Page 2 of 2 Born again - and again By Julian Delasantellis
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.
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.
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.
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.
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."
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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