Smith Faculty Opinion Article

By Dr. John A. Haslem, Professor Emeritus of Finance E-MAIL WEB SITE

The 30 Seconds Outlook
June 1, 2009

The prior Outlook focused on the Fed’s regulatory shortcomings. The SEC also made serious errors when it exempted the five largest investment banks from mandatory minimum capital requirements. In 2004, the SEC ruled the five largest investment banks could determine their own minimum capital requirements based on mathematical models. In return, the banks agreed to SEC supervision and examination of their holding companies in order to prevent EU supervision of their foreign operations.

The five investment banks included Bear Stearns, Morgan Stanley, Merrill Lynch, Goldman Sachs, and Lehman Brothers. Under the new no minimum capital requirements their leverage ratios ranged from 28 to 33, about three times that of EU investment banks.

In 2008, the SEC agreed supervision of investment bank holding companies had become, in fact, failed self-regulation, and ended the program. However, even prior to cessation the SEC’s staff warned Bear Stearns had serious problems with too concentrated holdings of mortgage securities, too much debt relative to capital, and poor risk management of mortgage-backed securities. The SEC also failed to follow EU agreements to limit total risk factors. In 2007, two Bear Stearns hedge funds failed, and no action was taken until the bank collapsed. The first domino had fallen.  

John A. Haslem