told — those with assets greater than $5 billion.”

Brilliant. We will only let the largest and most important firms leverage up like this so we can absolutely concentrate the risk in the most critical parts of the financial system.

What could possibly go wrong?