Business Times - 24 Oct 2009
The real Cassandra of the crisis
Lawyer Brooksley Born had warned that the completely unregulated and unobserved trade in derivatives could bring down the entire financial system
By LEON HADAR
MOST of those who follow economic news are familiar by now with the name of Nouriel Roubini, an economics professor at New York University's Stern School of Business, who was one of the few economists who had predicted the financial crisis more than three years ago.
In a speech at the International Monetary Fund (IMF), he warned of an impending collapse of the global financial system and a deep recession.
But there was apparently another Cassandra, who unlike Roubini hasn't been transformed into an instant celebrity, but who more than 10 years ago had not only warned that the completely unregulated and unobserved trade in financial derivatives could bring down the entire financial system, but who also had the guts to stand up to then Fed chairman Alan Greenspan and other powerful figures in Washington and Wall Street. Greenspan and his acolytes were opposed to any attempt by the federal government to interfere with the workings of the free market.
Washington lawyer Brooksley Born was appointed by then president Bill Clinton to run the tiny Commodities Future Trading Commission (CFTC), a financial regulatory agency. In 1997, she noticed that the banks didn't have to disclose what they were doing with all those exotic financial derivatives, and proposed to bring financial derivatives under the federal regulatory system.
But the powerful financial institutions in Wall Street were violently opposed to her ideas and cried out for help. In response, Maestro Greenspan, joined by Clinton's treasury secretary Robert Rubin and his deputy Lawrence Summers and Securities and Exchange Commission (SEC) chairman Arthur Levitt, called Born in and warned her to stop behaving badly.
When she refused to back down, these powerful men went to Capitol Hill to get her shut down, and Congress took away CFTC's right to regulate derivatives. Then Born resigned. End of story. And the rest, as they say, was history.
That history came back to life this week when Frontline, an American public television news programme aired a documentary, The Warning, about Brooksley Born and the way the Big Boys in Washington and Wall Street, in the name of defending unfettered capitalism, read her the riot act.
Her warnings were not heeded and the 'dark market' of over-the-counter derivatives stayed in the dark with terrible consequences for the American and global economy.
When she became head of CFTC, Born expressed her concern that since derivatives were not traded on exchanges, and were leaving behind no records or reports, there was an enormous potential for fraud. 'There was no transparency,' Born told Frontline correspondent Michael Kirk. 'There was no record keeping requirement imposed on participants in the market. We had no information.'
She believed the lack of transparency left the market open to fraud and asked her staff to look into such activities. Based on that examination she prepared a report that raised her concerns and proposed that Congress take steps to regulate the shadowy financial sector.
A special meeting of the Working Group, a committee that discussed and essentially set financial policy for president Clinton, and that included Rubin, Levitt, Summers and Greenspan was convened.
The 'clear mission' of which was to keep the CFTC from issuing its report, according to Michael Greenberger, a director of CFTC after Born, who was interviewed on The Warning. Born was instructed to back down.
As The Warning describes it, Born and Greenspan were at odds, reflecting conflicting ideological approaches to the role that government should play in the economy. In one of the meetings between Greenspan and Born in 1997, when she took over the CFTC, the Fed chairman apparently told the new CFTC head that her agency was not supposed to pursue fraud, and that the 'market would figure it out'.
Indeed, Greenspan's free-market ideology which was embraced by president Clinton's economic team ended up guiding US economic policy, including the continuing efforts to deregulate the financial markets up until the recent crisis.
Greenspan argued that derivatives helped businesses and banks and governments manage the risks to which they were already exposed more efficiently than they could have done before, and were therefore doing something that was useful for the financial system and the American economy.
Despite the opposition from Greenspan and his colleagues, Brooksley went on to publish her list of concerns about the market in derivatives. She testified before four congressional committees on the issue but failed to persuade the lawmakers under pressure from the Clinton administration. Congress stripped the CFTC of its powers to regulate the markets, forcing Born to resign.
Ten years later, Born watched as the financial markets collapsed. 'It was my worst nightmare coming true,' she told Frontline. 'The toxic assets of many of our biggest banks are over-the-counter derivatives and caused the economic downturn that made us lose our savings, lose our jobs, lose our homes. It was very frightening.'
But despite the financial crisis, the market in over-the-counter derivatives is alive and well and is now more than US$450 trillion in size - on paper at least. The House of Representatives' Financial Services Committee approved new rules for the market last week. But there are new Cassandras who argue that the rules aren't going to protect the economy from the next crisis.
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