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Lessons Learned...or not, Part II
We continue the story of how former Commodity Futures Trading Commission (CFTC) head Brooksley Born warned of the lack of oversight of the shadowy over-the-counter derivatives market. But her attempts to regulate were beaten back by then Federal Reserve Chairman Alan Greenspan, then-Treasury Secretary Robert Rubin and then-Deputy Treasury Secretary Larry Summers. Born resigned under pressure, June 1999. Following are further excerpts of an interview she conducted with PBS’ “Frontline” program this past August 2009. It has everything to do with today; the debate in Congress over who should regulate the markets, campaign contributions, and the disconnect between Main Street and Wall Street. We are likely doomed to repeat the failures of the past.
[Continuing with the examination of the derivatives market….]
Born: I felt that we did need to learn more about the market, and we needed to test whether the balance that the commission had earlier struck between exemption and keeping regulatory powers was appropriate.
So our Division of Trading and Markets, under Michael Greenberger, began, at my request, to prepare a list of questions that we needed answers to about the nature of the market. They prepared a document that listed the grounds for concern: the previous fraud, the collapses in the market, the rapid growth, the fact that we didn’t keep any enforcement tools to let us effectively police the markets for fraud and manipulation.
And it asked questions about the market. It also asked questions about whether certain changes needed to be made to the regulatory regime. Did there need to be record keeping? Should there be reporting to some federal regulator? Would clearing the transactions in a clearinghouse help protect against counterparty risk default on the part of one side or the other?
[Born’s CFTC released a report, asking market participants and over-the-counter derivatives dealers for their input, voluntarily.]
Frontline: Were you aware of the reaction that would befall you, the CFTC, as a result of just even talking about the concept release?
Born: I thought asking questions couldn’t hurt, and I was shocked that there was a strong negative reaction to merely asking questions about a market….
I wasn’t too surprised at the reaction of the over-the-counter derivatives dealers, because they believed in no regulation. Their position was that markets were self-regulatory, that this market was taking care of itself, there were no risks in the market and they thought there was no need for any government oversight or regulation.
I was more surprised at the other financial regulators who also were quite ignorant about this market, because I would have thought they would have welcomed information. And I had hoped that they would work with us to learn more about the market, decide whether there was an appropriate regulatory regime for it. And if so, what?
But my reading of the times was there was no impulse to regulate; there was an impulse to deregulate. Everything was going just fine, thank you very much.
Well, that’s true. We had had 15 years of deregulation up until then, really, and there was a great belief in the ability of the market to police itself without government intervention. Certainly that had shown itself in a lot of deregulatory actions that had been taken previously.
I was concerned about it because it seemed to me it overlooked the fact that market participants, obviously and quite rightly, would pursue their own interests rather than a broader public interest. And if systemic risk was being built up in the system, no individual participant would have any interest particularly in blowing a whistle or changing its behavior.
Frontline: There were, of course, counterarguments made. These markets are going to leave America; they’re going to go to London. Your response?
Born: It is true that there was a suggestion that merely asking questions would drive our biggest banks and investment banks to London. That puzzled me. You know, what was it that was in this market that had to be hidden? Why did it have to be a completely dark market? So it made me very suspicious and troubled….
Frontline: As to the other regulators, the other people in the President’s Working Group, was it your sense that they understood derivatives, how it was working?
Born: I was not sure how much understanding there was of the derivatives markets by the other regulators. And in fact, one of the things we tried to do in the President’s Working Group meetings was to explain our markets and what the concerns were.
Frontline: But it fell on deaf ears?
Born: Yes, there was very little interest in doing this. The markets were doing very well; the country was very prosperous. There was a lot of financial innovation in this area. In fact, I know [former Federal Reserve Board Chairman] Alan Greenspan at one point in the late ‘90s said that the most important development in the financial markets in the ‘90s was the development of over-the-counter derivatives.
Frontline: You think he understood what that meant?
Born: Well, he has said recently that there was a flaw in his understanding.
Frontline: When you proposed the [release of the CFTC report], there’s an extraordinary statement from Greenspan, Rubin and [former SEC head Arthur] Levitt that says Congress should pass legislation that prevents CFTC from oversight. How did you hear about it? Did you get a phone call? Do you remember?
Born: I don’t remember.
Frontline: It was an extraordinary moment. What did you think?
Born: I was very surprised, because of course we were an independent federal agency, and we were acting within our jurisdiction. And ordinarily, the tradition has been and the understanding has been that independent regulatory agencies should be permitted to do their job as they saw fit. But obviously, the other financial regulators thought that this was terribly important for them to step in and condemn.
Born: I think the reasons varied from department or agency. But one of the reasons was that some of the people involved really were purists in terms of beliefs in free markets and were absolutely, from a doctrinal point of view, opposed to regulation.
I think others were concerned with keeping the big banks and the investment banks happy and making sure that they were responsive to the demands of those entities.
One thing we have to remember is that the financial services industry was the largest campaign finance contributor then – and perhaps even now, I’m not sure – and it was very effective in lobbying both the executive branch and Congress.