I have rarely seen a more concrete example of how loose regulation is Wall Street's own worst enemy than Stephen Labaton's front page New York Times article today detailing how a rule change in 2004 at the Securities Exchange Commission contributed to the utter downfall of the investment banking industry.
It's a very simple story. The banks, including Goldman Sachs, then led by Henry Paulson, wanted to increase their ability to borrow money without increasing the amount of capital they would be required to keep in reserve. The banks would be trusted to use their own judgement as to how much risk they should properly take on.
They 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.
The banks got the exemption, used the cash to ramp up their bets, and ended up leaving themselves fatally vulnerable to the housing bust. Wall Street's woes are a self-inflicted wound, aided and abetted by the Bush administration.
Labaton levels pointed criticism at SEC Chairman Christopher Cox, who has consistently worked to loosen regulation of Wall Street throughout his career as a public servant. But there's a larger picture.
The commission's decision effectively to outsource its oversight to the firms themselves fit squarely in the broader Washington culture of the last eight years under President Bush.
A similar closeness to industry and laissez-faire philosophy has driven a push for deregulation throughout the government, from the Consumer Product Safety Commission and the Environmental Protection Agency to worker safety and transportation agencies.
"It's a fair criticism of the Bush administration that regulators have relied on many voluntary regulatory programs," said Roderick M. Hills, a Republican who was chairman of the S.E.C. under President Gerald R. Ford. "The problem with such voluntary programs is that, as we've seen throughout history, they often don't work.