Rules That Shape the World and Will Good Overcome Evil? - Part II

The following is an excellent excerpt from the book “ALL THE DEVILS ARE HERE: The Hidden History of the Financial Crisis” by Bethany McLean, Bestselling coauthor of “The Smartest Guys In the Room and Joe Nocera from page 105 and I quote: “One suspects that [Robert] Rubin thought this exchange would cause the issue to go away.  Instead, it gave [Brooksley] Born hope.  She was a big-time lawyer after all; a frank and fruitful exchange of views with the general counsel of the U.S. Treasury was a fine outcome.  It played to her strengths.  Except that for the next two weeks she couldn't get Treasury's lawyer on the phone.  That's when her steely side emerged.  In Born's view, if the general counsel couldn't be bothered to explain Treasury's legal reasoning, then she saw no reason to delay the publication of the concept release.  On May 7, the CFTC published it.

The other three members of the PWG were incensed.  Rubin, [Alan] Greenspan, and Arthur Levitt, the chairman of the SEC, immediately sent a letter to Congress requesting that it block the CFTC's effort to solicit comments.  Rumors were spread that Born was just an impossible woman—to shrill and strident to work with the august members of the Committee to Save the World.

Over the next few months, Born testified more than fifteen times in a series of highly charged congressional hearings about the concept release.  It was an extraordinary spectacle: in one hearing after another, an array of Clinton regulators lined up to publicly denounce the action of another Clinton regulator.  Congressional Republicans were only too happy to pile on.

In a hearing before the Senate banking committee in July, for instance, Greenspan made the specious claim that derivatives were already adequately supervised: “I would say that the comptroller and ourselves for the banks and the SEC for other organizations create a degree of supervision and regulation which, in my judgment, is properly balanced and appropriate.”

Jim Leach, the committee chairman, then addressed John Hawke, repeating Born's complaint in her testimony that the proposed legislation “would delegate review of federal law governing derivatives markets from the jurisdiction of the CFTC and SEC to a body dominated by banking regulators with no expertise in derivatives and market regulation.”  Leach continued, “I would like to ask Mr. Hawke—The name of the Treasury Secretary of the United States at this time is Robert Rubin.  Does he have a background in financial supervision and financial market participation?”

“If he were here, he could say he spent twenty-seven years in that,” replied Hawke.

Leach: “I would continue to ask Mr. Hawke—The name of the chairman of the Federal Reserve Board of the United States is Alan Greenspan.  Does he have a background in financial market participation?”

Hawke: “I believe he does.”

More than a decade later, you can still hear them chuckling at that exchange.

The concept release got nowhere.  Persuaded by Greenspan et al., Congress slipped a provision into the agriculture bill that prevented the CFTC from acting on derivatives for six months—which just happened to be the amount of time left in Born's term as chairman.

Three months later, Long-Term Capital Management blew up.

It would be hard to overstate the feeling of terror the LTCM collapse inflicted on Wall Street.  The Russian crisis was taking place at virtually the same time; indeed, it was the precipitating event that had led to LTCM's problems.  The markets were incredibly volatile.  The Dow Jones Industrial Average dropped 512 points one day in late August—the fourth largest drop in history—only to gain nearly 400 points one day in early September.  The fear that the financial crisis, having swept through Asia and Russia, was about to hit the United States was palpable.

The main reason it didn't was that the New York Fed ordered all the big Wall Street firms into a room and insisted that they hammer out a rescue plan.  In the end, fourteen firms injected equity into LTCM, effectively taking it over.  (Only Bear Stearns refused to participate.)  In other words, it was government action—not market discipline—that prevented disaster.

Washington was every bit as terrified as Wall Street—as it should have been.  The potentially destructive power of derivatives had been exposed.  For that matter, all the tools of modern finance—excessive leverage, probabilistic risk models, unseen counterparty exposure—had been shown to be flawed.  When Wall Street finally got a look at Long-Term Capital's books, for example, it was astounded by the size of the firm's total counterparty exposure: $129 billion.  Up until that moment, LTCM's lenders had only known about their own small piece of it.

During a hearing on October 1, 1998, even the Republicans on the Senate banking committee fretted about whether the LTCM disaster signaled the beginning of another S&L-style crisis.  If ever there was a moment when Bob Rubin could have used his immense stature to do something about the derivatives problems he had supposedly spent years worrying about, this was it.  Even hard-line deregulators might have followed his lead.  But he did nothing of the sort.  During that October hearing, Chairman Leach said to Born, ”We owe you an apology.”  One last time, Born pleaded with Congress to grapple with “the unknown risks that the over-the-counter derivatives market may pose to the U.S. economy.”   Even after LTCM, she remained the only administration official willing to talk about the need for government oversight over the derivatives business.

Six months later, the President's Working Group issued a report on LTCM, which focused much more on the firm's excessive leverage than its derivatives book, and which made exactly one regulatory recommendation: unregistered derivatives dealers should be required to report their financial risk profiles on some kind of regular basis.  In a footnote, Greenspan dissented even from that recommendation.

Although Brooksley Born signed her name to that report, she was unhappy with it, feeling that it only reinforced the government's laissez-faire attitude toward derivatives.  When the White House called and asked if she wanted a second term, she declined.  By June 1999, she had returned to Arnold & Porter, where she resumed her practice until she retired in 2003.

A few weeks after she left the government, so did Rubin.  Rubin never spoke to Born again after that April 1998 meeting.  Immediately after the Long-Term Capital Management fiasco, she had reached out to Gary Gensler, then a high-ranking official at Treasury—later, ironically, the chairman of the CFTC—asking him to convey a message to Rubin.  “We all seem to be on the same side now,” she told Gensler, hoping he would convey to Rubin that she wanted to work with him on the derivatives issue.  Rubin never responded.  Not long afterward, she attended a meeting at the Treasury Department in which she tried to congratulate Rubin for his role in containing the crisis.  He brushed past her without saying a word.

Years later, Rubin's defenders would claim that it was Born's hard-nosed approach that had turned him against her.  She was too strident, they said, too legalistic, not deferential enough to the Treasury secretary.  “If she had just been more collaborative,”said one such defender, “Rubin might have been her ally.”

Arthur Levitt, the SEC chairman, was one of those who had been told by Treasury that Born's supposed stridency made her impossible to work with.  Years later, though, he worked with her on a project and found her completely collegial.  He later told the PBS documentary show Frontline that he felt Treasury had misled him.  For his part, [Michael] Greenberger believes that Rubin didn't take her seriously because he didn't view her as a bona fide member of the establishment like himself.

Even so, why should Brooksley Born's personality or her background have been the deciding factor?  Derivatives either were a problem or they weren't.  Rubin either understood the trouble they might someday cause or he didn't.  If, as he says, he did understand the problem, then allowing his position to pivot on whether or not Born showed him the proper deference would seem, in retrospect, a pretty serious dereliction of duty.  Robert Rubin had spent most of his career affecting a kind of egoless management style.  His treatment of Born—his willingness to put his personal irritation ahead of the important public policy issues that derivatives posed—suggests that he wasn't quite as egoless as he let on.

It fell, finally, to Larry Summers to make sure that derivatives could never again be threatened by a regulator like Brooksley Born.

After Rubin left the Treasury Department, he took a position with Citigroup as “senior counselor,” where he had no operational responsibilities but was nonetheless paid around $15 million a year.  Clinton named Summers as his replacement.  A few months later, the President's Working Group issued a long-awaited report on derivatives—a report that had been prompted by the furor over Born's concept release.  “A cloud of legal uncertainty has hung over the OTC derivatives markets in the United States in recent years,” read the cover letter accompanying the report.  The report recommended that that uncertainty be remedied by Congress.  It was: Phil Gramm pushed through the Commodities Futures Modernization Act in 2000, which Clinton—with Summer's enthusiastic support—signed into law.  The new law explicitly stated that derivatives were not futures and could not be regulated by the CFTC—or any other government regulator.  It was the last bill Clinton signed before leaving office.

A year earlier, the president had signed a law that repealed Glass-Steagall, which had split commercial from investment banking so many years before.  Gramm-Leach-Bliley, as the new law was called, also had Summer's strong support.  One of its nods to modern finance was a provision that “expressly recognized and preserved this authority for national banks to engage directly in asset-backed securitization activities,” as Comptroller of the Currency John Dugan would note many years later.

In most respects, though, the repeal of Glass-Steagall was largely symbolic, a recognition of changes that had already taken place.  By 1999 all the big banks had investment banks and trading desks.  And in any case, the real problem was not that the wall that had long separated commercial and investment banks had been torn down.  Nor was it the CFTC was not allowed to regulate derivatives.   No, the core problem was that even as the old regulatory firmament was disappearing, nothing was being created to replace it.  If Rubin and Summers deemed the CFTC as not the right agency to regulate derivatives, they should have given the task to some other agency they felt could handle it.  Their defenders point out that the Republicans had firm control of both houses of Congress, and that is certainly true.  But that wasn't the only reason nothing was done to shore up the nation's financial system.  The other reason was that Bill Clinton's Treasury was every bit as complacent as Alan Greenspan's Fed.

After the financial crisis, one man who had worked closely with Rubin at Treasury would exclaim: “My God, I wish I had done more.””

 

(WHILE BROOKSLEY BORN, CHAIRMAN OF THE CFTC, WAS TRYING TO GET ANSWERS DURING THE CLINTON ADMINISTRATION, CONCERNING, IF THE DERIVATIVES WERE PROPERLY REGULATED, SHE WAS GETTING STONEWALLED BY THE OTHER REGUALTORS, PARTIUCLARLY ROBERT RUBIN AND ALAN GREENSPAN.  SENATOR JIM LEACH, CHAIRMAN OF THE SENA TE BANKING COMMITTEE HELD HEARINGS ON MS. BORN'S CONCEPT RELEASE, CONCERNING DERIVATIVES, WHERE HE QUESTIONED JOHN HAWKE, THE COMPTROLLER OF THE CURRENCY, AND I QUOTE FROM PAGE 106: “JIM LEACH, THE COMMITTEE CHAIRMAN, THEN ADDRESSED JOHN HAWKE, REPEATING BORN'S COMPLAINT IN HER TESTIMONY THAT THE PROPOSED LEGISLATION “WOULD DELEGATE REVIEW OF FEDERAL LAW GOVERNING DERIVATIVES MARKETS FROM THE JURISDICTION OF THE CFTC AND THE SEC TO A BODY DOMINATED BY BANKING REGULATORS WITH NO EXPERTISE IN DERIVATIVES AND MARKET REGULATION.”  LEACH CONTINUED, “I WOULD LIKE TO ASK MR. HAWKE—THE NAME OF THE TREASURY SECRETARY OF THE UNITED STATES AT THIS TIME IS ROBERT RUBIN.  DOES HE HAVE A BACKGROUND IN FINANCIAL SUPERVISION AND FINANCIAL MARKET PARTICIPATION?”

“IF HE WERE HERE, HE WOULD SAY HE SPENT TWENTY-SEVEN YEARS IN THAT,” REPLIED HAWKE.

LEACH: “I WOULD CONTINUE TO ASK MR. HAWKE—THE NAME OF THE CHAIRMAN OF THE FEDERAL RESERVE BOARD OF THE UNITED STATES IS ALAN GREENSPAN.  DOES HE HAVE A BACKGROUND IN FINANCIAL MARKET PARTICIPATION?”

HAWKE: “I BELIEVE HE DOES.”

MORE THAN A DECADE LATER, YOU CAN STILL HEAR THEM CHUICKLING AT THAT EXCHANGE. 

THE CONCEPT RELEASE GOT NOWHERE.  PERSUADED BY GREENSPAN ET.AL., CONGRESS SLIPPED A PROVISION INTO AN AGRICULTURE BILL THAT PREVENTED THE CFTC FROM ACTING ON DERIVATIVES FOR SIX MONTHS—WHICH JUST HAPPENED TO BE THE AMOUNT OF TIME LEFT IN BORN'S TERM AS CHAIRMAN.

THREE MONTHS LATER, LONG-TERM CAPITAL MANAGEMENT BLEW UP.

IT WOULD BE HARD TO OVERSTATE THE FEELING OF TERROR THE LTCM COLLAPSE INFLICTED ON WALL STREET.  THE RUSSIAN CRISIS WAS TAKING PLACE AT VIRTUALY THE SAME TIME; INDEED, IT WAS THE PRECIPITATING EVENT THAT HAD LED TO LTCM'S PROBLEMS”

IF PRESIDENT OBAMA CAN'T GET A STRONGER DODD-FRANK BILL, EVEN THOUGH THE REPUBLICANS WANT TO GET RID OF IT ENTIRELY, BECAUSE THEY'RE THE PARTY OF DEREGULATION, PRESIDENT OBAMA WILL GO DOWN AS A MAN THAT FAILED OUR SOCIETY BECAUSE HE COULDN'T PROTECT US FROM THE TAKE OVER OF GREEDY CORPORATIONS, THE INVESTMENT BANKS, HEDGE FUNDS, PRIVATE EQUITY AND VENTURE CAPITALISTS.  MAYBE THEN WE'RE GOING TO HAVE TO LOOK FOR AN INDEPENDENT CANDIDATE, MUCH LIKE TEDDY ROOSEVELT, WHO WAS KNOWN AS THE TRUST BUSTER, TO PROTECT THE WORLD FROM CORPORTE GREED, INCLUDING BASEL III, UNLESS SOME OTHER COUNTRY INVESTIGATES FIRST AND SAYS THAT GOLD, SILVER, LAND AND OTHER COMMODITIES ARE REAL ASSETS THAT HAVE VALUE.  NOT LIKE TOXIC DERIVAITVES WHICH ARE WORTHLESS WHEN COMPARED TO THESE COMMODITIES. THESE COMPARISONS MUST BE MADE.  THE LONGER WE PUT THEM OFF, THE WORST THE PROBLEM WILL BECOME AND IT COULD EVEN LEAD INTO PROBLEMS LIKE WE'RE SEEING IN SYRIA AND CYPRUS WHICH IS REALLY A CLASS WATR BETWEEN THE 99% AND THE 1% BUT DELIBERATELY NOT TALKED ABOUT.

 

LaVern Isely, Overtaxed Independent Overtaxed Middle Class Taxpayer & Public Citizen & AARP Members

 

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