Wall Street History

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Wall Street History

12/11/2009

Lessons Learned...or not, Part III

We wrap up the story of how former Commodity Futures Trading Commission (CFTC) head Brooksley Born handled the issue of the shadowy over-the-counter derivatives market and her attempts to regulate it that were beaten back by Greenspan, Rubin, and Summers.  Born was forced to resign under pressure. Following are further excerpts of an interview Born conducted with PBS’ “Frontline” program this past August 2009. This story is all about today and the debate in Congress over who should have oversight of a market that almost sent us spiraling into another Depression. 

Frontline: What’s the message that you’re trying to spread now in the ashes of what happened in 2008 and ’09? 

Born: I think we have to close the regulatory gap….We cannot afford as a society to go forward with an enormous unregulated market that poses this kind of danger because it’ll happen again if we don’t take the appropriate steps….We need to take a lesson from the existing futures markets where exchange trading has been safe. As much as possible of the over-the-counter derivatives market should be traded on a regulated derivatives exchange. The transaction should be cleared on a regulated OTC derivatives market. And personally, I think that remaining market should be limited as much as possible to no more than the customized contracts that are needed for specific businesses to hedge particular business risks. 

Frontline: If this moment passes again, the consequences are what from your perspective? 

Born: I think we will have continuing danger from these markets and that we will have repeats of the financial crisis. It 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. 

Frontline: Congress is the one, in the end, that had oversight over the regulators. How good a job were they doing? 

Born: Of course Congress has a critically important role since they, along with the administration, have to decide on any kind of statutory reform. I think it’s very difficult for a member of Congress to be an expert in every field. This is a complicated field…. They had a lot of other things on their plate. They were hearing from very respectable sources that there was no problem, and they chose to rely on those people. And I think that was understandable. I think it was unfortunate, but I think it was very understandable. 

Frontline: Did you know enough about [derivatives] to be able to understand why these things would have been invented and why they would be catching on like wildfire? 

Born: Oh, definitely, because futures and options are used the same way. They are a wonderful means of hedging risk or shifting risk from one entity to another. The whole reason we have derivatives exchanges is because commercial interests, agricultural interests, can in effect ensure against price changes or interest rate changes or other adverse business events by hedging through these instruments. 

Frontline: So in that sense, they’re a good thing? 

Born: Exactly. And I would never say derivatives should be banned or forbidden. 

Frontline: So what’s the problem? 

Born: The problem is that they can be extremely misused. These instruments offer two different roles to entities using it. One is to hedge price risk; the other is to gamble on price risk. And there are means within the over-the-counter market to gamble on price changes in an enormous way, putting up very little up-front money so that entities are tremendously leveraged. And that means that they can make tremendous profits when the price moves right for them. But when it moves wrong, they can collapse like AIG did. 

Frontline: So what do the American people need to know about why this is so important to get after right now, and why it was so important for you? 

Born: Because this is a market that can impact each of us. It’s AIG’s collapse. It’s the toxic assets on the books of many of our biggest banks that are over-the-counter derivatives and that caused the economic downturn that made us lose our savings, lose our jobs, lose our homes. We can’t face repeated harm like this from a totally black market, a dark market. 

Frontline: Do you think most people know there’s no government regulation in this territory? 

Born: I don’t know if they do or not. All other financial markets have some kind of government oversight protecting the public interest. 

Frontline: But not this? 

Born: Not this one. This one had very good lobbyists. The very same entities that are lobbying today to limit the effectiveness of a new regulatory reform are the people who in 2000 and 1999 deregulated these markets entirely. 

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