OTC, CFTC, CBT, CDOs, SEC, again - and again
It may seem tame considering what has come since, but Henry Levin's 1960 teen romantic comedy Where the Boys Are was fairly revolutionary for its time.
Hewing to the still mostly standard Hollywood formula of showcasing the limb-grinding adventures of attractive hormone-sodden young satyrs before, in the last reel, showing the said same fulfillment of these desires devastating their lives, the movie tells the tale of two college co-eds, Merritt (Dolores Hart) and Melanie (Yvette Mimieux) on spring break in Fort Lauderdale, Florida. Merritt hesitates on taking the penultimate step in the game of what she calls "backseat bingo" in order to win the heart of a special beau; Melanie fairly explicitly affirms (for the time, anyway) that she intends to show no such restraint.
Of course, it ends very badly for Melanie. Lured to a party at a roadside motel where she believes that her new boyfriend will be present along with other desirable young Ivy League "Yalies", she is next seen wandering aimlessly in the middle of a busy highway, hair and clothes disheveled - as the then movie morals code would not allow the word that described her obvious violation to be explicitly uttered, the audience was left to draw the obvious inference as to the terrible price she paid for her licentiousness.
She gets hit by a car; in the hospital, she confesses the worst part of her sin to Merritt. "They weren't even Yalies!" she sobs.
Thirty eight years later, in 1998, US Commodity Futures Trading Commission chairwoman Brooksley Born, in seeking to uphold the integrity of the financial system, was similarly accosted. However, in contrast to poor Melanie, the gang that attacked her possessed just about the highest imaginable academic pedigrees. They were the then deputy secretary of the Treasury (and now the chair of President Barack Obama's National Economic Council) Laurence Summers (BA Massachusetts Institute of Technology, Phd Harvard); Federal Reserve Board chairman Alan Greenspan (BA, MA Columbia, Phd New York University); and the leader of the gang, Treasury secretary Robert Rubin (BA Harvard, LLB Yale - yes! he was even a Yalie). After the attack on chairwoman Born, the gang carelessly hopped into their souped-up hot rod and proceeded to further make the preparations for their rich-kid, thrill-kill firebombing of the world financial system we see occurring today.
If you ever have the misfortune to be locked in a history seminar listening to the instructor drone on and on about how America in the interwar period withdrew from the world to focus on itself, isolationism, and just plain irrelevancies, it would not be impudent to raise your hand and ask "But just which interwar period are you talking about, Herr doktor professor?"
The common perception would be that the period being referred to was the 1918-1941 period between America's experience in the first and second world wars. But now there's another interwar period - the 12 years between the 1989 fall of the Berlin Wall, which represented the end of the Cold War, and the attacks of September 11, 2001, which essentially marked the beginning of the so-called "War on Terror". As Derek Chollet and James Goldgeier put it in their new book From 11/9 to 9/11- America Between the Wars
It was the same in economics and financial policy. Francis Fukuyama declared the "End of History", meaning that the central operative principle to be learned from the fall of state socialism was that the government which governed least governed best. Bill Clinton, noting the electoral disasters that befell leftist Democratic presidential nominees Walter Mondale and Michael Dukakis in 1984 and 1988, pointedly ran in 1992 with the blessing of the party's centrist Democratic Leadership Council. Following the electoral drubbing received by the party in 1994 after the public rejected his vision of a government-run healthcare system, his innate centrist instincts were brought even more to the fore. Proposals and bureaucrats advocating income redistribution and/or antagonistic stances towards business and finance would be banished to academia.
Since the administration's poll fortunes (not to mention its members' actual fortunes) rose so closely in tandem with the stock market, no "enemy of the people" would be allowed to advocate policies that might kill, or even mildly irritate, the golden goose. The Democratic economic policy secretariat might be more favorably inclined to more gender and/or racial diversity than the Republicans they replaced, and the art on their walls might be more Jackson Pollock and Mark Rothko than Frederic Remington and LeRoy Niemen; otherwise, their views were basically identical.
That pattern held at the US Commodity Futures Trading Commission (CFTC), the government agency charged with regulating and monitoring the frequently very topsy-turvy world of commodity and financial futures markets and trading. Clinton had appointed Mary Schapiro as his first CFTC chair in 1993 - she had been a member of the Securities and Exchange Commission ( SEC) from the Ronald Reagan-George Bush Snr era (and is now Obama's choice to lead the SEC). Clinton then in 1996 appointed Washington corporate lawyer Brooksley Born as his second choice to chair the CFTC.
As an associate with the uber-connected law firm of Arnold and Porter, the Clinton gang must have thought they had made an outstanding choice - another female face as a sop to the feminist component of the base, but one trustworthy enough not to shake the pro-business and markets applecart being plied by the adults upstairs.
Well, one out of two isn't bad.
One thing that the Clinton gang must have overlooked in making sure that Ms Born wasn't the financial regulation equivalent of the actor and drag queen Ru Paul was that her self-described most memorable case while at Arnold and Porter was litigation arising out of the failed attempt by the Hunt Brothers to corner the market in silver as the inflationary spike of the 1970s flamed out in 1979 and 1980.
In a 2003 interview in Washington Lawyer, Born noted that she personally witnessed the case "causing great damage to traders when the price [of silver] went up and then again when it collapsed".
"That's nice," the Clinton official who vetted her must have tut-tutted. "The press wants to know, what color will your credenza be."
In early 1998, she pulled something out of that credenza. They sure noticed her upstairs then.
Traditionally, the CFTC's mandate and purview extended no further than commodity options and futures traded on recognized and established commodity exchanges, such as the Chicago Board of Trade or the New York Mercantile Exchange.
In her interview, Born explains how she witnessed the development of futures-like contract instruments traded away from the exchanges, so-called over the counter (OTC) derivatives, and how it troubled her.
"One major issue was the enormous growth of over-the-counter derivatives. OTC derivatives had been legally permitted for the first time in 1993 ... This allowed the growth of a business that is now (2003-2007 estimates for this market put its notional value at over US$500 trillion) estimated at over a $100 trillion annually in terms of the notional value of contracts worldwide. [Federal Reserve chairman] Alan Greenspan had said that the growth of this market was the most significant development in the financial markets of the 1990s. The market was virtually unregulated and many, many times as big as the trading on the futures exchanges ... The commission had kept some nominal authority over this market, but there were no mechanisms for enforcing the rules. For example, antifraud rules were retained, but no reporting was required. The market was completely opaque. Neither the commission nor any other federal regulator knew what was going on in that market! Also, there had been a number of major problems in the market, including the near collapse of Barings Bank until it was taken over by ING ... I became enormously concerned about OTC derivatives and thought the market was a nightmare waiting to happen ... I was particularly concerned that there was no transparency. No federal regulator knew what kind of position firms like Long-Term Capital Management [LTCM] and Enron had in the derivatives markets.
"These instruments can be used to reduce economic risk, and they are certainly very valuable and useful economic instruments, but they can also create enormous risks, as they did at Enron and Long-Term Capital Management. Warren Buffett has recently called them financial weapons of mass destruction. I became concerned about it once I got to the commission and began to learn about the OTC market. The more I learned, the more I realized we didn't know. I realized there was a tremendous potential danger to the markets in the United States and to the international economy."
Yeah, yeah kid - go play outside.
But it was her next move that really got the alarm bells ringing up in the suites of the Ivy Leaguers who had Clinton's ear. This related to LCTM, the Greenwich, Connecticut hedge fund whose September 1998 insolvency necessitated an emergency rescue package by the Federal Reserve to prevent the entire world financial system from being dragged down along with it.
"About three months before we knew about Long-Term Capital Management, the commission came out with a concept release in the Federal Register asking for input from the industry and other interested people concerning the need for more oversight of the over-the-counter derivatives market."
Of course, these were the days of the American Republic's powerful ruling First Triumvirate - Rubin, Greenspan and Summers - the trio that Time Magazine would soon anoint as "The Committee to Save the World." Back in April 1998, however, all they were doing was keeping the US economy, and more importantly its stock market, humming along at crowd-pleasing and poll-boosting numbers.
Early that April, the Dow Jones Industrial Average topped 9,000 for the first time, nearly tripling in just over three years. The woman who was really giving Clinton conniption fits then was not Born but Monica Lewinsky, and by not getting the financial industry mad, by keeping the stock market hopping, Clinton, correctly it turns out, felt that he could defeat the real threat the Lewinsky scandal posed to his presidency. Therefore, one woman , Born, was not going to be allowed to sidetrack his defense against the threat posed by another - Lewinsky.
The roadside motel party came on April 21, 1998 - except that the location was changed to Rubin's oak-paneled conference room at the Treasury. Rubin had found out what Born was about to propose, and the former co-chairman of Goldman Sachs would have none of it. Formally, it was a meeting of the President's Working Group on Financial Markets, with Rubin, Greenspan and SEC chairman Arthur Levitt going three to one against Born.
Rubin laid out his, or, more accurately, the financial industry's concerns.
"So, you're not going to do anything, right?" Rubin, according to a report of the meeting published recently in the Washington Post.
Born was non-committal. The Rubin gang thought that they had gotten the message across. In that, couldn't have been more wrong. Born called and raised.
In the May 7, 1998, CFTC press release that introduced the initiative to the world, Born described her thinking, taking special note that, as had become sine qua non in Washington policymaking then and now, no monied sacred oxen would be gored.
At a July 30, 1998, meeting of the Senate Committee on Agriculture, Nutrition and Forestry, Born was forced to undergo another violation, this time before a packed hearing room of financial industry lobbyists, publicists, and other mouths for hire gathered to witness the ritual.
Then deputy secretary of the Treasury Lawrence Summers led off.
Not only did Greenspan oppose the expansion of CFTC jurisdiction to OTC derivatives; he even wanted it scaled back for standard, exchange-based futures trading.
A couple more flayings from industry executives, and the obvious lack of sympathy shown by the committee chairman, Republican Richard Lugar, to her positions, and Born began to wilt. Not only was Rubin's Treasury blocking her initiative to expand CFTC's jurisdiction further into OTC derivatives, it was authoring legislation to strip what little authority the CFTC had in the sector away from it.
Born tried to counterattack.
Not even the September LTCM crisis, which seemed to prove her point about the dangers of derivatives, changed any minds among her critics. "Yes," there was a crisis, they sniffed, but Uncle Alan fixed everything, so why can't we go back to making more money?
Still, Born tilted at windmills. Appearing before the House Banking Committee, Born warned of an
During those last 18 months of Bill Clinton's administration, as the old fox celebrated his escape from the baying hounds of impeachment, he basically put "For Sale" signs on his entire economic policy. In November 1999, Congress passed, and Clinton signed, the Gramm-Leach-Billey Act, repealing the 1933 Glass Steagall Act, which had previously maintained explicit corporate firewalls between investment and commercial banking. That led to a wave of financial system mergers and agglomerations that was the first step in the creation of the giant "too big to fail" wounded banking behemoths that so trouble our world today. Then, in the closing hours of his administration came the president's signature on the 2000 Commodity Futures Modernization Act, which, as if it were possible, put up an even bigger "NO TRESPASSING" sign in-between the CFTC and OTC derivatives.
In all these legislative deregulatory efforts championed by Rubin's Treasury et al, the legislation was shepherded through the Congress not by a northeastern elite school Democratic liberal, but by ultra-conservative Texas Republican Phil Gramm, with his Phd from the University of Georgia.
Gramm called the Glass-Steagall repeal an event that "will keep our markets modern, efficient and innovative, and it guarantees that the United States will maintain its global dominance of financial markets".
Did the Clinton team ever question the ideological incongruity of this ill-fated alliance? Probably not; this only concerned the people's welfare in the economy; it wasn't as if they had to share their box with him at the Metropolitan Opera or something.
The rest, as they say, is history, and not very pleasant history at that. In the dark alleys of some greed-soaked imaginations of Wall Street quantitative analysts, OTC derivatives conducted a witches' sabbath with the existing mortgage finance industry. This created a home financing framework that would circumvent Fannie Mae and Freddie Mac, the government's two existing real-estate finance institutions that, for the most part, had kept American housing on an even keel for over 60 years.
The new paradigm was, instead of selling mortgage loans to Fannie and Freddie, the mortgage paper would be rolled out into ever and ever more-leveraged rounds of collateralized debt obligations (CDOs). The CDOs were insured not by the government, but by unregulated credit default swaps (CDS) of which no one in authority or anywhere else ever knew the full extent or quantity, nor knew who was carrying the counterparty risk on the other side of the trade.
The tide of liquidity let loose by this scheme, sometimes called the "shadow banking system", blew the real-estate bubble all the way out to the subprime mortgage borrowers, but when real-estate prices drove so far away from reality that they couldn't even see cloud cuckoo land in the rear-view mirror anymore, the real-estate market cracked and the whole edifice of the sorcerer's apprentice was thrown into reverse.
CDOs and other mortgage-backed securities suddenly acquired a new, far less complimentary title - that of "toxic banking assets". It was AIG's central role in the CDS market that drove it into the arms of the government; as for the rest of the OTC derivatives that Brooksley Born warned of, no type of even the lightest regulation was ever applied to them. There are only estimates of just how many more are out there waiting to fail, or how many more will fail with each successive leg down in real-estate values.
But when you're out walking in the financial forest, with each crash you hear signifying another hollowed-out shell of a once-great financial institution toppling over under the crushing weight of its own incompetence and hubris, that sound tells you that once again Born is being proved correct.
The rapidly dwindling cult of defenders of The Committee to Save the World claim that hindsight is always 20/20: "If we knew now what we knew then - etc, etc." But the real problem was not that they could not see, but they would not hear. Brooksley Born's foresight was perfect; it was the tin ears possessed by those whom she warned that were the problem.
There are numerous metrics I and other writers have repeatedly cited that illustrate the growing role and centrality in the US economy of the financial services sector. In the New York Times, Gretchen Morgensen noted that, in 2007, there were more financial engineers, those who put together all the CDS and CDOs and OTC derivatives, than there were actual physical engineers, people who actually made stuff, employed in the US. My favorite metric was that, as the financial services sector topped out in that last giddy summer of 2007, it represented about 21% of the market-based weighting of the S&P 500, but over 40% of its earnings.
America, a nation steeped in Christianity down to its grain, apparently failed to apply the Golden Rule to this circumstance - that he who has the gold makes the rules. In allowing the continuation of a political system driven by money, it became virtually inevitable that, once the financial industry took over the country's economic system, it would only have to go just a bit further to take over the political system as well.
When it did, it virtually assured the eventual creation of the maladies we see today - a general population straining under the weight of the collapse of the once-booming, now-busted banking system that once financed much of its basic necessitates, with the elite and mid-level of the financial system luxuriating behind the physical security of the high walls of its gated communities, and the economic security of the equally formidable legal ramparts that protect its rapacious bonus arrangements.
In an article in the May edition of the Atlantic, Simon Johnson, former International Monetary Fund official and current professor of finance at Massachusetts Institute of Technology, writes of what he calls "the quiet coup", finance's takeover of the American polity.
Maybe. Maybe not. There's the old story of a thoroughly drunk (and married) Winston Churchill stumbling up to an attractive woman at a party.
"Madam, will you sleep with me for five million pounds?"
"Maybe."
"Would you sleep with me for one pound?"
"Of course not, what kind of woman do you think I am?"
"Madam, we've already established what kind of woman you are," said Churchill. "Now we're just negotiating the price...."
Soft-power Naivete...
It may seem tame considering what has come since, but Henry Levin's 1960 teen romantic comedy Where the Boys Are was fairly revolutionary for its time.
Hewing to the still mostly standard Hollywood formula of showcasing the limb-grinding adventures of attractive hormone-sodden young satyrs before, in the last reel, showing the said same fulfillment of these desires devastating their lives, the movie tells the tale of two college co-eds, Merritt (Dolores Hart) and Melanie (Yvette Mimieux) on spring break in Fort Lauderdale, Florida. Merritt hesitates on taking the penultimate step in the game of what she calls "backseat bingo" in order to win the heart of a special beau; Melanie fairly explicitly affirms (for the time, anyway) that she intends to show no such restraint.
Of course, it ends very badly for Melanie. Lured to a party at a roadside motel where she believes that her new boyfriend will be present along with other desirable young Ivy League "Yalies", she is next seen wandering aimlessly in the middle of a busy highway, hair and clothes disheveled - as the then movie morals code would not allow the word that described her obvious violation to be explicitly uttered, the audience was left to draw the obvious inference as to the terrible price she paid for her licentiousness.
She gets hit by a car; in the hospital, she confesses the worst part of her sin to Merritt. "They weren't even Yalies!" she sobs.
Thirty eight years later, in 1998, US Commodity Futures Trading Commission chairwoman Brooksley Born, in seeking to uphold the integrity of the financial system, was similarly accosted. However, in contrast to poor Melanie, the gang that attacked her possessed just about the highest imaginable academic pedigrees. They were the then deputy secretary of the Treasury (and now the chair of President Barack Obama's National Economic Council) Laurence Summers (BA Massachusetts Institute of Technology, Phd Harvard); Federal Reserve Board chairman Alan Greenspan (BA, MA Columbia, Phd New York University); and the leader of the gang, Treasury secretary Robert Rubin (BA Harvard, LLB Yale - yes! he was even a Yalie). After the attack on chairwoman Born, the gang carelessly hopped into their souped-up hot rod and proceeded to further make the preparations for their rich-kid, thrill-kill firebombing of the world financial system we see occurring today.
If you ever have the misfortune to be locked in a history seminar listening to the instructor drone on and on about how America in the interwar period withdrew from the world to focus on itself, isolationism, and just plain irrelevancies, it would not be impudent to raise your hand and ask "But just which interwar period are you talking about, Herr doktor professor?"
The common perception would be that the period being referred to was the 1918-1941 period between America's experience in the first and second world wars. But now there's another interwar period - the 12 years between the 1989 fall of the Berlin Wall, which represented the end of the Cold War, and the attacks of September 11, 2001, which essentially marked the beginning of the so-called "War on Terror". As Derek Chollet and James Goldgeier put it in their new book From 11/9 to 9/11- America Between the Wars
... in one respect, however, the 1990s were indeed a "holiday." The end of the Cold War made many Americans and their leaders believe the world had become more benign and, therefore, of less concern. The three Presidential campaigns of that era - in 1992, 1996, and 2000 - spent little time on foreign policy issues. The mainstream media closed overseas bureaus and reduced the newsprint and airtime spent on events abroad. Instead of looking outward, Americans looked in - obsessed with oddities such as the OJ Simpson trial and hopes fueled by the booming stock market. In many respects, these years were self indulgent ones. David Halberstam called them "a time of trivial pursuits."Gordon W Prange's 1982 book At Dawn We Slept tells the tale of an America blissfully unaware of the true nature of the world threats facing it as the world fell into war and the Japanese prepared the attack on Pearl Harbor; if America was sleeping in 1941, in the late 1990s it was in a permanent haze of total blitzed zonk generated by the world's most-prescribed sleeping pill, Halcion, and very much enjoying it as it gazed wistfully at its plastic Kabbalah bracelet and nodded off some more.
It was the same in economics and financial policy. Francis Fukuyama declared the "End of History", meaning that the central operative principle to be learned from the fall of state socialism was that the government which governed least governed best. Bill Clinton, noting the electoral disasters that befell leftist Democratic presidential nominees Walter Mondale and Michael Dukakis in 1984 and 1988, pointedly ran in 1992 with the blessing of the party's centrist Democratic Leadership Council. Following the electoral drubbing received by the party in 1994 after the public rejected his vision of a government-run healthcare system, his innate centrist instincts were brought even more to the fore. Proposals and bureaucrats advocating income redistribution and/or antagonistic stances towards business and finance would be banished to academia.
Since the administration's poll fortunes (not to mention its members' actual fortunes) rose so closely in tandem with the stock market, no "enemy of the people" would be allowed to advocate policies that might kill, or even mildly irritate, the golden goose. The Democratic economic policy secretariat might be more favorably inclined to more gender and/or racial diversity than the Republicans they replaced, and the art on their walls might be more Jackson Pollock and Mark Rothko than Frederic Remington and LeRoy Niemen; otherwise, their views were basically identical.
That pattern held at the US Commodity Futures Trading Commission (CFTC), the government agency charged with regulating and monitoring the frequently very topsy-turvy world of commodity and financial futures markets and trading. Clinton had appointed Mary Schapiro as his first CFTC chair in 1993 - she had been a member of the Securities and Exchange Commission ( SEC) from the Ronald Reagan-George Bush Snr era (and is now Obama's choice to lead the SEC). Clinton then in 1996 appointed Washington corporate lawyer Brooksley Born as his second choice to chair the CFTC.
As an associate with the uber-connected law firm of Arnold and Porter, the Clinton gang must have thought they had made an outstanding choice - another female face as a sop to the feminist component of the base, but one trustworthy enough not to shake the pro-business and markets applecart being plied by the adults upstairs.
Well, one out of two isn't bad.
One thing that the Clinton gang must have overlooked in making sure that Ms Born wasn't the financial regulation equivalent of the actor and drag queen Ru Paul was that her self-described most memorable case while at Arnold and Porter was litigation arising out of the failed attempt by the Hunt Brothers to corner the market in silver as the inflationary spike of the 1970s flamed out in 1979 and 1980.
In a 2003 interview in Washington Lawyer, Born noted that she personally witnessed the case "causing great damage to traders when the price [of silver] went up and then again when it collapsed".
"That's nice," the Clinton official who vetted her must have tut-tutted. "The press wants to know, what color will your credenza be."
In early 1998, she pulled something out of that credenza. They sure noticed her upstairs then.
Traditionally, the CFTC's mandate and purview extended no further than commodity options and futures traded on recognized and established commodity exchanges, such as the Chicago Board of Trade or the New York Mercantile Exchange.
In her interview, Born explains how she witnessed the development of futures-like contract instruments traded away from the exchanges, so-called over the counter (OTC) derivatives, and how it troubled her.
"One major issue was the enormous growth of over-the-counter derivatives. OTC derivatives had been legally permitted for the first time in 1993 ... This allowed the growth of a business that is now (2003-2007 estimates for this market put its notional value at over US$500 trillion) estimated at over a $100 trillion annually in terms of the notional value of contracts worldwide. [Federal Reserve chairman] Alan Greenspan had said that the growth of this market was the most significant development in the financial markets of the 1990s. The market was virtually unregulated and many, many times as big as the trading on the futures exchanges ... The commission had kept some nominal authority over this market, but there were no mechanisms for enforcing the rules. For example, antifraud rules were retained, but no reporting was required. The market was completely opaque. Neither the commission nor any other federal regulator knew what was going on in that market! Also, there had been a number of major problems in the market, including the near collapse of Barings Bank until it was taken over by ING ... I became enormously concerned about OTC derivatives and thought the market was a nightmare waiting to happen ... I was particularly concerned that there was no transparency. No federal regulator knew what kind of position firms like Long-Term Capital Management [LTCM] and Enron had in the derivatives markets.
"These instruments can be used to reduce economic risk, and they are certainly very valuable and useful economic instruments, but they can also create enormous risks, as they did at Enron and Long-Term Capital Management. Warren Buffett has recently called them financial weapons of mass destruction. I became concerned about it once I got to the commission and began to learn about the OTC market. The more I learned, the more I realized we didn't know. I realized there was a tremendous potential danger to the markets in the United States and to the international economy."
Yeah, yeah kid - go play outside.
But it was her next move that really got the alarm bells ringing up in the suites of the Ivy Leaguers who had Clinton's ear. This related to LCTM, the Greenwich, Connecticut hedge fund whose September 1998 insolvency necessitated an emergency rescue package by the Federal Reserve to prevent the entire world financial system from being dragged down along with it.
"About three months before we knew about Long-Term Capital Management, the commission came out with a concept release in the Federal Register asking for input from the industry and other interested people concerning the need for more oversight of the over-the-counter derivatives market."
Of course, these were the days of the American Republic's powerful ruling First Triumvirate - Rubin, Greenspan and Summers - the trio that Time Magazine would soon anoint as "The Committee to Save the World." Back in April 1998, however, all they were doing was keeping the US economy, and more importantly its stock market, humming along at crowd-pleasing and poll-boosting numbers.
Early that April, the Dow Jones Industrial Average topped 9,000 for the first time, nearly tripling in just over three years. The woman who was really giving Clinton conniption fits then was not Born but Monica Lewinsky, and by not getting the financial industry mad, by keeping the stock market hopping, Clinton, correctly it turns out, felt that he could defeat the real threat the Lewinsky scandal posed to his presidency. Therefore, one woman , Born, was not going to be allowed to sidetrack his defense against the threat posed by another - Lewinsky.
The roadside motel party came on April 21, 1998 - except that the location was changed to Rubin's oak-paneled conference room at the Treasury. Rubin had found out what Born was about to propose, and the former co-chairman of Goldman Sachs would have none of it. Formally, it was a meeting of the President's Working Group on Financial Markets, with Rubin, Greenspan and SEC chairman Arthur Levitt going three to one against Born.
Rubin laid out his, or, more accurately, the financial industry's concerns.
"So, you're not going to do anything, right?" Rubin, according to a report of the meeting published recently in the Washington Post.
Born was non-committal. The Rubin gang thought that they had gotten the message across. In that, couldn't have been more wrong. Born called and raised.
In the May 7, 1998, CFTC press release that introduced the initiative to the world, Born described her thinking, taking special note that, as had become sine qua non in Washington policymaking then and now, no monied sacred oxen would be gored.
The Commission believes it is appropriate to review its regulatory approach to OTC derivatives. The goal of this re-examination is to assist it in determining how best to maintain adequate regulatory safeguards without impairing the ability of the OTC derivatives market to grow and the ability of US entities to remain competitive in the global financial marketplace. In that context, the Commission is open both to evidence in support of broadening its existing exemptions and to evidence of the need for additional safeguards.Probably the only way this could have been made less threatening to the derivatives industry would have been if traders had been offered lollipops and freshly made ice-cream sundaes, but, still, the industry was outraged, and they knew exactly what to do. If the attack by the executive branch's most senior economic managers wasn't enough to silence this impudent upstart, this blowsy tart, the legislature was always on hand to do the industry's bidding for a price.
Thus, the concept release identifies a broad range of issues in order to stimulate public discussion and elicit informed analysis. The Commission seeks to draw on the knowledge and expertise of a broad spectrum of interested parties, including OTC derivatives dealers, end-users of derivatives, other industry participants, other regulatory authorities, and academicians. The Commission emphasized that it is mindful of the industry's need to retain flexibility permitting growth and innovation, as well as the need for legal certainty.
The release does not in any way alter the current status of any instrument or transaction under the Commodity Exchange Act. All currently applicable exemptions, interpretations and policy statements issued by the Commission remain in effect, and market participants may continue to rely on them. Any proposed regulatory modifications resulting from the concept release would be subject to rulemaking procedures, including public comment, and any changes that imposed new regulatory obligations or restrictions would be applied prospectively only.
At a July 30, 1998, meeting of the Senate Committee on Agriculture, Nutrition and Forestry, Born was forced to undergo another violation, this time before a packed hearing room of financial industry lobbyists, publicists, and other mouths for hire gathered to witness the ritual.
Then deputy secretary of the Treasury Lawrence Summers led off.
Mr Chairman, the OTC derivatives market has grown from nothing to become a highly lucrative industry of major international importance. It is reasonable to consider whether it is necessary to make changes in how this market is regulated. But there is currently no clear consensus in the government or in the private sector concerning any possible additional regulation for this market. And there is certainly no consensus that the CFTC currently has the legal authority to regulate this market or raise questions about possible regulation of this market in the future.Then Federal Reserve chairman Greenspan. Back in 1998, the masses listened intently to each magnificent inflection of every brilliant syllable the great oracle uttered, for people literally believed that the prophet cum savior had the ability to spin gold from dross. Only now, 10-plus years later, do we realize that his true skills could be more accurately described as being just the opposite.
Not only did Greenspan oppose the expansion of CFTC jurisdiction to OTC derivatives; he even wanted it scaled back for standard, exchange-based futures trading.
The Federal Reserve believes that the fact that OTC markets function so effectively without the benefits of the CEA [the 1936 Commodity Exchange Act, which authorized the CFTC] provides a strong argument for development of a less burdensome regulatory regime for financial derivatives traded on futures exchanges. To reiterate, the existing regulatory framework for futures trading was designed in the 1920s and 1930s for the trading of grain futures by the general public. Like OTC derivatives, exchange-traded financial derivatives generally are not as susceptible to manipulation and are traded predominantly by professional counterparties.Next up, SEC chairman Levitt. The former president of the American Stock Exchange was certainly not bullish on Brooksley Born.
The CFTC's concept release raises important policy questions that should not be addressed by the CFTC alone, but rather require the attention of Congress, members of the financial regulatory community, and interested industry participants.In that spirit, perhaps Levitt would have advocated death-row inmates write the laws for capital punishment, as they certainly could be termed "interested industry participants".
A couple more flayings from industry executives, and the obvious lack of sympathy shown by the committee chairman, Republican Richard Lugar, to her positions, and Born began to wilt. Not only was Rubin's Treasury blocking her initiative to expand CFTC's jurisdiction further into OTC derivatives, it was authoring legislation to strip what little authority the CFTC had in the sector away from it.
Born tried to counterattack.
The legislative proposal offered by the Treasury Department raises serious concerns. The Treasury proposal would severely limit the CFTC's ability to fulfill its oversight responsibilities with regard to OTC derivatives transactions within its statutory authority, would result in a substantial change in the CEA, and would potentially leave the American public without federal protection in the event of an emergency in the OTC derivatives market. No justification has been offered for these sweeping changes in OTC derivatives regulation. Indeed, the Treasury proposal does not appear to be based on any principled concern about the need for a coordinated approach to the OTC derivatives market, since it aims to restrict only the activities of the CFTC.Lugar wanted Born to drop her proposal, threatening her with writing new laws into statute limiting the CFTC's jurisdiction. Born was willing to entertain a temporary moratorium to allow the bureaucracy time to attempt to unify behind a common position, but, for the sharks circling around her, that was just her blood in the water.
Not even the September LTCM crisis, which seemed to prove her point about the dangers of derivatives, changed any minds among her critics. "Yes," there was a crisis, they sniffed, but Uncle Alan fixed everything, so why can't we go back to making more money?
Still, Born tilted at windmills. Appearing before the House Banking Committee, Born warned of an
immediate and pressing need to address whether there are unacceptable regulatory gaps ... This episode should serve as a wake-up call about the unknown risks that the over-the-counter derivatives market may pose to the US economy and to financial stability around the world.It would all be for naught, for lined up against Born's integrity and vision were the entire government/financial complex shuttling in and out of positions in Bill Clinton's administration. Congress passed the six-month hold on CFTC's regulatory authority, making it permanent in 1999. During those six months what little legislative support for tighter restrictions collapsed. Born resigned from the CFTC in the spring of 1999.
During those last 18 months of Bill Clinton's administration, as the old fox celebrated his escape from the baying hounds of impeachment, he basically put "For Sale" signs on his entire economic policy. In November 1999, Congress passed, and Clinton signed, the Gramm-Leach-Billey Act, repealing the 1933 Glass Steagall Act, which had previously maintained explicit corporate firewalls between investment and commercial banking. That led to a wave of financial system mergers and agglomerations that was the first step in the creation of the giant "too big to fail" wounded banking behemoths that so trouble our world today. Then, in the closing hours of his administration came the president's signature on the 2000 Commodity Futures Modernization Act, which, as if it were possible, put up an even bigger "NO TRESPASSING" sign in-between the CFTC and OTC derivatives.
In all these legislative deregulatory efforts championed by Rubin's Treasury et al, the legislation was shepherded through the Congress not by a northeastern elite school Democratic liberal, but by ultra-conservative Texas Republican Phil Gramm, with his Phd from the University of Georgia.
Gramm called the Glass-Steagall repeal an event that "will keep our markets modern, efficient and innovative, and it guarantees that the United States will maintain its global dominance of financial markets".
Did the Clinton team ever question the ideological incongruity of this ill-fated alliance? Probably not; this only concerned the people's welfare in the economy; it wasn't as if they had to share their box with him at the Metropolitan Opera or something.
The rest, as they say, is history, and not very pleasant history at that. In the dark alleys of some greed-soaked imaginations of Wall Street quantitative analysts, OTC derivatives conducted a witches' sabbath with the existing mortgage finance industry. This created a home financing framework that would circumvent Fannie Mae and Freddie Mac, the government's two existing real-estate finance institutions that, for the most part, had kept American housing on an even keel for over 60 years.
The new paradigm was, instead of selling mortgage loans to Fannie and Freddie, the mortgage paper would be rolled out into ever and ever more-leveraged rounds of collateralized debt obligations (CDOs). The CDOs were insured not by the government, but by unregulated credit default swaps (CDS) of which no one in authority or anywhere else ever knew the full extent or quantity, nor knew who was carrying the counterparty risk on the other side of the trade.
The tide of liquidity let loose by this scheme, sometimes called the "shadow banking system", blew the real-estate bubble all the way out to the subprime mortgage borrowers, but when real-estate prices drove so far away from reality that they couldn't even see cloud cuckoo land in the rear-view mirror anymore, the real-estate market cracked and the whole edifice of the sorcerer's apprentice was thrown into reverse.
CDOs and other mortgage-backed securities suddenly acquired a new, far less complimentary title - that of "toxic banking assets". It was AIG's central role in the CDS market that drove it into the arms of the government; as for the rest of the OTC derivatives that Brooksley Born warned of, no type of even the lightest regulation was ever applied to them. There are only estimates of just how many more are out there waiting to fail, or how many more will fail with each successive leg down in real-estate values.
But when you're out walking in the financial forest, with each crash you hear signifying another hollowed-out shell of a once-great financial institution toppling over under the crushing weight of its own incompetence and hubris, that sound tells you that once again Born is being proved correct.
The rapidly dwindling cult of defenders of The Committee to Save the World claim that hindsight is always 20/20: "If we knew now what we knew then - etc, etc." But the real problem was not that they could not see, but they would not hear. Brooksley Born's foresight was perfect; it was the tin ears possessed by those whom she warned that were the problem.
There are numerous metrics I and other writers have repeatedly cited that illustrate the growing role and centrality in the US economy of the financial services sector. In the New York Times, Gretchen Morgensen noted that, in 2007, there were more financial engineers, those who put together all the CDS and CDOs and OTC derivatives, than there were actual physical engineers, people who actually made stuff, employed in the US. My favorite metric was that, as the financial services sector topped out in that last giddy summer of 2007, it represented about 21% of the market-based weighting of the S&P 500, but over 40% of its earnings.
America, a nation steeped in Christianity down to its grain, apparently failed to apply the Golden Rule to this circumstance - that he who has the gold makes the rules. In allowing the continuation of a political system driven by money, it became virtually inevitable that, once the financial industry took over the country's economic system, it would only have to go just a bit further to take over the political system as well.
When it did, it virtually assured the eventual creation of the maladies we see today - a general population straining under the weight of the collapse of the once-booming, now-busted banking system that once financed much of its basic necessitates, with the elite and mid-level of the financial system luxuriating behind the physical security of the high walls of its gated communities, and the economic security of the equally formidable legal ramparts that protect its rapacious bonus arrangements.
In an article in the May edition of the Atlantic, Simon Johnson, former International Monetary Fund official and current professor of finance at Massachusetts Institute of Technology, writes of what he calls "the quiet coup", finance's takeover of the American polity.
In its depth and suddenness, the US economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn't be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn't roll over their debt did, in fact, become unable to pay.Johnson's policy prescription in this matter seems to have the big financial oligarchs broken up into much smaller operating entities; the assumption there seems to be that they would then be collecting commensurately less monopoly rent that could be used to buy the political system.
This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the US financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people. But there's a deeper and more disturbing similarity: elite business interests - financiers, in the case of the US - played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse.
More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.
Maybe. Maybe not. There's the old story of a thoroughly drunk (and married) Winston Churchill stumbling up to an attractive woman at a party.
"Madam, will you sleep with me for five million pounds?"
"Maybe."
"Would you sleep with me for one pound?"
"Of course not, what kind of woman do you think I am?"
"Madam, we've already established what kind of woman you are," said Churchill. "Now we're just negotiating the price...."
Soft-power Naivete...
It has been interesting to see how quickly the Obama administration has retreated from some of the more extravagant soft power claims that greeted it during the honeymoon period. A few short weeks ago, you could find newspapers touting how "U.S. Offers Goodwill, and Expects Something in Return." Nowadays, one is more apt to find "Obama May Find Europe Reticent on Some U.S. Goals."
In fact, as Der Spiegel put it, "Europe's Obama Euphoria Wanes." President Obama remains a wildly popular public figure and everyone, heads of state included, would like to get their picture taken with him. But when it comes to the tough issues of the day -- the ramp up of commitments in Afghanistan or coordinating global stimulus packages -- the Obama team and its fans in Europe are not quite the Fred Astaire and Ginger Rogers team that we had been promised. Or rather they are more this than this.
Some Obama critics might blame the apparent inefficacy of soft power on the Obama team's rookie mistakes, whether it is needless insults, botched gifts, or the vacancies in key posts. I think such a view is unfair to the administration, and wrongly implies that if only it could hit its own "reset" button, it could reclaim the honeymoon. But the truth is, the issues that bedevil Obama are the very same ones that bedeviled President Bush, and having a more popular leader at the top may not do much to change the underlying conflicts of interest.
On many issues, our European partners are more like "in-laws" than "allies." In-laws are people who share a common identity, even a shared long-term and enduring covenant, and this common identity is strong enough (usually) to outlast many frequent (and sometimes stormy) conflicts of interest. Allies submerge their conflicts of interests in order to accomplish an overriding goal, typically victory against a common enemy. In-laws will continue to meet at family reunions (what is the G-20 if not a family reunion?; perhaps a dysfunctional family reunion?), but they may only agree on where to stand for the family photo. We should all be grateful for in-laws (I am deeply grateful for mine, in case they are reading), but we should not be surprised by conflicts. And we should attribute failures of cooperation to those underlying conflicts of interest rather than to boorish diplomacy.
Many people thought the election of Obama would yield a soft power bonanza, but it hasn't worked out that way. Soft power is the ability to get other states to want what you want, and it is distinguished from hard power, which is the ability to get other states to do what you want (even if they don't want to). Obama at the start undoubtedly has more soft power at his disposal than Bush did at the finish, but so far this has not produced much greater European cooperation on American goals. The atmospherics and optics are more positive, but the actual results are not.
Does this mean soft power is overrated? Perhaps some are naïve about what it can do, but I would characterize the naiveté more as a misunderstanding -- specifically, a failure to understand that soft power operates in both directions. We are seeking to exert soft power on others, and others are seeking to exert soft power on us. Viewed this way, in recent months we have witnessed a fairly impressive display of transatlantic soft power, but it has traveled mostly east to west, rather than west to east.
Not too long ago, America wanted Europe to:
- adopt more American approaches to addressing the global financial crisis;
- shoulder more of the military and economic load in Afghanistan; and
- accept more responsibility for holding the detainees currently at Guantanamo Bay.
And Europe wanted the opposite -- for America to:
- adopt more European approaches to addressing the global financial crisis;
- shoulder more of the military and economic load in Afghanistan; and
- accept more responsibility for holding the detainees currently at Guantanamo Bay.
These conflicts of interest have been worked out not with hard power tools of threats and intimidation but with soft power tools of shaming and suasion. And the results so far are:
- America is going to adopt more European approaches to addressing the global financial crisis;
- America is going to shoulder more of the military and economic load in Afghanistan; and
- America is going to accept more responsibility for holding the detainees currently at Guantanamo Bay.
My purpose here is not to critique the results. So far, they are more or less what I expected, and I can imagine far more disastrous foreign policy moves than the ones Obama has made thus far. But we should not miss the opportunity to learn a bit of realism that should be obvious to anyone who served in a position of responsibility in American foreign policy since the end of the Cold War. Soft power is a useful component of foreign policy, but it is a means to an end, not an end in itself. And if you make "being liked" a centerpiece of your foreign policy, you will find your soft power eroding and the soft power of others growing.
I am pretty sure the Obama team -- the one running foreign policy now, not the one running for office last fall -- already understands this. And I am pretty sure they are going to return from Europe understanding it even better....
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