In the morning I walked to the bank. I went to the automatic teller machine to check my balance. I inserted my card, entered my secret code, tapped out my request. The figure on the screen roughly corresponded to my independent estimate, feebly arrived at after long searches through documents, tormented arithmetic. Waves of relief and gratitude flowed over me. The system had blessed my life. I felt its support and approval. The system hardware, the mainframe sitting in a locked room in some distant city. What a pleasing interaction. I sensed that something of deep personal value, but not money, not that at all, had been authenticated and confirmed. A deranged person was escorted from the bank by two armed guards. The system was invisible, which made it all the more impressive, all the more disquieting to deal with. But we were in accord, at least for now. The networks, the circuits, the streams, the harmonies.
[Julie Dickson, head of the Office of the Superintendent of Financial Institutions] points to three specific restrictions: capital requirements, quality of capital and a leverage ratio. “We had a tier one capital target of 7 per cent going back to 1999,” she says, referring to the proportion of the bank’s equity considered to be of the highest grade. “We also paid attention to quality of capital, so 75 per cent of that tier one had to be in common shares [as opposed to preferred stock, which is considered a hybrid of equity and debt]. And our leverage ratio [of debt to equity], of 20 to 1, was very important, we think.”
Mark Carney at the Bank of Canada cited those same three rules, and this nearly word-perfect unanimity between the two speaks to a fourth, structural advantage – Canada’s uncomplicated and well co-ordinated regulatory framework.
... The bank chiefs seem to get the message. According to [Ed] Clark, whose TD bank has significant operations in the US: “The message in the US is it’s your responsibility to meet our rules. In Canada, the responsibility is to run the institution right. Julie says [to the CEO]: you are the chief risk officer of the bank.”
"The industry was really fighting us. I will never forget [when] a group of mortgage bankers came in, it was probably January, February, 2007, and ... sat down and just vigorously argued against doing anything."
The FDIC and other regulators went ahead and finalized a set of sub-prime mortgage lending standards, but it knew that it had to tackle the huge number of sub-prime mortgage loans that had already been created. The regulator urged the parties behind the risky mortgages to extend the lower "starter" rates on the mortgages, the alternative being that huge numbers of mortgages holders would be unable to make the higher mortgage payments and ultimately default and devastate the housing market.
"We thought the industry was on top of this, ahead of this, and it was going to happen, and then late summer or early fall Moody's.com came out with a report that said less than 1% of these distressed subprime loans were getting restructured, and an overwhelming majority were going into foreclosure."
In the fall of 2007, Ms. Bair spoke at a financial industry meeting and challenged participants to extend the starter rates and deal with the looming threat to the housing market. One unsympathetic participant spoke up and said, 'You can't help these people. You try to give these people a break they are just going to go out and buy a flat-screen TV.'
She recalled that she responded with the question, "Why did you give them the mortgage in the first place?' And I will never forget; his answer was 'Bad regulation.'
"So much for the self-regulating market," concluded Ms. Bair.
The Securities and Exchange Commission changed the leverage rules for just five Wall Street banks in 2004. The “Bear Stearns exemption” replaced the 1977 net capitalization rule’s 12-to-1 leverage limit. In its place, it allowed unlimited leverage for Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns. These banks ramped leverage to 20-, 30-, even 40-to-1. Extreme leverage leaves very little room for error.
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