03/18/2010 05:12 am ET Updated May 25, 2011

How Capital Requirements Were Changed

The link below is a fascinating short document, a 2001 analysis by Deloitte and Touche of the then-new regulation that changed the capital requirements for mortgage-backed securities (MBS). The regulation took effect in January of 2002.

According to Deloitte and Touche, it loosened the capital requirements for AA and AAA-rated MBS so that capital required for $1 of AA rated MBS was now 1.6 cents (even for BBB it was only 8 cents).

This new 60-1 leverage (they thought AA and AAA rated MBS are safe), together with the corrupt ratings agencies, led to the explosion of that market, and the rest is history.

You still have to wonder why banks -- allowed to put up only $1.60 for every $100 of AAA MBS -- would be so reckless as to actually do it. And even more interesting: who would be so dumb to lend them the $98.40? (I am afraid that question goes above my pay grade).

Here's the document (PDF).