If I had to pick one decision which played the pivotal role in the financial crisis, it would have to be the SEC’s agreement to waive leverage limits at the biggest investment banks in 2004. From traditional levels in the low teens, leverage ratios at banks like Lehman Brothers and Bear Stearns skyrocketed to the mid thirties and higher. I don’t care how good a risk manager you are, if you only have three dollars in equity supporting $100 in assets, the merest market move or collapse in trading liquidity can kill you. If you fail with a balance sheet of $10 or $20 billion, a bunch of shareholders, employees, and counterparties will wipe away a tear and mourn your passing. If you’re holding half a trillion to a trillion dollars, however, the collateral damage from your ruin will have everybody licking their wounds—and writing outraged letters to the Times—for years, if not decades.
From this fantastic blog post by the Epicurean Dealmaker.
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