The financial crisis explained to dummies in terms of capital requirements for banks: Lehman Brothers - AIG - Greece

The regulators, with Basel II, decided that against any private sector assets rated AAA banks, and against any sovereign rated as Greece was until November 2009, banks needed to hold only 1,6 percent in capital, meaning these could with those assets leverage their capital over 60 times to 1. (When holding “risky” assets like loans to entrepreneurs and SMEs they were only allowed to leverage 12 times to 1. 

On April 28, 2004 the SEC decided that was good for the Basel Committee was good enough for them and allowed Lehman to leverage over 60 times to 1 with AAA rated securities guaranteed with mortgages to the subprime sector… Since Europe were allowing their banks to do the same… the demand for these AAA securities became so huge that it overpowered all the quality controls in their manufacturing and packaging process… and Bang!

If AIG that was AAA rated guaranteed an asset, banks could dramatically reduce the capital they needed to hold against that assets, and this overwhelmed AIG’s capacity to resist selling “very profitable” loan default guarantees… and Bang!

Greece was of coursed offered loans in such amounts and in such generous terms, so their otherwise "so" disciplined and fiscally conservative governments could not resist the temptations… and Bang!

And as should have been expected not one single asset class that was perceived as risky played any role in causing the financial crisis… although of course these assets also suffered a lot when the “safe” came tumbling down.

One would think regulators would by now have discovered that banks already clear for the perceived risks with their risk premiums and the size of their exposure; and so to also force them to also clear in the capital for exactly the same risks, would cause banks to overdose on perceived risks. But no, they haven’t. So this little financial history lesson for dummies is of course primarily directed to them.

What is our major problem now? John Kenneth Galbraith explained it well: “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections.”

An indebted unemployed student’s story:

An indebted unemployed student: "At last I thought I had a reasonably good paying job that would make me be able to repay my student debt, and earn me something on top of that, for all the time and efforts I had invested in my studies. But, that was not to be, because the owner of the SME who was offering me the job, had his credit application denied by the local bank that had the most intimate knowledge of his business and plans. Much saddened, even despaired, I asked the employer I had counted on… How come?”

SME owner: “The banker told me that if he gave me the loan then, because I was officially perceived as risky from a credit risk point of view, regulators required him to hold much more equity than if he lent that money to an AA rated corporation or invested it in treasury bills. And, unfortunately, he did not have that equity.”

Indebted unemployed student: “What? In the home of the brave, banks are required to hold more equity against loans to the supposedly risky than against loans to the supposedly safe?” 

SME owner: “Yes, ever since the US signed up on the principles of the Basel Accord back in 1988, and especially after the approval of Basel II in 2004, that is how it is. Sorry my dear unemployed student loan debtor, there’s nothing I can do about it! I am just as sad and hurt.”

Indebted unemployed student: “But why would the regulators do a thing like that?”

SME owner: “Beats me. As far as I know all real big bank crises have never ever resulted from excessive loans to “risky” SMEs and entrepreneurs like me, these have always resulted from excessive bank exposures to what banks, and regulators, believed to be absolutely safe, but turn out not to be.”

Indebted unemployed student: “But that’s plain crazy!”

SME owner: “Indeed, it is an odious discrimination, and by killing opportunities it promotes inequality.  But, no one dares to question the regulators, especially when it has become so fashionable to question bankers… or perhaps the regulators are all just statists and love the idea that banks should foremost lend money to government bureaucracy, as well as to their intimate friends of the AAArisktocracy they usually see in Davos.”

This fictitious but sadly too real story, is sent upon request to Rep Elijah Cummings and Senator Elizabeth Warren 

PS. I have always believed students should be given access to student debt as if they were AAA rated, because although they might not have an AAA credit rating, they sure have an AAA rated purpose. That said, much much more important than their debts, are their possibilities of future jobs.