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Treasury, Chris Dodd & Barney Frank Sell Out To Wall Street

Robert Lenzner, 06.24.10, 7:00 PM ET

The most crucial element in the re-regulation of Wall Street has been gutted. At least for now, there will be no limits on how much money Wall Street can borrow to do its business. It's an invitation to dare a new meltdown or financial crisis. The big banks' lobbyists have convinced Treasury and Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee, not to support Rep Barney Frank's, D-Mass., insistence on limiting the leverage Wall Street can use to trade securities.

At the moment, Frank has lost the battle to limit Wall Street to borrowing $15 for every $1 in capital. If there is no limit it means the risk taking that triggered the demise of Lehman and Bear Stearns, the shotgun marriage of Merrill Lynch and the costly bailouts of Citigroup, and Bank of America, and other financial institutions, is again a very real possibility.

Harvard Business School professor David Moss says that "a cap on leverage is absolutely essential. We need to tighten the limits on borrowing at major financial institutions, both on balance sheet and off. Regulators should use their discretion in setting these limits, but there should also be a statutory cap on leverage, a maximum speed limit, if you will, that regulators can't loosen. After all, many regulators let down their guard last time around."

Lax government oversight and deregulation of the financial services industry were major causes of the economic and financial meltdown we experienced from 2007 until March. It was the leverage employed by banks that wiped out their capital when the value of mortgage-backed securities dramatically declined in value during 2007 and 2008.
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It cost the Fed and Treasury better than $1 trillion to bailout banks in to save the banking system from collapse and throw the U.S. economy into another severe depression. Investors own securities that have never risen back to their pre-financial crisis level. The Dow Jones Industrial Average at 10,200 is still 40% below its October 2007 peak of 14,100.

The proposed language of the statute presently reads that 15-to-1 leverage can only be mandated for institutions that are clearly in "grave or imminent threat" of failing. This last minute bandage makes no sense because if the institution is in such dire straits, the necessity of selling assets to reduce leverage will mean that substantial amounts of its capital are to be written off, making it even more vulnerable to insolvency and failure.

Who will decide if "grave or imminent danger" is at hand? The Financial Advisory Council of regulators that is meant to advise the Federal Reserve. But would this oversight group be well enough informed as to the dangers? How could they possibly have up-to-date balance sheet and off balance sheet numbers? Who will have the necessary information to evaluate the value of assets the banks own with the borrowed money? If there is no tight regulation, it is a recipe for disaster


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