The SEC allowed the five major investment firms to dramatically increase leverage, allowing the Wall Street firms to move from a manageable debt to equity ratio of 12:1 to 30:1-40:1.

Making matters worse, according to Mr. Pickard, who helped write the original rule in 1975 as director of the SEC's trading and markets division, is a move by the SEC this month to further erode the restraints on surviving broker-dealers by withdrawing requirements that they maintain a certain level of rating from the ratings agencies.

"They constructed a mechanism that simply didn't work," Mr. Pickard said. "The proof is in the pudding — three of the five broker-dealers have blown up."

The so-called net capital rule was created in 1975 to allow the SEC to oversee broker-dealers, or companies that trade securities for customers as well as their own accounts. It requires that firms value all of their tradable assets at market prices, and then it applies a haircut, or a discount, to account for the assets' market risk. So equities, for example, have a haircut of 15%, while a 30-year Treasury bill, because it is less risky, has a 6% haircut.

The net capital rule also requires that broker dealers limit their debt-to-net capital ratio to 12-to-1, although they must issue an early warning if they begin approaching this limit, and are forced to stop trading if they exceed it, so broker dealers often keep their debt-to-net capital ratios much lower.

I feel bad for the employees of the firms that have imploded and angry at the executives who cashed out while placing not only their firms but the financial markets and the economy at such systematic risk, but there is a certain ironic justice to the collapse of the firms which lobbied the government to allow them to increase leverage.

The financial system is a joke.  Wall Street poured millions of dollars into the coffers of politicians to de-regulate the financial markets so they could increase leverage.  The more leverage Wall Street could pile onto their balance sheets, the more revenues they could generate.  And the more revenues they could generate, the more they could pay themselves.

And you wonder why starting investment banking associates straight out of MBA with a few years work experience were being paid over $300,000.

If the financial industry is allowed to buy its way out this debacle by paying off the next group of politicians who will attempt to re-regulate the industry then we are going to be in this mess again in another 10 years.

It should never have come to this. 

It is time to re-regulate the investment industry.

Via Barry Ritholtz