Monday, October 27, 2008

The future is always uncertain...

Being a student of MBA it is indeed very interesting to follow the everchanging world of Finance, each time coming to same old conclusion that it is nearly impossible to predict what is going to happen a few months hence. A study of the life and background Mr Henry M. Paulson, the current United States Treasury Secretary, proves just this.

Currently, Mr Paulson is in the limelight for the much debated $700 billion bailout plan to rescue the US economy from the aftermath of the subprime crisis, which led to major investment banks, like Lehman brothers and Bear Stearns, going bankrupt.

What is interesting to note is the role the "Net Capital Rule" ( or rather the lack of it) plays in these bankruptcies. According to this rule, brokerages and firm that are under the regulation of the US SEC are supposed to maintain a minimum amount of capital reserves for protection against just this type of a situation :)

In April 2004, heads of the major Investment houses met the then SEC chairman, Mr. William S. Donaldson and requested him to release them from the restrictions of the Net capital rule. As a result, this rule was unanimously abolished by the commission for banks whose assets exceeded $5billion. This SEC decision allowed firms to invest without restrictions which resulted in massive borrowings and dwindling assets. In Bear Stearns case the ratio was 33:1, with heavy investments in mortgage backed securities. With the collapse of the real estate sctor they had no hope of ever recovering their money and thus went bankrupt.

That famous meeting in 2004 was presided over by none other than the current US Treasury Secretary, Mr Paulson who was the CEO of Goldman Sachs at the time! Little did he know that that meeting would be one of the major reasons for a global financial crisis and trigger off a recession in America which he would have to control!