All The Devils Are Here: Unmasking the Men Who Bankrupted the World (22 page)

When the SEC put its plan out for public comment, Greenberger quickly drafted the CFTC’s response. Writing that the SEC proposal raised serious “jurisdiction” issues, the CFTC argued that if any agency should by rights be overseeing derivatives it should be the CFTC. Born would later say that she didn’t care who wound up regulating derivatives, so long as it was done right. The SEC’s “lite” approach hardly qualified. She then instructed Greenberger to draft a policy paper. The draft he came up with, thirty-three pages long, was called a concept release; it asked market participants and others a series of open-ended questions aimed at “reexamining” the agency’s approach to derivatives. Should players in the swap markets be required to report their positions to the government? Should swaps be sold through a central clearing facility? Should the CFTC impose capital requirements on derivatives transactions? Should derivatives dealers be made to conform to certain internal control standards? And so on.

The draft of the concept release was completed in March 1998. As an independent regulator, Born had the right to simply publish it and let the world react. But she didn’t do that. Viewing herself as someone who wanted to collaborate with other regulators, she sent it around to all the other important actors—not just the other regulators, but lobbyists, key legislators, and the Treasury Department—to solicit their feedback.

Feedback? Blowback was more like it. “One day I walked into Brooksley’s office,” says Greenberger. “She put down the phone and all the blood was drained from her face. She said, ‘That was Larry Summers.’ He had been screaming at her.” Summers had told her that he had just been visited by a group of bankers who said that if the CFTC insisted on pursuing their concept release, they would move their derivatives business to London. “Summers wanted us to stop,” says Greenberger. Adds Born: “There was so much pressure. The derivative dealers did not want this market looked at—at all. For some of them, derivative trading made up 40 percent of their profits.”

A month later, the President’s Working Group met to discuss Born’s concept release. The PWG, as it’s called, consists of four regulators: the chairs of the Fed, the SEC, and the CFTC, plus the Treasury secretary. But this had become such a hot-button issue in Washington that virtually all the bank
regulators were there: Larry Summers. John Hawke, the comptroller of the currency. Ellen Seidman, the director of the Office of Thrift Supervision. William McDonough, the president of the New York Fed. “It was a very tense meeting,” recalls one person who was there. The date was April 21, 1998.

The purpose of the meeting, it quickly became clear, was to persuade Born to back off. The other regulators made all the old arguments about the dangers of classifying derivatives as futures. Born, for her part, said that CFTC was a long way from trying to regulate derivatives; all it was trying to do was ask some useful questions and glean some useful answers. “Greenspan thought even asking the questions was dangerous,” recalls Born.

And where was Rubin? Given his history of concerns about derivatives, you might have expected him to be Born’s one ally in the room. During the Asian financial crisis, Rubin had asked one of his aides to find out how much derivatives exposure U.S. financial institutions had to South Korea. “We couldn’t find out,” this aide recalled. Rubin was stunned. But in this meeting, Rubin sided, without hesitation, with his fellow regulators. His reaction to Born’s arguments was almost visceral—a far cry from the man who was so admired for his ability to listen and ask questions. He bullied Born in a way that seemed out of character to anyone used to watching him manage a meeting. “It was controlled anger,” Greenberger later recalled for the
New York Times
. “I’ve never seen him like that before or after.”

Late in the meeting, Rubin turned to Born and said brusquely, “My general counsel says you have no jurisdiction.”

“Our view is that we have exclusive jurisdiction,” she replied.

Rubin: “Would you agree to discuss this with our general counsel before you issue the concept release?”

Born: “Of course.”

One suspects that Rubin thought this exchange would cause the issue to go away. Instead, it gave Born hope. She was a big-time lawyer after all; a frank and fruitful exchange of views with the general counsel of the U.S. Treasury was a fine outcome. It played to her strengths. Except that for the next two weeks she couldn’t get Treasury’s lawyer on the phone. That’s when her steely side emerged. In Born’s view, if the general counsel couldn’t be bothered to explain Treasury’s legal reasoning, then she saw no reason to delay the publication of the concept release. On May 7, the CFTC published it.

The other three members of the PWG were incensed. Rubin, Greenspan, and Arthur Levitt, the chairman of the SEC, immediately sent a letter to Congress requesting that it block the CFTC’s effort to solicit comments.
Rumors were spread that Born was just an impossible woman—too shrill and strident to work with the august members of the Committee to Save the World.

Over the next few months, Born testified more than fifteen times in a series of highly charged congressional hearings about the concept release. It was an extraordinary spectacle: in one hearing after another, an array of Clinton regulators lined up to publicly denounce the action of another Clinton regulator. Congressional Republicans were only too happy to pile on.

In a hearing before the Senate banking committee in July, for instance, Greenspan made the specious claim that derivatives were already adequately supervised: “I would say that the comptroller and ourselves for the banks and the SEC for other organizations create a degree of supervision and regulation which, in my judgment, is properly balanced and appropriate.”

Jim Leach, the committee chairman, then addressed John Hawke, repeating Born’s complaint in her testimony that the proposed legislation “would delegate review of federal law governing derivatives markets from the jurisdiction of the CFTC and SEC to a body dominated by banking regulators with no expertise in derivatives and market regulation.” Leach continued, “I would like to ask Mr. Hawke—The name of the Treasury secretary of the United States at this time is Robert Rubin. Does he have a background in financial supervision and financial market participation?”

“If he were here, he would say he spent twenty-seven years in that,” replied Hawke.

Leach: “I would continue to ask Mr. Hawke—The name of the chairman of the Federal Reserve Board of the United States is Alan Greenspan. Does he have a background in financial market participation?”

Hawke: “I believe he does.”

More than a decade later, you can still hear them chuckling at that exchange.

The concept release got nowhere. Persuaded by Greenspan et al., Congress slipped a provision into an agriculture bill that prevented the CFTC from acting on derivatives for six months—which just happened to be the amount of time left in Born’s term as chairman.

Three months later, Long-Term Capital Management blew up.

It would be hard to overstate the feeling of terror the LTCM collapse inflicted on Wall Street. The Russian crisis was taking place at virtually the same time; indeed, it was the precipitating event that had led to LTCM’s
problems. The markets were incredibly volatile. The Dow Jones Industrial Average dropped 512 points one day in late August—the fourth largest drop in history—only to gain nearly 400 points one day in early September. The fear that the financial crisis, having swept through Asia and Russia, was about to hit the United States was palpable.

The main reason it didn’t was that the New York Fed ordered all the big Wall Street firms into a room and insisted that they hammer out a rescue plan. In the end, fourteen firms injected equity into LTCM, effectively taking it over. (Only Bear Stearns refused to participate.) In other words, it was government action—not market discipline—that prevented disaster.

Washington was every bit as terrified as Wall Street—as it should have been. The potentially destructive power of derivatives had been exposed. For that matter, all the tools of modern finance—excessive leverage, probabilistic risk models, unseen counterparty exposure—had been shown to be flawed. When Wall Street finally got a look at Long-Term Capital’s books, for example, it was astounded by the size of the firm’s total counterparty exposure: $129 billion. Up until that moment, LTCM’s lenders had only known about their own small piece of it.

During a hearing on October 1, 1998, even the Republicans on the Senate banking committee fretted about whether the LTCM disaster signaled the beginning of another S&L-style crisis. If ever there was a moment when Bob Rubin could have used his immense stature to do something about the derivatives problem he had supposedly spent years worrying about, this was it. Even hard-line deregulators might have followed his lead. But he did nothing of the sort. During that October hearing, Chairman Leach said to Born, “We owe you an apology.” One last time, Born pleaded with Congress to grapple with “the unknown risks that the over-the-counter derivatives market may pose to the U.S. economy.” Even after LTCM, she remained the only administration official willing to talk about the need for government oversight over the derivatives business.

Six months later, the President’s Working Group issued a report on LTCM, which focused much more on the firm’s excessive leverage than its derivatives book, and which made exactly one regulatory recommendation: unregistered derivatives dealers should be required to report their financial risk profiles on some kind of regular basis. In a footnote, Greenspan dissented even from that recommendation.

Although Brooksley Born signed her name to that report, she was unhappy with it, feeling that it only reinforced the government’s laissez-faire attitude toward derivatives. When the White House called and asked if she wanted a second term, she declined. By June 1999, she had returned to Arnold & Porter, where she resumed her practice until she retired in 2003.

A few weeks after Born left the government, so did Rubin. Rubin never spoke to Born again after that April 1998 meeting. Immediately after the Long-Term Capital Management fiasco, she had reached out to Gary Gensler, then a high-ranking official at Treasury—later, ironically, the chairman of the CFTC—asking him to convey a message to Rubin. “We all seem to be on the same side now,” she told Gensler, hoping he would convey to Rubin that she wanted to work with him on the derivatives issue. Rubin never responded. Not long afterward, she attended a meeting at the Treasury Department in which she tried to congratulate Rubin for his role in containing the crisis. He brushed past her without saying a word.

Years later, Rubin’s defenders would claim that it was Born’s hard-nosed approach that had turned him against her. She was too strident, they said, too legalistic, not deferential enough to the Treasury secretary. “If she had just been more collaborative,” said one such defender, “Rubin might have been her ally.”

Arthur Levitt, the SEC chairman, was one of those who had been told by Treasury that Born’s supposed stridency made her impossible to work with. Years later, though, he worked with her on a project and found her completely collegial. He later told the PBS documentary show
Frontline
that he felt Treasury had misled him. For his part, Greenberger believes that Rubin didn’t take her seriously because he didn’t view her as a bona fide member of the establishment like himself.

Even so, why should Brooksley Born’s personality or her background have been the deciding factor? Derivatives either were a problem or they weren’t. Rubin either understood the trouble they might someday cause or he didn’t. If, as he says, he did understand the problem, then allowing his position to pivot on whether or not Born showed him the proper deference would seem, in retrospect, a pretty serious dereliction of duty. Robert Rubin had spent most of his career affecting a kind of egoless management style. His treatment of Born—his willingness to put his personal irritation ahead of the important public policy issues that derivatives posed—suggests that he wasn’t quite as egoless as he let on.

It fell, finally, to Larry Summers to make sure that derivatives could never again be threatened by a regulator like Brooksley Born.

After Rubin left the Treasury Department, he took a position with Citigroup as “senior counselor,” where he had no operational responsibilities but was nonetheless paid around $15 million a year. Clinton named Summers as his replacement. A few months later, the President’s Working Group issued a long-awaited report on derivatives—a report that had been prompted by the furor over Born’s concept release. “A cloud of legal uncertainty has hung over the OTC derivatives markets in the United States in recent years,” read the cover letter accompanying the report. The report recommended that that uncertainty be remedied by Congress. It was: Phil Gramm pushed through the Commodities Futures Modernization Act in 2000, which Clinton—with Summers’s enthusiastic support—signed into law. The new law explicitly stated that derivatives were not futures and could not be regulated by the CFTC—or any other government regulator. It was the last bill Clinton signed before leaving office.

A year earlier, the president had signed a law that repealed Glass-Steagall, which had split commercial from investment banking so many years before. Gramm-Leach-Bliley, as the new law was called, also had Summers’s strong support. One of its nods to modern finance was a provision that “expressly recognized and preserved this authority for national banks to engage directly in asset-backed securitization activities,” as Comptroller of the Currency John Dugan would note many years later.