United capital self liquidating loan
In a July 2009 report, the Government Accountability Office ("GAO") reported that SEC staff had stated to the GAO that (1) CSE Brokers did not take on larger proprietary positions after applying reduced haircuts to those positions under the 2004 rule change and (2) leverage at those CSE Brokers was driven by customer margin loans, repurchase agreements, and stock lending, which were marked daily and secured by collateral that exposed the CSE Brokers to little if any risk.
The report also stated officials at a former CSE Holding Company told the GAO they did not join the CSE program to increase leverage.
That article explained the net capital rule applied to the "brokerage units" of investment banks and stated the 2004 rule change created "an exemption" from an old rule that limited the amount of debt they could take on.
According to the article, the rule change unshackled "billions of dollars held in reserve against losses" and led to investment banks dramatically increasing their leverage.
Daniel Gross wrote in Slate magazine: "Going public allowed investment banks to get bigger, which then gave them the heft to mold the regulatory system to their liking.
Perhaps the most disastrous decision of the past decade was the Securities and Exchange Commission's 2004 rule change allowing investment banks to increase the amount of debt they could take on their books—a move made at the request of the Gang of Five's CEOs." He was referring to the net capital rule change.
Financial reports filed by those companies show an increase in their leverage ratios from 2004 through 2007 (and into 2008), but financial reports filed by the same companies before 2004 show higher reported leverage ratios for four of the five firms in years before 2004. The companies that received SEC approval to use its haircut computation method continue to use that method, subject to modifications that became effective January 1, 2010.
Beginning in 2008, many observers remarked that the 2004 change to the SEC's net capital rule permitted investment banks to increase their leverage and this played a central role in the financial crisis of 2007-2009.
Pickard, Director of the SEC's Division of Market Regulation (the former name of the current Division of Trading and Markets) at the time the SEC's uniform net capital rule was adopted in 1975. Pickard wrote that before the 2004 rule change, broker-dealers were limited in the amount of debt they could incur, to a ratio of about 12 times their net capital, but that they operated at significantly lower ratios.
She also stated the SEC was reviewing whether the "alternative net capital computation" system established by the 2004 rule change "should be substantially modified" and more generally whether minimum net capital requirements should be increased for all broker-dealers.
The SEC's "Uniform Net Capital Rule" (the "Basic Method") was adopted in 1975 following a financial market and broker record-keeping crisis during the period from 1967-1970.
Under the 2004 rule change the difference is that those CSE Brokers (like Citigroup Global Markets Inc. before them) are now owned by bank holding companies subject to consolidated supervision by the Federal Reserve, not by the SEC under the CSE Program described below.
In her prepared testimony for a January 14, 2010, hearing before the Financial Crisis Inquiry Commission ("FCIC"), SEC Chair Mary Schapiro stated SEC staff had informed CSE Brokers in December 2009 that "they will require that these broker-dealers take standardized net capital charges on less liquid mortgage and other asset-backed securities positions rather than using financial models to calculate net capital requirements." In her prepared testimony for an April 20, 2010, hearing before the House Financial Services Committee, Chairman Schapiro repeated this explanation and added that the new requirements took effect January 1, 2010.