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As George Miller welcomed 60 bankers to the chandeliered Charlotte City Club one evening in September, the focus was on more than the recent bankruptcy of Lehman Brothers Holdings Inc. From their 31st-floor perch, members of the American Securitization Forum, which Miller leads, fretted about the future of their $10.7 trillion industry.
The bankers were warned that a Financial Accounting Standards Board plan would force trillions of dollars back onto balance sheets, requiring cash reserves to soar. Their business of pooling and reselling assets had dropped 47 percent in the first six months of the year, and the industry couldn't afford another setback.
The next day, Miller, 39, the forum's executive director, took that message from North Carolina to a Senate hearing in Washington examining the buildup of off-balance-sheet assets. ``There are great risks to the financial markets and to the economy of moving forward quickly with bad rules,'' he said of FASB's proposal.
Miller was trying to preserve an accounting rule for off- the-books assets that helped U.S. banks export toxic debt around the world. It is a loophole that Jack Reed, the Rhode Island Democrat who chairs the Senate securities subcommittee, said had contributed ``to the severity of the current crisis.''
Efforts by lobbyists have delayed FASB decisions and kept key parts of the American financial system beyond the reach of regulators. Their victories included ensuring that over-the- counter derivatives stayed unregulated and persuading the Securities and Exchange Commission to let investment banks' broker-dealer units reduce capital requirements. That allowed them to increase borrowing and magnify profits. Bank watchdogs also didn't move to tighten mortgage-industry standards until after the collapse of the subprime market.
``I wouldn't be surprised if the Fed ends up officially becoming our systemic-risk regulator,'' said Robert Litan, an economist at the Brookings Institution in Washington.
That's ironic to Donald Young, an investor advocate and FASB board member from 2005 until June 30. He testified at the same Senate hearing on Sept. 18 that both the Fed and the SEC joined the banks they oversaw in resisting proposals for more disclosure of off-the-books assets.
``There was an unending lobbying of FASB'' by companies and regulators, Young told the committee.
`Lack of Transparency'
The former FASB board member made a similar point in a June 26 letter to Senator Reed. ``We lacked the ability to overcome the lobbying efforts that effectively argued that if we made substantive changes we would hamper the credit markets and hurt business,'' Young wrote. ``Our inaction did not hamper credit markets -- it helped to destroy them.''
Ten years ago, Wall Street was enjoying a bull market fed by a booming dot-com industry, a Fed chairman, Alan Greenspan, who trusted the market to correct its own ills, and a Congress amenable to lightening the touch of regulators.
That same year Greenspan, Treasury Secretary Robert Rubin and SEC Chairman Arthur Levitt opposed an attempt by Brooksley Born, head of the Commodity Futures Trading Commission, to study regulating over-the-counter derivatives. In 2000, Congress passed a law keeping them unregulated.
Outstanding credit-default swaps, derivative contracts used to hedge or speculate on a company's debt, would grow to $62 trillion from $631 billion in 2001. While the swaps spread risk, as intended, they also helped spread fear. Ninety percent of the trades were concentrated in the hands of 17 banks, according to the Federal Reserve Bank of New York. That left them exposed to losses if one failed, as Lehman Brothers did in September, and contributed to the unwillingness to lend to each other that's at the center of the recent credit squeeze.
In 2004, the SEC allowed the biggest securities firms -- Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman and Bear Stearns Cos. -- to set up a system giving the commission oversight of the investment banks' holding companies, rather than just their brokerage units, as had been the case.
Increased Leverage
With the change, approved in April that year, the Wall Street firms avoided having their operations in Europe regulated by the European Union. They were also able to reduce the amount of cash their broker-dealer units had to set aside as a cushion against unexpected losses by as much as 30 percent, Annette Nazareth, then head of the SEC's market-regulation staff, said in an interview. Nazareth, who later became an SEC commissioner, is now a partner at New York law firm Davis Polk & Wardwell.
That allowed the banks to increase their leverage, the ratio of borrowed funds to each dollar of equity capital held, and to invest even more heavily in subprime-related securities. Bear Stearns increased its leverage to 33.5-to-1 after the rule change from 26.4-to-1.
The continued delays and revisions of FASB's off-balance- sheet rules let financial institutions keep the scope of their assets from public view.
Except the derivatives market actually functioned just fine. It was the regulated parts of the economy, the banks, that were the problem.
The derivatives market most likely wouldn't have collapsed if they were trading in "A" paper, rather than undercollateralized "D" paper issued as "A" paper.Wall Street paid lobbyists mountains of money to ensure that they weren't regulated in the derivatives market, which ultimately collapsed, and to allow them to increase leverage.
The derivatives market most likely wouldn't have collapsed if they were trading in "A" paper, rather than undercollateralized "D" paper issued as "A" paper.Wall Street paid lobbyists mountains of money to ensure that they weren't regulated in the derivatives market, which ultimately collapsed, and to allow them to increase leverage.
