Financial Regulation From Clinton to Bush to Obama

In the midst of a crisis, there’s rarely time to question what caused the crisis. But it’s useful to know who helped get markets to where they are so we can avoid mistakes as we get through the triage and begin formulating policy solutions. Below are two stories that discuss a key player in the run-up to the crisis—Brooksley Born, the head of the Commodity Futures Trading Commission from 1996 to 1999. She pressed for getting derivatives such as credit default swaps under the purview of the CFTC so that they wouldn’t be viewed just by the two parties that entered into the contracts—her goal was to have the same level of transparency as other derivatives, where all market participants can see positions.

But she was shut down by Fed chairman Alan Greenspan, SEC chairman Arthur Levitt, Treasury Secretary Robert Rubin, and Rubin’s successor Lawrence Summers—and not long after she left the CFTC post in 1999, then-Senator Phil Gramm did the deregulatory bidding of these other leaders and got his CFTC Modernization bill through congress. This open market advocacy is fine because you can’t have over-regulated markets if you expect to compete globally. But you can’t let derivatives go utterly unregulated.

The Enron run-up and failure was the first direct result of Gramm’s CFTC Modernization bill. The current crisis is the second. Here’s how The Economist sums up derivatives regulation:

Every bubble sees excesses; it seems odd to single out the CDS. Think back to the crash of 1987 when fingers pointed at the equity-futures market, which institutions were using to protect against falls in their share portfolios. It was argued that this exacerbated the crash. A commission was established; restrictions were imposed. Twenty years later, the Chicago equity futures and options market is vast: some $45 trillion of contracts traded on the S&P 500 index alone last year compared with the total American stockmarket value of just $10 trillion. But equity futures are unnoticed and unblamed in the crisis.

In 20 years the CDS may well be as little remarked as the equity future is now. But only with reform. As well as a clearing house, the market must be more transparent. Banks and other quoted firms should reveal how exposed they are to the market. CDSs have their uses. There is no reason why investors should not speculate in corporate debt if they can speculate on equities, currencies, commodities and the rest.

This is something Born was trying to defend, but according to much of the reporting since then, she wasn’t a savvy politician and her approach was ostensibly spurned on the basis of her approach rather than the merit of her argument. Maybe regulators, Lawrence Summers being the only one of that era with a significant position in the Obama administration, will finally understand this time.

Recent Stories Revisiting Derivatives De-Regulation That Led To Crisis

• Bloomberg: Former CFTC Head Brooksley Born Vindicated as Swap Rules Take Shape.
• NY Times: Taking Hard New Look At Greenspan Legacy