The Regulatory System
While we're concerned here principally with the microeconomic level, it's true that the regulatory system does, or should, play a key role in maintaining healthy flow of capital, fair markets, and an economy supportive of corporate growth, providing a sound basis and protections for all parties. As such, regulators have a direct effect not only on macroeconomics, but also on individual industries and companies. But a number of things went terribly wrong in the subprime debacle.
Securities and Exchange Commission
The SEC has long been considered one of the most effective government institutions, held in high esteem on both sides of the Congressional aisle. Well, its reputation has been tarnished. There was a brief and little-noticed meeting of the Commission way back in the spring of 2004 with major investment banks. News later came out that the banks asked for and received an exemption regarding the amount of debt their brokerage units could take on. Billions of dollars held as a cushion against losses were freed up and invested in mortgage-backed securities and exotic derivative instruments, while the SEC relied on the bank's own computer models to determine the risks inherent in those investments.
We now know what transpired. The bank's leverage ratios skyrocketed, with Bear Stearns's ratio, for example, going as high as 33 to 1. Reportedly the SEC did little to monitor the situation. Reports at the time indicate that the office originally identified as ...