The Education of Brooksley Born, Part II: The Lesson

The Players:

Robert Rubin: Secretary of the Treasury during Clinton’s presidency, after which he joined the board of Citibank; has been an economic advisor to Obama

Larry Summers: Deputy Secretary of the Treasury under Clinton; later, Secretary of the Treasury; under Obama, was head of the White House National Economic Council until December, 2010

Arthur Levitt, Jr.: Chairman of the Securities and Exchange Commission under Clinton

Timothy Geithner: Undersecretary of the Treasury for International Affairs under Clinton; Secretary of the Treasury under Obama

Joseph Stiglitz: Chair of the Council of Economic Advisors under Clinton, Senior Vice President at the World Bank, and Professor at Columbia University

Alan Greenspan: Chairman, Federal Reserve (1987-2006)

The first thing that struck me as I began to delve into this odd world of finance regulation and derivatives, specifically, was the number of men, and the lack of women.  I also noticed that the names of the men all repeat from one president to another.  Could I have found one reason we saw financial crisis in 1998 and 2008?  Actually, it’s quite possible – because no one seemed to see the error of their ways until 2009.  And yet, they are still in power, still advising a president, and trying to get the economy turned around.

Let’s go back to the late ‘90s.  Previously, I gave you the background on Brooksley Born, someone I would consider a pioneer for women.  She joined the boys club of financial regulators under Clinton.  Not to long after taking office as chair of the Commodity Futures Trading Commission (CFTC), she started hearing about the over-the-counter derivatives market and how little any federal regulators knew about it.

As simply I can explain – and this will not be thorough – a derivative is a contract promising to protect the investor from losses.  If it can be traded on the stock market, it can be a derivative.  It is like betting on what will happen with a stock, a loan… or a mortgage.  Derivatives are traded over-the-counter between banks, insurance companies, other funds and companies, with little transparency for the counterparty (or buyer) and little knowledge of how value and prices are determined.

Did that not explain it?  Probably because there are very few people in world who truly understand what it is and how it works!  They are supposed to allow firms and corporations to take more risks than they normally would – lending more money, being more lenient in to whom and how much is lent.  (Think sub-prime mortgages.)  They are then traded to limit the risk, as that increase the number of parties exposed if problems arise.  (Think Lehman Brothers, Bear Stearns, AIG.)

No one in government knew how big these were, how much money was in there, how many parties were involved.  As Born began hearing about how big the derivatives market was getting, she started looking into whether or not they should be regulated; they had been illegal until 1983, when President Reagan deregulated much of the financial industry.  Born and the CFTC began putting together a document that looked at whether or not regulation was right or necessary.  The point was to ask questions and find out what was happening in a market that was completely dark to financial regulators.

Oversight and regulation would have done a few key things: 1. Control abuses, fraud and manipulation in the market, which is really what the CFTC was supposed to watch for; 2. Limit speculation, or betting in the market; and, 3. Make sure a major default wouldn’t cause a domino effect in the economy (again, think Lehman Brothers, Bear Sterns, and AIG – especially AIG).  As the situation stood, there was no record keeping requirements, no reporting, and no information was shared with anyone.

The more Born pushed and tried talking to other regulators, officials at Treasury, and advisors to the president, the more she was told to “back off, just drop it.”  Curiouser and curiouser, she went forward with the document in 1998 because she worried about what a default could do to the economy.

In the battle over regulation, Alan Greenspan continued to insist the market would take care of itself.  There wasn’t a need to watch for fraud – if a broker was committing fraud, the customer would know and stop doing business with them.  Born’s “concept paper” of questions about regulation needs was in an uphill battle – not just against Greenspan, but against Rubin, Summer, and Levitt.  She was warned that regulation would cause the market would implode and a tidal wave of lawsuits would result.  Rubin insisted she didn’t have legal authority to regulate derivatives. The boys club wasn’t going to stop, though.

Then, in fall of 1998, Long Term Capital Management (LTCM) nearly collapsed – holding a losing derivative, with the market turning against them.  Banks had been lending LTCM unlimited loans, unaware of anyone else’s involvement, or LTCM’s exposure in the market.  If it collapsed it would default on huge loans from several major banks, spreading risk throughout the economy.  Suddenly Born’s concerns were happening in real time.

In the end, those who’d loaned LTCM money, were the ones who bought the bad loans, essentially bailing them out.

Victory for Born – time to stand up and say “I told you so!”  Instead, she emphasized the dangers in the market and need for reform.  No victory laps.

Meanwhile, the boys club was working with Congress to take away her power to regulate anything.  Congress passed a statue saying the CFTC could not take regulatory action in the OTC derivatives market for the next six months, and requested that the President’s Working Group (a group of economic advisors and financial regulators) study hedge funds and OTC derivatives and report to Congress any problems in those areas.  In 1999, the Working Group reported no need to regulate those areas of the market.

In 2000, the Commodity Futures Modernization Act took away all OTC derivative regulation ability from the CFTC, and took away potential jurisdiction from the SEC. It also forbid state regulators from interfering and exempted them from all government oversight.  The OTC derivatives market was allowed to keep growing.

In 2003, Greenspan told the Senate Banking Committee derivatives had been found to be extraordinarily useful vehicles to transfer risk from those who shouldn’t take it to those willing to and capable of doing so.

George Soros said, “We didn’t really understand how they work.”  Warren Buffett called derivatives “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Felix Rohatyn, an investment banker, described them as “potential hydrogen bombs.” Wow!

And yet Greenspan insisted, with support from Rubin, Geithner, and Summers, that the crisis of 1998 was not a wake up call for many of the financial regulators and economic advisers.  It was just an anomaly.  It wouldn’t happen again.

Since the 2008 crisis, Born has received more respect for her early warnings.  Though will little changes to regulation, she worries we are still not out of the woods – and something more could still happen.

In the April 18, 2010 episode of “This Week” on ABC, former President Clinton said Rubin was wrong in his advice to not regulate derivatives.

As some of the players slowly come around, I have to wonder – have those who are still in a role of presidential advisor changed their tune?  Why are there still so few women in financial regulation and economics?  The boys club is still there – and I’m curious how they’re treating the women they work with 13 years after pushing the lone female in the club out.


Originally appeared on Fem2.0


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