The key to understanding the 2004 regulatory change is to forget the narrative about deregulation. Look at it as an expansion of regulation, which is how the SEC saw it.

“The amendments should help the Commission to protect investors and maintain the integrity of the securities markets by improving oversight of broker-dealers and providing an incentive for broker-dealers to implement strong risk management practices. Furthermore, by supervising the financial stability of the broker dealer and its affiliates on a consolidated basis, the Commission may monitor better, and act more quickly in response to, any risks that affiliates and the ultimate holding company may pose to the broker-dealer,” the SEC says in the Federal Registrar entry encoding the law.

Even after the financial crisis, the SEC continued to see it this way.

“First, and most importantly, the Commission did not undo any leverage restrictions in 2004. Rather, I believe that the Commission sought to fill a gap in the statutory system of supervision by offering to the US investment banks, for the first time, a regime of comprehensive consolidated oversight by virtue of its conditions on the broker-dealers. Given pressures from Europe, it was expected that the five largest US investment banks would make the necessary one-time election to be supervised under this regime. Thus the Commission effectively added an additional layer of supervision at the holding company where none had existed previously,” Eric Siri, the director of the SEC’s Division of Markets and Trading, said in a 2009 speech.

In particular, what the 2004 amendments to the net capital rules did was bring the parent holding companies of the biggest investment banks under SEC supervision. Prior to the amendments, only the broker-dealer units were directly regulated by the SEC. After the amendments, the entire company structures of Lehman Brothers, Bear Stearns, Goldman Sachs, Morgan Stanley and Merrill Lynch came under regulatory purview as “consolidated supervised entities” or CSEs.

It’s helpful here to look back to a bit of the history of how these investment-bank holding companies had escaped regulation for so long. Prior to the 1970s, the broker-dealers were largely regulated only by the stock exchanges—particularly the New York Stock Exchange. But a series of financial calamities that came to be known as the “paperwork crisis” saw hundreds of Wall Street firms collapse, leaving investors with serious losses—both of funds and confidence.

To restore confidence, Congress enacted a form of deposit insurance for brokerages. Worried that insurance would lead to moral hazard and excess risk, Congress also imposed the original capital adequacy rules for Wall Street. But since these were only intended to cover the insured entities—the brokerages—they didn’t reach into the parent companies, investment banking arms, and so on. So Wall Street’s biggest firms were largely unsupervised entities with broker-dealer arms that fell under SEC purview.

As the securities business expanded in the 1980s and broker-dealers grew into large international financial conglomerates, regulators became increasingly worried that a broker-dealer could fail due to the insolvency of its parent holding company. This fear became a reality when the 1990 bankruptcy of Drexel Burnham Lambert led to the liquidation of its broker-dealer affiliate.

The 2004 amendments meant that the big five Wall Street firms now had to report financial data to the SEC in a manner consistent with the capital adequacy standards for U.S. bank holding companies. Which meant, at the time, a version of the Basel II risk-weighted asset approach that had been adopted by the FDIC, the Federal Reserve, the Office of Thrift Supervision and the Office of the Comptroller of the Currency. And that meant—cue ominous music—the big Wall Street firms were going to go crazy buying mortgage assets.

The original Basel financial regulations had a built-in mortgage bias that was intended to encourage banks to acquire mortgage-related assets. The German delegation to the original Basel meetings had urged a tilt toward mortgages in hopes of stimulating their domestic mortgage market. The Federal Reserve reluctantly agreed to accept that mortgages would get a 50 percent risk weighting.