Henry C.K Liu is one of the great chroniclers of finance and economics in our times. His writings, which I have followed for years at Asia Times Online and on his website, go beyond the mechanical propensities of most economists and financiers. He writes with a deep understanding of finance, Asia, and as you can see in the piece that follows, U.S. politics. He also breathes an insightful and playful humanity into all of the subjects he explores. We are fortunate, as Henry expresses in the article below, to have had Brooksley Born acting on behalf of the American people in the 1990s. We can also be thankful that we have Henry C.K Liu to illuminate the pathway forward as we address the vital challenges that mankind faces around the world.–Robert Johnson, Director of Financial Reform at the Roosevelt Institute
The 2009 John F. Kennedy Profile in Courage Award was given to Brooksley Born for her former role as chair of the Commodity Futures Trading Commission (CFTC) and her efforts to bring OTC (over the counter) financial derivatives.
The award citation read: “In the booming economic climate of the 1990’s, Born battled other regulators in the Clinton Administration, skeptical members of Congress and lobbyists over the regulation of derivatives, warning that unregulated financial contracts such as credit default swaps could pose grave dangers to the economy. Her efforts brought fierce opposition from Wall Street and from Administration officials who believed deregulation was essential to the extraordinary economic growth that was then in full bloom. Her adversaries eventually passed legislation prohibiting the CFTC from any oversight of financial derivatives during her term.”
Born, an attorney, was nominated as CFTC chair by President Clinton in 1996. She served from 1996 to the end of her term in April, 1999, after which she stayed on to serve as acting chair until her resignation on June 1, 1999.
At CFTC, Brooksley Born conducted a financial analysis which led her to anticipate a serious financial crisis due to growth in the trade of unregulated derivatives. Born was particularly concerned about swaps, financial instruments that are traded over-the-counter on the dark market. Swaps are traded on a cross network Alternative Trading System (ATS) that matches buy and sell orders electronically for execution without first routing the order to an exchange or other market which shows a public quote. Instead, the order is either anonymously placed into a black box or flagged to other participants of the crossing network. The advantage of the crossing network to the transaction parties is the ability to execute a large block order without impacting the public quote. Swaps thus have no transparency except to the two counter-parties. The disadvantage to the market is that material information is hidden from market participants.
On May 7, 1998, the CFTC, under Brooksley Born, issued a “Concept Release Concerning OTC Derivatives Market” requesting comments on whether the OTC derivatives market was properly regulated under the existing exemptions of the Commodity Exchange Act (CEA), passed during the New Deal era, and on whether market developments required regulatory changes.
Financial regulation, even against fraud, was strenuously opposed by Federal Reserve chairman Alan Greenspan, Treasury Secretary Robert Rubin and Undersecretary Larry Summers, who is now the top economic policymaker in the Obama White House. On May 7, 1998, SEC Chairman Arthur Levitt joined Rubin and Greenspan in objecting to the issuance of the CFTC’s Concept Release. Their response off-handedly dismissed Born’s concerns on inadequate regulation on the ground that discussing the regulation of swaps and other OTC derivative instruments would increase legal uncertainty of such instruments, potentially creating turmoil in the already adequately self-regulated markets, and reducing the market value of these instruments. Further concerns voiced were that the imposition of new regulatory constraints would stifle innovation and push coveted transactions offshore through cross-border regulatory arbitrage.
In the Senate Agriculture Committee hearing on July 30, 1998, Chairman Richard G. Lugar, Indiana Republican, attempted to extract a public promise from Born to cease her campaign for regulation on the OTC derivative market in exchange for warding off a move in Congress for a Treasury-backed bill to slap a moratorium on further CFTC action.
To her credit, Born stood her ground, portraying her agency as being under attack for carrying out its statutory mandate by anti-regulation agencies, namely, the Fed, the Treasury and the SEC. Fed chairman Greenspan shot back angrily that CFTC regulation was superfluous, and that existing laws were quite adequate. “Regulation of derivatives transactions that are privately negotiated by professionals is unnecessary,” Greenspan said, referring to OTC derivatives, adding, “Regulation that serves no useful purpose hinders the efficiency of markets to enlarge standards of living.”
According to Greenspan et al, the market can police itself even against fraud because it is run by honorable people who have strong incentives to protect the market from fraud. But the issue at the hearing was more than bureaucratic turf war. It was an ideological battle with the full power of the Federal government siding with Wall Street to suppress the dutiful carrying out of the statutory mandate of a small agency to protect the general public. Born was effectively silenced by a concerted effort by top officials in the Clinton administration after she responded to a challenge from a Committee member on what she was trying to protect by saying: “We’re trying to protect the money of American public.”
Larry Summers then as Treasury Undersecretary, now top economic policymaker in the Obama administration, was reportedly the Clinton administration’s hatchet man to shut up Born and shut down CFTC demand for regulation of the OTC derivatives market. Born resigned as head of CFTC on June 1, 1999 in frustration.
After the global financial crisis of 2008, Greenspan has since publicly confessed to Congress that he had erred in his judgment on the self regulating power of the market. It is not known if he has apologized to Ms Born personally privately.
An October 2009 PBS “Frontline” documentary described Born’s failed efforts to regulate and bring transparency to the secretive derivatives market, and noted the continuing resistance to reform. The program concluded with Born sounding another warning: “I think we will have continuing danger from these markets and that we will have repeats of the financial crisis — may differ in details but there will be significant financial downturns and disasters attributed to this regulatory gap, over and over, until we learn from experience.”
*An extended version of this article is available on Henry Liu’s website.
Roosevelt Institute Braintruster Henry C.K. Liu is an independent commentator on culture, economics and politics.