To follow up last discussion about capital supply, when faced with enormous "cheap credits", investment banks were tempted to borrow more. Meanwhile, the change of SEC leverage rule also facilitated banks to land on a higher leverage ration. As a matter of fact, during the past SEC had limited companies debt-to-net capital ratio to 12-to-1, while in 2004 SEC gave 5 major investment banks (3 failed in the housing crisis) an unbelievable exemption of 30-to-1 or even 40-to-1!
When market is functioning, the high leverage brought huge profit to investment banks, thus also making them greeder and driving them to leverage more. So it's not surprising that when the housing bubble burst, the investment banks had difficulties in refinancing their short-term debt and were forced to bankruptcy.
One lesson from the housing crisis is that regulators should come up with more stringent leverage requirements as a safeguard against credit crisis. In 2007,FDIC did caution against the more flexible risk management standards of the Basel 2. According to Chair Shelia Bair : "There are strong reasons for believing that banks left to their own devices would maintain less capital—not more—than would be prudent...Without proper capital regulation, banks can operate in the marketplace with little or no capital. And governments and deposit insurers end up holding the bag, bearing much of the risk and cost of failure. History shows this problem is very real … as we saw with the U.S. banking and S & L crisis in the late 1980s and 1990s. The final bill for inadequate capital regulation can be very heavy. In short, regulators can't leave capital decisions totally to the banks. We wouldn't be doing our jobs or serving the public interest if we did."
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