Brooksley Born’s Derivatives Warning Was Ignored – Again.

Posted on December 16, 2014

by Jerry Alatalo

superior2222-1Alphabet While Chair of the Commodity Futures Trading Commission (CFTC) from 1996-1999, Brooksley Born warned Federal Reserve Chairman Alan Greenspan, Treasury Secretary Robert Rubin, Securities Exchange Commission Chair Arthur Leavitt, and the United States Congress about the massive potential risks to the nation’s financial system from the unregulated over the counter derivatives market. She became ignored and attacked for recommending firm regulation, then the “Great Recession” of 2008 occurred – as a direct result of that ignorance.

Ms. Born delivered the following talk titled “Financial Regulatory Reform – Imperative For Our Future” at the Woodrow Wilson School for Public and International Affairs in March of 2012. She explains what happened in 2008 – and what just occurred days ago in the United States Congress – in an excellent, wise, easily understood discussion which should come to the awareness of all Americans.

Unbelievably, as shown by the recent repeal of Dodd-Frank restrictions on derivatives trading from financial industry language included in the omnibus U.S. government spending bill, she wasn’t heard… again.

She began her talk by speaking to how vital regulatory reform is to the well-being of the American people. She points out that the global economic crisis of 2008 was not the result of a normal economic downturn, but the lack of regulation in the American financial sector. The consequences were, and continue being experienced around the world today, devastating. Trillions of tax dollars went toward the bailout of out various sectors of the economy, 22 million people lost their jobs, millions lost their homes, and millions more are in the process of facing foreclosure.

Trillions of dollars of wealth have been lost by the American people, businesses large and small have suffered, state and local governments have suffered great financial harm, and the impacts will continue being felt for at least a generation.

Brooksley Born told the audience that the crisis was avoidable. The primary cause was a widespread failure of regulation and oversight, excessive borrowing, risky investments, lack of transparency in unregulated derivatives trading, lack of accountability, and lack of ethics. According to Ms. Born, a well-tailored set of government regulations is an absolute necessity to prevent a repeat of 2008’s crisis. Some twenty years of emphasis on deregulation, based on the false assumption that markets can somehow regulate themselves and are sufficient, formed the basis of a deeply flawed philosophical view which led to inaction and catastrophe.

That catastrophe is viewed by Brooksley Born and many other observers as “perhaps the greatest financial crisis in history”.

At this point in her talk, she gives an explanation of derivatives. They are complex financial transactions which are carried out in forms of a variety of economic, financial situations, some legitimate, such as when a farmer tries to protect him or herself in the case of falling prices for the foods or livestock they grow. Where the problems rise is when speculators “bet” with derivatives on economic circumstances like the rising and falling of interest rates, the price of commodities, metals, or housing, foreign exchange rates, credit risks, the rise or fall of nations’ financial conditions, or even the weather. Speculators, unlike farmers or manufacturers who take part in derivatives for mostly legitimate business purposes, produce nothing but either sometimes tremendous profits or systemically risky losses.

The pivotal point which saw the potential for damage from unregulated derivatives markets was during the Clinton administration when the Glass-Steagall Act became repealed. The act prevented banks from engaging in speculative transactions while putting customer deposits at risk, written after the Great Depression, when speculation excesses tore down the economy. After that repeal, the flood gates became opened wide for the over-the-counter derivatives market to explode.

Before Ms. Born took over as head of the CFTC, in 1993 the wife of Texas Senator Phil Graham, Wendy, held the position. During Ms. Graham’s “service”, certain derivatives became exempt from regulation. Derivatives grew into the tens of trillions of dollars after 1993, while secretive and unregulated. In 1996 a Japanese corporation lost $2.6 billion on over-the-counter derivatives copper manipulations.  In 1994, Orange County, California went bankrupt after risking and losing taxpayer money on interest rate derivatives. Ms. Graham went on to Enron, which proceeded to become bankrupt, the at-the-time largest corporate bankruptcy in U.S. history, the fall precipitated by derivatives transactions gone bad.

While the Chair of the CFTC, Ms. Born faced the task of keeping financial giants like J.P. Morgan Chase, Goldman-Sachs and others in line, overpowered by them due to the small organization she managed. She became very concerned about the derivatives market’s tremendous growth, the mentioned secret nature of the transactions, and the increasingly more apparent risks to the financial system. She decided action had become required, and directed attempts to decide whether a derivatives regulatory framework was necessary. She became met by a “firestorm” of opposition from the Greenspan, Rubin, Leavitt, and Clinton economic advisor Larry Summers.

The financial industry lined up against Brooksley Born as well, for derivatives had become an extremely profitable center of activity. There were 17 hearings in Congress about the issue, while in that timeframe the world’s largest hedge fund, Long Term Capital Management, nearly collapsed from the weight of $1.2 trillion in derivatives losses. The Federal Reserve Bank of New York arranged for a number of derivatives dealers to pitch in $3.6 billion each to take over Long Term Capital Management.

Brooksley Born resigned in 1999; several months later Greenspan, Rubin, Leavitt, and Summers told Congress to eliminate all regulations on derivatives, then the previously mentioned Texas Senator Phil Graham became the political force behind the bill which removed all derivatives regulations: The Commodity Futures Modernization Act.

After the Act passed in Congress, derivatives grew to $673 trillion, 10 times the gross domestic product of all nations on Earth. Insurance giant AIG collapsed in 2008. Lehman Brothers, with some 900,000 derivatives transactions, also collapsed, its counter-party obligations covered by the U.S. taxpayers. The Dodd-Frank Act of 2010 was the first attempt to deal with the results of decades of deregulation leading to the crisis.

When Brooksley Born gave this talk in 2012, she noted that the derivatives market had grown to over $700 trillion, was still unregulated, and large financial institutions became engaged in “full efforts to prevent implementation of Dodd-Frank rules”.

Dodd-Frank derivatives rules were overturned on December 15, 2014 when the United States Senate failed to prevent a Citigroup-written provision of the nation’s spending bill from being included, thereby preventing the dis-implementation of extremely important Dodd-Frank legislation.

Brooksley Born warned while head of the Commodity Futures Trading Commission from 1996-1999. She warned again in 2012 when she concluded this talk: 

“The political power of the financial sector is still enormous, and policy makers in Congress, the Executive branch, and the regulatory agencies must have the political will to resist those efforts to derail regulatory reform. If we do not learn from the financial crisis and put in place the needed regulatory reforms to address its causes, we may well face future catastrophic crises”.

“The American people deserve something better”.   


(Thank you to Woodrow Wilson School of Public and International Affairs at YouTube)

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