Limit Leverage!

The astounding thing about the collapse of Jon Corzine’s gambling venture, MF Global, is the revelation that his bets were leveraged at about 40 to 1. This is like playing poker and borrowing 97 percent of your stake. If you guess wrong on a big bet (as Corzine did), you are wiped out (as he was).

The same thing happened to Lehman Brothers.

This also shows how utterly feeble Dodd-Frank is and how little the system has changed since the collapse of 2008.

The so-called shadow banking system—outfits like Corzine’s—can still bet the house if they have a taste for risk. The only good news was that at $8 billion, Corzine’s MF wasn’t big enough to take down the system or require a government bailout. But it could have been.

As a regulatory matter, it would not be difficult to limit all kinds of leverage for any financial institution to, say, 10 to 1. And the more risky the kind of institution and its strategy, the more leverage should be limited.

You could require all financial institutions to make real-time filings to the SEC of how much money they are borrowing compared to their own capital, and any one that goes over the ratio of ten to one is shut down.

The lesson of the Dodd-Frank aftermath is that blurry laws produce an infinite paper chase of regulatory details that are pathetically easy to ridicule and to evade. The Wall Street Journal has made great sport of the fact that the Volcker Rule’s ban on proprietary trading has given rise to endless hearings, 1,347 queries from regulators, rules that will run some 300 pages and will still be easy to evade because of their very complexity.

On the other hand, if you have simple rules, like strictly limiting leverage, prohibiting commercial banks from engaging in all forms of investment banking (not just securities trading), banning credit-default swaps as inherently subject to abuse, you have a chance of taking back the banking system.

Comments

The greatest period of wealth-creation the world has ever seen was from 1945 to 1955 in the US.

The most fundamental principle of banking during that period was Steagall-Glass: bankers don't get to be gamblers; gamblers don't get to be bankers. Crusty old Congressman Gonzales of Texas kept the law alive for a generation, against the might of all the money on Wall Street, and the US prospered in large part for that single reason.

Steagall-Glass went down after Gonzales' sad death, and the result was almost instant: the ending of middle-class income gains under Reagan, followed by the near-destruction of the world's economy under the two George Bushes.

Now then, can anybody here guess where banking reform has to start?

This necessary reform might be a little easier if a few of the crooks involved under the junior Bush were sent to prison (and separated from their vast lobbying funds while on trial.) Since the leaders of almost every large bank in America was involved in one or several violations of fiduciary duties, in most cases legally binding and/or sworn fiduciary duties, this might lead to a somewhat interesting change in the leadership of Wall Street.

No doubt the populations of say Grand Bahama, the Netherlands Antilles, and other strange little places would gain some high-spending new visitors.

Typo in second-last paragraph: "leadership," not "leaders."

-dlj.

While Mr. Corzine might be "wiped out" after this bankruptcy—I have a feeling he won't be frequenting any soup kitchens this winter—one might wonder who it was who lent him the money to flutter in the first place.

I also was curious to know whether it was during Mr. Corzine’s tenure that GS was involved in the introducing the Greek government to the wonders of CDS?

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