Jump Starting "Too Big to Fail" in 2004

“We’ve said these are the big guys,” Harvey J. Goldschmid, a Securities and Exchange Commissioner said, provoking nervous laughter, “but that means if anything goes wrong, it’s going to be an awfully big mess.”

It was a mess, but the government cleaned up the mess at the expense of you and me, by giving more favors to the same large banks very similar to the ones it gave them at that fateful meeting in the spring of 2004.

Mr Goldschmid's "big guys" were Bank of America, Merrill Lynch, Lehman Brothers, Goldman Sachs, and Morgan Stanley. On April 28, 2004, they approached the SEC with a deal that all of the SEC commissioners except (initially) for Goldshmid thought was too good to pass up.

In retrospect, I agree with Michael Lewis, author of "The Big Short", who, a couple of years ago said:

If you think about where we stand right now, we essentially have socialism for capitalists and capitalism for the rest of us. The big Wall Street firms are essentially operating with a government guarantee, having been bailed out by the government. They were failed institutions. If the free markets had been allowed to run their course, if nature had run its course, all these businesses – Morgan Stanley, Goldman Sachs, Bank of America, Citigroup – they’d all be out of business, they’d all be failed.

Yet, not only were the not allowed to fail, they were given the green light by the Securities and Exchange Commission to engage in behavior that was contained a heavy likelihood of failure.

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.

Were the banks promised that day that they'd be bailed out if something went wrong?  Probably not.  But this certainly jump-started that--to the big banks, comfortable--idea.  One of the leaders of the five investment banks that solicited the favor of the SEC that day was Goldman Sachs head Henry Paulsen, who would become US Treasury Secretary under George W Bush just two years later.

Interestingly, when Goldschmid initially objected to severely curtailing regulation of the big banks, he was told by the other nine people in the room that it was perfectly safe.  Why was it safe? Their less than impeccable logic indicated that it was because this favor would only be available to the five investment banks who were represented at the SEC meeting that day.
The meeting was not covered by the media.

Goldschmid was either cowed or reassured, and the Securities and Exchange Commission voted 5-0 that day to unleash the floodgates of "Too Big to Fail".

Christopher Cox, who became the SEC chief about a year later, put almost no priority on overseeing the increasingly risky behavior of the five investment banks. Issues of impropriety and undue risk were brought to the SEC's attention, but those concerns were ignored.

Later on, when the banks were on the verge of failure, government bailed them out, in no small part for the reason that one of the very investment bank heads who got special treatment from the SEC was the head of the US Treasury when the bailing out needed to be done. How convenient.

Henry Paulsen, as well as the other bank heads who got priority treatment from the SEC that day are criminals of a far higher magnitude than Bernard Madoff ever dreamed of being.  Yet only Madoff is in prison.

And the SEC just stood there and let it happen.