This important article points out that Paulson and Cox were indeed part of the problems which created the Big $hit Pile and the Big Me$$.

Both Paulson and Cox worked to deregulate, defund, and weaken actual oversight. Trust the market. Let the Big Investment Banker Boiz call the shots.

Paulson was part of the band of Merry Banksters who approached the SEC back in April, 2004 (earliest as far as we find documented, but the Bole letter suggests this was broached prior to this meeting, since Bole comments on the possible dangers) to allow the Big Banker Boiz, and only them, to take on far more debt ratio than permitted by then current regulations. This was to be in exchange for the Big Banks being more transparent to the SEC and thus subject to greater regulation.

However, once Paulson became Treasury Secty he began to work to have these regulations lessened and worked to weaken the SEC regulators and the SEC itself.

Cox as head of the SEC worked to defund and dismantle regulatory parts of the agency, including the very group set up to make sure the Big Banks were transparent about their increased leverage.

Fox, meet hens. If Cox heard any disturbances in the henhouse, he did nothing about it. Bcz Paulson was in there initially, acting just like the other foxes? Then, bcz Paulson dresses up real nice and you can take him to Cabinet meetings and have him impress Congress?

My hat is tipped to The Brian Leher Show on WNYC which scheduled an impromptu discussion of the NYTimes front page article about this crucial SEC decision taken in 2004 permitting higher leverage ratios (Heh, I typoed “rations,” which also works) for the Big Banker Boiz. He talked with Merritt B. Fox, professor at Columbia Law School, about the 10/3 front page New York Times report. The vote was unanimous to allow the Big Investment Banker Boiz to run their own shows and increase their leverage. Audio of the segment is available at WNYC.

Stephen Labaton writes in his article (emphasis mine):

…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.
…
They [The Big Banker Boiz] 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.

This decision made at this meeting made the tremendous growth of Big $hit Pile possible, imho. Without this loosening of regulations, the Big Banker Boiz could not have enabled the explosion of resale of sliced and diced mortgages, which then made it possible for the subprime market to flourish, selling to the Merry Banksters, who did additional slicing and dicing and pureeing--until the Ponzi scheme failed. The explosion of these derivatives resulted in the Big Me$$.

It also could not have worked without the ratings agencies accepting the word of the Big Banker Boiz that their sliced and diced difficult to decipher financial “instruments” were good, very good, and gave them AAA ratings. More needs to be found about their role. Congress? FBI?

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.

Could the Merry Banksters have continued so long without one of their own in the position of Treasury Secty? Did Paulson manage things so as to keep his Merry Band solvent as long as possible?

A lone dissenter — a software consultant and expert on risk management [Leonard D. Bole] — 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.

Bole’s letter is available here, and Hipparchia has written comments added at the bottom of this post which exlicate the Bole letter and offer some background on terms.

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.

“We’ve said these are the big guys,” Mr. Goldschmid said, provoking nervous laughter, “but that means if anything goes wrong, it’s going to be an awfully big mess.”

See, they knew even back then the name would be Big Me$$!

The article is 3 NYTimes web site pages long, but they’re chockablock with interesting (alarming, telling, scarifying, should be nullifying the Paulson Fix Is In) details. As usual with bad legislation, BushCo pushed for great speed and little deliberation. Audio of the meeting is at the NYTimes link, left col., about halfway down.

Labaton quotes an analyst as saying there was too much faith in the market:

The 2004 decision also reflected a faith that Wall Street’s financial interests coincided with Washington’s regulatory interests.

“We foolishly believed that the firms had a strong culture of self-preservation and responsibility and would have the discipline not to be excessively borrowing,” said Professor James D. Cox, an expert on securities law and accounting at Duke School of Law (and no relationship to Christopher Cox).

“Letting the firms police themselves made sense to me because I didn’t think the S.E.C. had the staff and wherewithal to impose its own standards and I foolishly thought the market would impose its own self-discipline. We’ve all learned a terrible lesson,”he added. [Ya think??]

And for this they deserve $Billions—$Trillions?? Blind Faith in the Magic Hand of the Market, indeed.

Under “Who knew?” place Cox--who took proactive steps to make oversight more difficult. Again from the article:

Under Mr. Cox, the commission responded to complaints by some businesses by making it more difficult for the enforcement staff to investigate and bring cases against companies. The commission has repeatedly reversed or reduced proposed settlements that companies had tentatively agreed upon. While the number of enforcement cases has risen, the number of cases involving significant players or large amounts of money has declined.

Mr. Cox dismantled a risk management office created by Mr. Donaldson that was assigned to watch for future problems. While other financial regulatory agencies criticized a blueprint by Mr. Paulson, the Treasury secretary, that proposed to reduce their stature — and that of the S.E.C. — Mr. Cox did not challenge the plan, leaving it to three former Democratic and Republican commission chairmen to complain that the blueprint would neuter the agency.

In the process, Mr. Cox has surrounded himself with conservative lawyers, economists and accountants who, before the market turmoil of recent months, had embraced a far more limited vision for the commission than many of his predecessors.

BushCo appointed Cox to not regulate the SEC, but to mitigate as much as possible against the requirements of transparency imposed by Sarnes-Oxley. He did not disappoint Bush, it appears. Wonder how they like the results now....

Last Friday, the commission formally ended the 2004 program, acknowledging that it had failed to anticipate the problems at Bear Stearns and the four other major investment banks.

Classic. Closing barn door after the horses have left.

Hipparchia wrote two comments (second in two parts) which give more information about the Bole letter, terms used, and what Bole saw as problematic, and I’m adding them to this post bcz they help to understand the situation (my emphasis, mostly).

1) Leonard Bole, computer guy in Indiana--
This is the only link i found on the computer guy in Indiana —

A lone voice of dissent in the 2004 proceeding came from the software consultant from Indiana, who said that the computer models run by the companies - and that the regulators would be relying on - could not anticipate moments of severe market turbulence.

“With the stroke of a pen, capital requirements are removed!” the consultant, Leonard Bole, wrote to the SEC on Jan. 22, 2004. “Has the trading environment changed sufficiently since 1997, when the current requirements were enacted, that the commission is confident that current requirements in examples such as these can be disregarded?”

He said that similar computer standards had failed to protect Long-Term Capital Management, the hedge fund that collapsed in 1998, and were unable to protect companies from the market plunge of October 1987.

2) And her links to explanations of terms:

i found this to be the best overall description of the regulation that the commission came up with back in april 2004. nb: 'holding company' = cse = 'consolidated supervised entity'.

i like investopedia's description of var; here's more at wikipedia.

gee, whodathunkit, but maybe the cse program was a stupid idea after all.

3) Followed by her explication of the Bole letter and SEC meeting discussion:

i’ll take a stab at describing what it looks like to me...

i listened to the hearing you linked to, paying attention mostly to just the two times they talked about models. apparently the old rule was that if broker-dealers wanted to use statistical models [presumably to calculate their own capital requirements, rather than let the sec tell them how much capital they had to keep on hand], they had to get them approved first, and had to show the actual models they wanted to use. apparently [and this is another guess on my part], broker-dealers preferred keeping their particular models secret, and in exchange for this, they were willing to consent to increased oversight [broker-dealers and affiliates would join together under a few holding companies, and those holding companies would be subject to regulation].

so, anyhoo, the broker-dealers wanted to essentially use black boxes to calculate how risky their deals were and how much cash they had to keep on hand to cover those deals -- and nyah nyah nyah to the sec for trying to tell them how much capital to keep on hand.

at the same time, changing to the cse/holding company way of organization/regulation fell in line with the way their counterparts in the e.u. financial markets were organized and regulated -- and wah! it's unfair for american companies participating in foreign markets to be required to follow both european regulations and american regulations! this is poppycock, of course, bole points out that multinationals follow mutiple countries' laws and regs all the time [yes, it does cost a bit more to do so].

The american regulations at that time included requiring broker-dealers and/or their holding companies to keep a certain amount of capital on hand. all that lovely capital just sitting around in case something crashed, instead of out working in the marketplace, was anathema to our traders.

leonard bole’s argument is that while var calculations are widely used in risk management, they're inadequate for prediction in the case of catastrophic occurences [100-year floods if we're talking climate; black monday 1987 if we're talking stock markets; etc]. he seems ok with the change to a european-style cse structure, but only so long as the regulators continue to be the ones who decide how much capital the traders need to keep on hand -- NOT relying on the traders' estimations of their own risks in making that decision. he points to the failed company long term capital management as his case in point: their var calculations were obviously flawed.

bole's closing paragraph --

Lowering capital charges for US broker dealers in return for greater regulatory control could erode the system that has safeguarded US investors. By all means, work with the large firms to facilitate a level playing field in Europe, but at the same time continue to protect market participants in this country by preserving the safety net afforded by the current capital requirements.

but could the securities and exchange commission be bothered to listen to leonard cassandra bole? heck no! there's money to be made!

Update: Did some of the foxes turn on the others? Was there a falling out among the Merry Banksters? Some cannibalism as they ran out of hens? Oh, my.

Via Naked Capitalism comes this WSJ article about Lehmann creditors suing JPMorgan, alleging it withheld Lehmann assets:

The creditors' group alleges that J.P. Morgan Chase & Co., which acted as a financial middleman between Lehman and other lenders, helped spark a "liquidity crisis" at Lehman before the firm filed for Chapter 11 bankruptcy proceedings earlier this month...

According to the court filing, about $17 billion in Lehman cash and securities were being held at J.P. Morgan as collateral. In serving as a middleman, or so-called clearing bank, J.P. Morgan operates the bank plumbing that connects firms such as Lehman to third-party lenders. In that role, J.P. Morgan held collateral to ensure the lenders' loans to Lehman can be repaid. In its claim, the creditors group alleges that J.P. Morgan "withheld $17 billion in excess assets" from Lehman Brothers "in the days just prior to the bankruptcy filing."

Is there no honor among thieves?