We can expect a lot of revisionist history in the next several months, as policymakers and pundits attempt to spin the historical record to fit their interests.
We had a speaker at Tuck today who mentioned the SEC's 2004 rule change, which eliminated some leverage restrictions on investment banks in favor of capital requirements by type of asset as well as more reliance on self-regulation and reporting to the SEC. A good reference for a similar story is here in the NYT.
I have been meaning to look into this "smoking gun" for some time as it did sound intriguing. Of course, the headline is usually something like the NYT's: "Agency's '04 Rule Let Banks Pile Up New Debt." The subheading is, naturally, that we need more regulation not less and that the Bush administration was at fault.
Now there might be some issues about regulation of the banks, and I myself am very surprised at how poorly market forces seemed to enforce reasonable behavior on the part of the banks. Like Alan Greenspan, I have I guess a nostalgic view of how self-regulation should work (well).
But as to the story on the 2004 deregulation -- it simply does not hold water. I pulled out the Bear Stearns 2003 and 2006 annual reports -- before and after the regulatory change, but before falling asset prices caused an endogenous increase in liquidity.
In 2003, Bear had an overall leverage ratio of 26.4, and a net adjusted leverage ratio of 12.4. In 2006, the respective numbers were 26.5 and 13.6.
Do you think the NYT reporter could have looked that up and told us as well?
12 comments:
This graph seems to tell a different story: http://en.wikipedia.org/wiki/File:Leverage_Ratios.png
I think that I'm gonna get my info from the NYT going forward...
The wikipedia graph certainly confirms my data on Bear Stearns, which came from the annual report. Notice that the ratios in the graph are gross leverage, not the best measures.
As I said in my post, I would not use the 2007 data as a measure of leverage choice, since by that time asset prices were falling rapidly and leverage would necessarily be moving up.
Note also that the firms that showed the most increase in leverage from 2003 to 2006 were Morgan Stanley and Goldman Sachs. The ones that showed the smallest increase were Merrill, Lehman and Bear. Lehman, for instance, increased only from about 22.5 in 2003 to a bit over 25 by 2006.Now, who encountered the most trouble?
Uhhhh....I think the answer is that they all would have been wiped out had the government not interfered.
Accordingly, Wiki and NYT each get 1 point. I will give you 0.5 points for noticing that Bear did not lever up a lot until 2007 in your initial post. But, you get a 0.4 point deduction for stickin' to you guns and not admitting that the NYT nailed it even after Wiki supported the article. So, you are left with 0.1 points.
Robert, Your response seems to suggest that you believe that there's an inverse relationship between leverage and viability? Perhaps, you don't even believe that reckless risk-taking is at the heart of this financial crisis?
I believe that each firm was adversely affected by how much borrowed money it invested, AND affected by the amount of leverage taken collectively by all firms. The wiki chart shows a clear trend... the IBs consistently took on more leverage from 2003 to 2007. Okay, if you want, throw 2007 out. Still, they collectively had a lot more leverage in 2006 than 2003. And, this exacerbated the forced-selling in the markets the last couple of years which caused each firm's portfolio to run against it and increased it's leverage in 2007/2008. Perhaps, the high IQs of the people at MS/GS allowed them to handle more leverage than Merrill, Bear & Lehman. But, their leverage certainly helped push the other three banks to the tipping point and into the abyss. And, as another response points out, MS/GS were drowning too, and needed a lifeline by the feds.
I am not denying that risk-taking and leverage by the banks contributed greatly to the crisis. Clearly, it was an absolutely key factor. If you go back to the summer of 2007, I think that was the time, UBS was one of the first banks to get into trouble. Look at what it had been doing: loading up on its own MBS instead of following the underwrite/distribute model. The concentration of risk in the major financial institutions was a huge cause of the crisis. That is not being disputed.
What I started out disputing was what I still think is naive blame laid on the 2004 change in leverage regulation. Just like you cannot naively blame the repeal of Glass Steagall (just look at which banks made it through -- the ones who took advantage of combining commercial and investment banking).
There is going to be a ton of new regulation placed on the financial services industry as a result of this crisis. The major news services could do the world justice by doing their research and reporting all the relevant facts.
I can't believe that Anonymous is still willing to give the NYT one point when they failed to provide even a simple graph to support their story. Don't we expect a little more from the premier US newspaper?
It does not matter if the NYT puts a graph in there or not. As long as the statements they make are supported by relevant graphs on Wiki and elsewhere, then they are doing their job.
In fact, that is why I gave you 0.5 points. I think their statement about Bear's increased leverage could have been deemed to be somewhat misleading. Your original post keenly noted that this leverage was just added in 2007 and NOT right after the meeting. The NYT article should have done a better job describing that.
Unfortunately, the other investment banks increased their leverage almost immediately. That is why the NYT gets to keep their full point.
I agree that the government may add a lot of regulations to the industry. And, people need to be aware and concerned that they may overreact. In addition, it is also true that other types of de-regulations in the past couple of decades were good and did help our country.
Regardless, though, you have to accept that this particular de-regulation caused severe harm. And, if you can not accept that soon, I may need to deduct the final 0.1 points you have been allotted.
Do you agree that the data show that the IBs increased their leverage from 2003 to 2006?
If so, why is it naive to assume that the 2004 change in leverage regulation resulted in the IBs taking more leverage? The two are certainly consistent, and why it technically doesn't prove causality, I think that the relationship is pretty clear and reasonable. Ultimately, it was the leverage the killed the IBs and if anything, I wish that regulators restricted the amount of leverage that the IBs were allowed to take.
Also, a related note: I'm not sure that it's fair to just disregard 2007 data. Yeah, their portfolios were running against them. But, if they weren't allowed to take more leverage, perhaps each IB would have taken their losses and reduced their exposure in a more controlled manner two years ago. Instead, with the ability to handle more leverage, each IB thought it could ride out the storm, which only allowed the crisis to gain momentum and made the eventual crash even more severe.
Like you, I'm generally disappointed with the press. But, I can point to more serious concerns than a NYT story omitting a graph that would have supported their argument.
I have a couple more visitor to Tuck tonight who were in risk management at a couple large financial institutions. As I am moderating their talk, I will definitely ask them how the 2004 regulatory changes, and others, affected risk taking behavior.
Help me to finish this sentence, Professor Hansen:
"If banks had maintained their leverage at 2003 levels, the financial crisis would have _____________________."
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