“The messenger wore a skirt,” says Marna Tucker, “Could Alan Greenspan take that?”*
Re-posted from New Agenda April 2009, Bill reminds us of some of the history leading up to today:
Editor’s note: We are pleased to present this guest post by Bill H, who’s known around the internet as run75441, and who can usually be found writing in his area of expertise: finance.
Recently, Stanford Magazine did a nice article on one of the University’s former law review presidents who graduated at the top of the 1964 class. The first female to hold either distinction of graduating first in her class and also as president of the school’s Law Review. “Prophet and Loss.” April 2009.
“Well, you probably will always believe there should be laws against fraud, and I don’t think there is any need for a law against fraud,” Alan Greenspan
“I thought it was counterproductive. If you want to move forward . . . you engage with parties in a constructive way,” Rubin told the Washington Post.
“My recollection was . . . this was done in a more strident way” … “characterized as being abrasive.” Arthur Levitt
It would seem these three, coupled with Larry Summers’s push back in Congress on the regulation of derivatives, had the problem and not Brooksley Born. Since then, all three men have suggested there should have been more regulation of the derivatives market that Greenspan has called its recent collapse a “once in-a-century credit tsunami.” Called a modern day Cassandra by Stanford Magazine, one could only wonder where we would be today if the economic and financial wizards had heeded her words.
Short histories on CDO/CDS . . . Collateral Debt Obligations (CDO) were invented by Drexel Burnham Lambert (Milken) as a way to package asset based securities. The CDO was tranched into similar asset backed securities of the same rating allowing investors to concentrate on the rating rather than the issuer of the bond. Ten years later, JP Morgan invented Credit Default Swaps (CDS) was used as a mechanism to bet on a 3rd party default. In 2000, CDS were made legal with the passage of the Commodity Futures Modernization Act and any regulation of them was stymied with this bills passage. Later on, an investment firm decided to team CDS and CDO together, transferring the risk from the CDO to the issuer of the CDS, and creating a synthetic CDO.
It was 1994, that Bankers Trust lost ~$800 million from various derivative investments. The chief losers were P&G and Gibson Greetings. Bankers Trust was formed by a consortium of banks, shedding the loan image for conducting trades. Bankers Trust was successfully sued by P&G for its losses by claiming racketeering and fraud. Bankers Trust also became known for its remarks about Gibson Greetings not knowing what Bankers Trust was doing. In 1998, Bankers Trust pled guilty to institutional fraud due to the failure of certain members of senior management to escheat abandoned property to the State of New York and other states. Again in 1998, LCTM was struck by a downturn in the market when Russia defaulted on government bonds, a security LCTM was holding. To make a significant profit on small differences in value, the hedge fund took high-leveraged positions. At the start of 1998, the fund had assets of about $5 billion and had borrowed about $125 billion. When investors panicked and sold Japanese and European bonds and bought US treasuries, the spreads between LCTM holdings increased, resulting in a loss of ~$1.8 billion by August 1998. LCTM was saved by an orchestrated Fed bailout utilizing private investors.
It was in 1998 and Brooksley Born testified to Congress about the dangers of the unregulated derivatives market referencing the LCTM losses as a recent example. It was also then that deputy Treasurer Larry Summers testified to Congress that Born’s desire to regulate is “casting a shadow of regulatory uncertainty over an otherwise thriving market.” Larry’s testimony set the stage for Congress to rein in the power of the Brooksley Born’s CFTC and the passage of Phil Gramm’s Financial Service Modernization Act of 1999 prohibiting the regulation of the derivatives market (In 2005, the revised bankruptcy laws would place derivatives outside of the laws also making it the first to receive compensation). W$ and banks had clear unregulated sailing in the sea of laissez faire in 2000 with a closing of the door for debtors in 2005. It was little better than a roach motel, you could check in but you can not check out.
Again in 1999 and in the Senate that opposition arose to the passage of the Financial Services in the form of Senator Dorgan of North Dakota. An excerpt from the Senator’s speech that day before the bill was passed:
“I, obviously, am in a minority here. We have people who dressed in their best suits and they just think this is the greatest piece of legislation that has ever been given to Congress. We have choruses of folks standing outside this Chamber who spent their lifetimes working to get this done, to say: Would you just forget all that nonsense back in the 1930s about bank failures and Glass-Steagall and the requirement to separate risk from banking enterprises; just forget all that. Time has moved on. Let’s understand that. Change with the time.
We have folks outside who have worked on this very hard and who very much want this to happen. We have a lot of folks in here who are very compliant to say: Absolutely, let me be the lead singer. And here we are. We have this bill, which I will bet, in 5, 10, 15 years from now, we will be back thinking of this bill like we thought of the bill passed in the late 1970s and early 1980s, in which this Congress unhitched the savings and loans so some sleepy little Texas institution could gather brokered deposits from all around America and, like a giant rocket, become a huge enterprise. And guess what. With all the speculation in the S&Ls and brokered deposits and all the things that went with it that this Congress allowed, what did it cost the American taxpayer to bail out that bunch of failures? What did it cost? Hundreds of billions of dollars. I will bet one day somebody is going to look back at this and they are going to say: How on Earth could we have thought it made sense to allow the banking industry to concentrate, through merger and acquisition, to become bigger and bigger and bigger; far more firms in the category of too big to fail?
— Senator Dorgan’s Speech, November 4, 1999 on “Gramm-Leach-Bliley Act” also known as the Financial Services Modernization Act
Larry Summers has been present throughout much of this change, supporting it, denigrating the opposition, and now claiming his experience at D. E Shaw gives him an insider’ knowledge as to how the derivatives market works. While President of Harvard University; Larry received a letter (May 12, 2002) from Iris Mack, a new employee of the Harvard Management Company managing Harvard’s endowment funds. A Doctorate in Mathematics from Harvard and a former employee of Enron who dealt in derivative trades, she expressed concerns about the trades (swaps and other complex financial instruments) being made by the funds and the lack of understanding of the trades by the traders. On July 1, Iris was called into the office of Jack Meyer, the chief manager of Harvard Management. On July 2, Iris was fired for making what Harvard Management termed as: “baseless allegations against HMC to individuals outside of HMC.” “Ex-Employee Says She Warned Harvard of Risky Moves” Boston Globe, April 3, 2009. While Harvard Management Company claims above normal returns on its endowment funds, it has spent much of last year selling off private equity and investments to raise cash.
The attitude expressed by our head of the Economic Council is one of “trust me now” as I have all of the experience necessary to fix the current economic and financial problems even though he has helped to initiate today’s issues by denigrating Brooksley Born’s request for regulatory power to Congress, even though he ignored the advice of Iris Mack at Harvard University, even though he consulted to D.E. Shaw, a hedge fund, and making ~$5.2 million while being the financial engineer’s engineer, and even though he has been repeatedly wrong in his direction and advice to Congress and Industry. In the name of deregulation and global efficiency, Larry was its cheer leader while signing off on a letter encouraging the dumping of toxic wastes in Asia at the World Bank. He helped to shepherd China into the WTO claiming:
“’The agreement with China is a one-way street,’ Summers said. ‘China opens its markets to an unprecedented degree, while in return the United States simply maintains its current market access policies,’ he said. ‘It is difficult’, Summers added, ‘to discern any disadvantage to the United States in passing this legislation.’”
— Robert Waldman, Economist, Angry Bear blog.
Personality, ego, and a blind belief in the ability of the market place to dictate the proper path and the correction has gotten in front of common sense. Maybe it is time to sideline Summers and his protégé Geithner in favor of Born, Mack, and Dorgan. Each has shown more foresight into how today’s problems and issues were created and how to resolve them.
“I certainly am not pleased with the results,” she adds. “I think the market grew so enormously, with so little oversight and regulation, that it made the financial crisis much deeper and more pervasive than it otherwise would have been.”
— Brooksley Born, Stanford Magazine, April 2009
*“The messenger wore a skirt,” says Marna Tucker, a Washington lawyer and a longtime friend of Born. “Could Alan Greenspan take that?”
The parallels between the 1990s and now are little worrisome. Congress is still apprehensive to adequately regulate W$ over concerns that doing so will have some negative impact on the economy–coupled with this insane love affair with the notion that self-regulating markets “work.” (the House Agricultural Committee recently passed 7 resolutions that are headed to the floor for a vote. these resolutions would basically gut Dodd-Frank of any ability to regulate the derivatives markets).
Recently I found some interesting quotes from Bob Corker, who is suppose to be one of the more enlightened Members of Congress on issues of finance, banking, and the like. He is concerned that Section 121 of Dodd-Frank (the section that gives the gov. the power to break up the banks) could be used on “healthy” institutions. Seriously? Have we already forgotten that the problem with TBTF is the systemic risk they pose to the system, and when they begin their downward spiral, at best, all that anyone can do is slightly soften the blow of the collapse of these financial behemoths? The thing that many pundits and experts on the collapse marvel at is the speed at which it happened. Lehman collapsed in a matter of months, with the more drastic events happening 6 days apart. Anyone really think that under Sec. 121 the gov could act quickly enough to resolve the LB problem–which does not even touch upon the issue of commitments and obligations LB and similar banks/financial institutions will have entered into prior to the gov.’s decision to break up the entity under 121. In other words, would using Sec. 121 at the time of the downward spiral (which is what Corker is suggesting is the only appropriate time if we can break up a “healthy” bank) prevent an event like 2008?
Greenspan is grinning from ear to ear. He knows when this one bursts he won’t even be a close second to the worst fed chairman in history. In fact, he will write yet another book claiming that Bernanke was actually pulling all the strings during the late 1990s bubble as well. And thus, Greenspan himself had nothing to do with it, as he was already senile at that point. Plus, all the Viagra he used in wooing Andrea Mitchell at the time drew all the blood out of his brain which clouded his thinking.
The way that Greenspan, Rubin, Arthur Levitt, and Larry Summers treated Born was particularly appalling. As regulators, they should have immediately realized how benign and non-threatening Born’s concept release was. And even if they had substantive disagreements with her, they should never have aired those disagreements in public. The whole thing reeked of sexism.
The reason Born was partly the “Cassandra of the credit crisis” is that she warned about exactly the situation the Fed and Treasury found themselves in with AIG…”
”The Commodity Exchange Act addresses excess speculation in commodity markets, and states that “the Commission shall…fix such limits on the amounts of trading which may be done or positions which may be held by any person.” The only exceptions are “to permit producers, purchasers, sellers, middlemen, and users of a commodity or a product derived therefrom to hedge their legitimate anticipated business needs”(7 USC 6a).
The CFTC regulations 17 CFR 1.3(z) further spells out who is to be considered a bona fide hedger in such intricate detail as to make it unmistakable that exemptions to speculative limits are intended only for those commonly known as “the trade” who carry on a cash business in the commodity itself.
The Commission acknowledges that speculative limits apply to indexers: “Mutual funds (or for that matter institutional traders) who want to gain commodity exposure”, whether in an individual commodity future or in several commodity futures that make up an index, are not entitled to an exemption as a bona fide hedger.”
But what agency takes away with one hand, it gives back with the other: “Swaps dealers that have swap agreements with clients that provide the clients with a return on an index of commodities can hedge the exposure from that agreement by buying futures contracts in the commodities underlying the index.”
In proposing the new exemptions, the CFTC acknowledges that index-based positions differ enough from bona fide hedges as to make hedge exemptions inappropriate under current law. It does not state where it found the authority to classified swap dealers as hedgers in the first place. It is also unclear why swap dealers should be accorded special treatment.
Administration under CFTC Chairman Wendy Graham (the other half of the Texas Senator Phil Grahm’s duo that Barron’s dubbed “Mr. & Mrs. Enron”). She began exempting swaps from CFTC oversight in 1989, and in 1992 granted Enron regulatory exemption for its energy-swap operation just five days before resigning her Chair to join Enron’s audit committee.
In 2000 the CFTC officially granted dealers broad relief with the result that today swaps are cleared through the US futures clearing systems alongside futures contracts, thus affording exchange level payment guarantees to non-exchange traded and non-regulated derivative contracts.
Then in 2006, in undertaking a “Comprehensive Review of the Commitments of Traders Report” the Commission acknowledged that its practice of reporting the positions of swap dealers under the “commercial” category may be misleading. Though it received a record public response with practical unimity for continued and expanded position reporting, it bowed to the one dissenter.
The International Swaps and Derivatives Association (ISDA), although opposed to a separate reporting category altogether, allowed that “If the Commission decides otherwise, we recommend that any additional reporting be in a no more than two-year pilot program that we would be prepared to work with the Commission to design with a limited number of commodities.”
More enlightening than the swap dealers wish for anonymity, was the reason stated in the ISDA’s letter to the CFTC: “the [swap dealer] category is highly concentrated, with, we believe, the top four swap dealers composing over 70% of the category. In some of the lower-volume commodities markets, only a single swap dealer is a dominant participant”.
With one to four unregulated swap dealers controlling upward of 60% of the long open interest in some markets, the CFTC’s has created a nightmarish level of concentration. Even assuming that their dealings in fact originate from non-leveraged investors, sudden setbacks in other investment areas could easily jeopardize a swap dealer’s ability to meet margin calls, al la Bear Stearns.
Sadly, futures markets are but the tip of the iceberg that the financial system is headed for. http://commitmentsoftraders.org/28/what-you-didnt-read-in-the-barrons-cover-story/#more-28
See Steve Briese – I know, never heard of him but one of the best with commodities, etc…….Alan Heap as well, though not sure he’s still alive.
Aside from that, Congress has really done
distinctions between regulation and enforcement
CFTC Chair Born resigned effective June 1999. Her successor, William Rainer, was CFTC Chair when the PWG Report was issued in November 1999…
GSCI was created in same time frame…
Capital allocation theories added weight to commodities…
and a long run commodity price bubble began coming to life…but of course it could not have been what it was and to degrees is……
First – Excellent piece Run…..
Speaking of CDOs, did you have any experience with CDO^3 or masmenos same via CDS?
What can I say – structured finance, Lordy lordy call Janet Tavokoli.
Second, recent piece from Briese –
Bad news for the banks. Good news for the public.
COMMODITY FUTURES TRADING COMMISSION, Washington DC.
Commissioner Jill Sommers Announces her Resignation
01/24/2013 03:02 PM EST
Appointed by President Bush in 2007, Sommers previous job was chief lobbyist for the International Swaps and Derivatives Association, and is the poster child for “First, Do Nothing” in regulatory reform in the financial industry. As Commissioner, she opposed implementation of any regulation that might impact the ability of the four large swap dealers who account for 94% of swap contracts: JP Morgan/Chase, Bank of America, Citigroup, Goldman Sachs.
Watch the news. Best guess is she will land on her feet–in a plush office with a major bank.”
Thank you for adding to my comments on Born. There were so few who understood the danger of unregulated gambling derivatives. Combine this with those who actually took a stand on them such as Born, Dorgan, and Mack. It would have been just rewards if those who promoted and dealt in them had been allowed to fail rather then foist their malfeasant errors upon main street. The greatest tragedy is that we were forced to bail them out and going into recession.
Thank you for your comments. If I could find the list of participants who assisted in the failure of Wall Street, I would post it. It goes well beyond the fab foursome of Greenspan, Rubin, Summers, and Levitt. Even the neophyte Geithner had a hand in this failure.
I agree with your comments on Corker, the Senator from Toyota (ever watch the movie The Rising Sun?). He needs to be watched closely and kept on a short lead or a shocker collar.
You made me smile for once rather than take exception to your comment. Greenspan is definitely on of the orcs (Lord of The Rings). He dances around his responsibility for being the prime reason for our demise.