The Washington Post (hat tip Mark Thoma) has a profile of Brooksley Born, who has been credited by dozens of commentators (including us) for unsuccessfully attempting to increase regulation of derivatives in the late 1990s while serving as the head of the Commodity Futures Trading Commission. There’s much to admire, including being the first female president of the Stanford Law Review, making partner while working part-time, and, most importantly, this:
Born keeps informed, but she has other concerns, bird-watching jaunts and trips to Antarctica to plan, mystery novels to read, four grandchildren to dote on. “I’m very happily retired,” she says. “I’ve really enjoyed getting older. You don’t have ambition. You know who you are.”
Then there are the frightening flashbacks to the regulatory battles we are sure to relive this fall:
Greenspan had an unusual take on market fraud, Born recounted: “He explained there wasn’t a need for a law against fraud because if a floor broker was committing fraud, the customer would figure it out and stop doing business with him.”
Translation: Imperfections in free markets are logically impossible.
She wanted to release a “concept paper” — essentially a set of questions — that explored whether there should be regulation of over-the-counter derivatives. . . . [Robert Rubin, Larry Summers, and Arthur Levitt] warned that if she did so, the market would implode and predicted tidal waves of lawsuits.
Translation: You cannot say anything that might upset the markets.
In one call, Summers said, “I have 13 bankers in my office and they say if you go forward with this you will cause the worst financial crisis since World War II.”
Translation: The Deputy Treasury Secretary should listen to the thirteen bankers in his office.
Mark Thoma sums up:
The people in charge of the regulatory agencies were convinced that unregulated markets were self-correcting, and that regulation was not needed and would more likely do harm than good. As this shows, no amount of convincing from people who weren’t as smart as the smartest guys in the room was going to change that. The question for me is whether those in charge now, Summers for example, have learned their lesson and the humility to be derived from it, or whether they will be defensive of their own role to the extent that it affects the type of regulation they can support. I’d very much like to believe they have learned their lesson, though humility seems to be lacking, but watching Summers and others argue that the private sector and the market is preferable to temporary government takeover of banks (i.e. his and the administration’s opposition to temporary nationalization), – the continued faith that the market always knows best – makes me wonder if they have.
By James Kwak
The Baseline Scenario 
Larry Summers showed his true colors when he “mediated” for Enron out in California. Is it surprising that he would clamp down Brooksley Born???? Sleeping at Obama’s meetings, giving lectures to Harvard faculty relating to women’s ability at math. Other than his pedigree, can someone explain to me one good thing about this guy???
Sounds like Summers is one the the Chicago Boys.
Thirty years since Reagan wanted to cut business loose from those surly bonds of government – and please tell me we’ve learned that regulation is vitally important.
At least that’s the glaringly obvious lesson to me, post-crash. The profit motive can be as terribly damaging as government regulation. And isn’t that what the bankers were telling Congress a few months ago? That self-regulation wasn’t working?
Kinda sounds like the bankers brought pitchforks into the meeting with Summers. I would love it if someone could explain how regulating derivatives would create a more dysfunctional market than the one that’s in the doldrums inspired by the latest financial crisis….
From the WaPo fishwrapper “Barbara Holum, who was a CFTC commissioner at time, said Born irreparably damaged the agency’s reputation by releasing the concept paper without achieving a consensus”
Barbara’s comment gives a valuable insight into the American state of denial.
WSJ 11/03/98
Ms. Born had endured months of
political pummeling for insisting that unregulated OTC markets required
fresh scrutiny. Her problems began after the SEC proposed late last year
to scale back regulation of derivatives dealers to encourage Wall Street
firms to sell the investments through their U.S. broker-dealer operations
and…
Congress, spurred by the Long-Term Capital debacle and by Ms. Born’s
warnings, is considering revamping a patchwork regulatory structure. No
one agency has direct oversight of OTC derivatives, or hedge funds, the
little-regulated private investment partnerships that wager huge sums in
global markets in search of quick profits.
http://cyber.law.harvard.edu/rfi/press/CFTC%20Chief.htm
too bad she wasn’t hispanic.
For those interested in the actual document, Born’s concept paper is available at http://www.cftc.gov/opa/press98/opamntn.htm
Crooks, whether they see themselves as crooks or not, don’t regulate their business very well, because their business is being crooks.
So do we need self-regulating and self-correcting crooks and crooks’ markets?
My question is: have “they” learned the lessons with good dose of humility? I am not sure about that and I am less sanguine about capitalism to the extent that it repeats exactly and cyclically the same mistakes. It also appears that capitalism is not an abstract system but just a bunch of people with faith in markets and free markets. That means that people with good faith in capitalism tend not to learn the lessons. A faith is a faith and cannot be corrected… People’s faith in self-correcting and self-regulating markets, although not necessarily free markets, makes me wonder if lessons always remain lessons. Apart from lessons we should start to write who should do what and by when otherwise next time we will be looking again for cassandras but we will be basically unable to make people accountable and fire them.
It’s like that old riddle:
Q: What do you call 13 bankers at the bottom of the sea?
A: A good start.
Simple answer. NO.
Love it.
Q: What do you call 13 crooks in your office?
A: Capitalism, self regulating and self correcting
Comment of the week.
Brooksley Born’s problem is that she IS too balanced. She needed to allow herself to be dragged down to the Greenspan, Summers, Rubin level and beat them. But ohh no, she had to go ahead and be a typically useless fair-minded member of the fairer sex.
Just think if she’d hung out with Hillary. If Bill had unleashed Hillary on the financial sector instead of health, we might be looking at a VERY different sector.
I bet Catherine Austin-Fitts is happy to see this.
Gotta love those economists, like Greenspan, living in a dreamland, far, far away from reality:
“He explained there wasn’t a need for a law against fraud because if a floor broker was committing fraud, the customer would figure it out and stop doing business with him.”
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Three people, a chemist, an engineer, and an economist, are shipwrecked – and washed ashore with only cases of canned beans as food. They discuss how they can open the cans of beans.
~ The chemist says she could probably derive an acid from some of the vegetation…but it will likely contaminate some of the beans.
~ The engineer says he might be able to open them by dropping them from a high point onto the coral reef…but some of the beans will get washed out to sea.
~ The economist ponders the situation and says, “Well, we could assume we have a can opener.”
If you add to the bunch of people a crook or a banker, with good faith, he could launch the can in the air and hope in self-opening….
bt, you really gave me a good laugh. I have the urge to send that to my old Economics teachers, but I’m afraid they would think I’m just being snarky or spiteful. Actually I love the “dismal science” and those who practice it, but you have to see the irony in taking real life situations and trying to explain them on a 2 dimensional graph with lines.
See a good Stanford magazine profile on Ms. Born: http://www.stanfordalumni.org/news/magazine/2009/marapr/features/born.html.
The markets eventually do correct – Lehman bk’d, Bear, Merrill eaten, Countrywide, Indymac, WaMu, Natn’l City, BKUnited, etc all, millions of homes with bad mortgages in foreclosure. What people fail to realize, even today is that the correction has a time lag, and damage is done between the bad act and market correction.
Consider a butcher who sells bad meat. People die, and eventually others figure out not to buy from that butcher. Did the market work? The bad butcher is out of business, but people died in the meantime. Adam Smith talked about butchers & bakers a lot more than bankers, but we would not imagine weakening FDA or USDA regulations.
We had a system where actions produced great short-term benefits and terrible medium term results (mortgages blowing up in < 2 years is almost still short-term). That type of feedback system will be inherently unstable. If the potential losses showed up before the potential gains, the positive feedback effect would have been absent.
“there wasn’t a need for a law against fraud because if a floor broker was committing fraud, the customer would figure it out and stop doing business with him.”
People sometimes criticize James for his posts on market psychology, but to understand why we are where we are, it’s sometimes critical to comprehend what has been driving things underneath. This frightening quote is an entire lesson in psychology itself.
What it shows is intelligence in itself is not the metric we need. Clearly Greenspan is the “smartest guy in the room” when he walks in, but he’s blinded by an ideology, a literal religion of orthodox thought of market infallibility.
That someone with his resume can be so literally daft, again blinded, should give us all reason for introspection – what “truisms” underlie our own beliefs? Moreover it should make clear, whether markets, religion, philosophy, physics, whatever, that the so called “unbiased” analyses are rarely that. That ultimately whatever is produced by humans should be viewed with the skepticism that it is not entirely “science” but reflects the humanity that created it, with all the flaws that implies.
i think that greenspan failed to consider that someone might do business with a counterparty precisely because that counterparty was committing fraud. if they were getting away with something someone would like to do but is deterred only by the personal consequences of the law, finding someone else to do it for them is a completely logical thing ot do.
@ winstongator:
You may well be correct about the time lag, and that’s precisely why we need good government regulation, run by folks who aren’t revolving door types for the regulated industry. Economic actors, to use Mr. Greenspans euphamism for businesses, always work to maximize short term profits, not to achive medium term or long term stability. Thus unregulated markets may well slef correct at some future point, but in the process they generally shoot off their own feet (not to mention a good number of other limbs, and the limbs of others). If the national interest is served by long term stability (which, ironically would help businesses), then there needs to be a government regulatory entity.
Had Ms. Born’s ideas been given weight there might well have been a short term impact, but at least there would sstill be derrivative trading . . . .
Guys like Summers are fact-collecting dopes. He would do OK on a TV quiz show, but would probably get scammed buying a used car.
an example of this was mr. madoff. many of his victims suspected that he was breaking a law, though most suspected that he was breaking a different law than he was.
I don’t care about a market’s shooting its own foot off, it’s their shooting my head that I’m concerned about. The credit bubble bursting causing aggregate demand to collapse has affected all industries. If somehow, ‘subprime [could have been] contained’ and only banks felt this problem, it would not be nearly as bad.
Far fewer lamented the dot-com/tech bust because it didn’t directly affect them. This bust is affecting everyone, which is why better steps should have been taken in prevention, and better regulation is needed going forward.
If a more regulated derivatives market is likely, then a consultation process on how best to migrate towards this should be underway and more public than appears to be the case currently. Darrell Duffie has argued that introducing a central clearing house can increase risk if it is only in one segment of the market, as counterparties have multiple offsetting trades so one leg disappears with only partial central clearing. This has been partially done with the Big Bang protocol in CDS, but a roadmap for how such a transition could occur is required as you cannot move to a regulated, centrally-cleared, exchange-traded market overnight.
It actually makes sense that these great financial minds avoided the issues Brooksley Born was trying to get them to discuss. How else could this group of shysters made so much money if they didn’t participate in part of the financial products sham that has now been responsible for the nightmare we’re living in every day? For additional insight see http://www.bobgreenfest.wordpress.com.
“Economic actors … always work to maximize short term profits”. I’m not sure that teh always really follows. In the Corporatist system we have created, where economic actors’ first responsibility is to produce profit for shareholders, this is clearly true. There are several other historical models that have, to a lesser or greated extent, avoided this trap, while still being called “capitalism”. The example of the family owned local company where the owners LIVE in the same town as the consumers and workers springs to mind. In that model, civic mindedness (while not assured) is at least a reasonable outcome. In our current system, civic mindedness is for suckers.
If her adversaries were genuine about their fears, then they already knew that failure of this sector posed systemic risk. Merely exploring the concept of regulation would “cause the worst financial crisis since World War II”… “They warned that if she did so, the market would implode…”
If a hypothetical discussion could cause such devastation, what does it say about the stability of the system. In the late 90s, her adversaries already knew how little it would take to rock the world.
The most important observation made by Mr. Thoma is his concern as to whether Summers and the Obama administration have learned the important lesson that lies behind the financial crisis and its negative long term impact — both direct and indirect — on the economy.
Nearly all of their actions since taking over the reign have indicated that they have not. I have yet to decide whether this is due to:
A) a real belief in market self stabilization, with a nudge from tax dollars belonging to those most impacted by, but least responsible for the crisis
B) decades of effective marketing against government intervention that primarily benefits the masses has caused real political fear of being labeled as “socialists”.
Of course, the modern day epithet comes from the very people who created and benefited from the environment that led to the collapse of the financial markets to begin with — and who embrace (or rather, extort) the current transfer of wealth from the *masses* to the *few* — in order to return to a system that remains much the same as before.
or C) we’re being duped. Purposefully.
Finally, a strong and stable financial system is the most important element to assure the safety, survival and growth of our nation. Even more important than our military itself, because without the former the latter cannot exist. So why is it that it would be seen as absurd and downright irresponisible to leave oversight and control of our military in the hands of private enterprise, yet the same does not apply to financial institutions?
Anne,
Not to veer towards socialism here, but your post about the Reagan era reminded me how many of the same people who want completely unregulated markets would also argue that we need the death penalty, stiffer sentencing for minor crimes and unlimited personal weapons rights for their crime-deterrent value …. I find this amusingly ironic ….
The most laughable quote in the article:
“TEMPORARY government takeover of banks”
Temporary ~ that’s rich.
It takes an extraordinary amount of willful ignorance to deduce that socialism (which has never worked anywhere) is preferable to capitalism (which has produced among the most vibrant economies the world has ever known).
An interesting side-effect from this socialist experiment for you to analyze:
Yesterday I went to buy a toaster, and they gave me a free bank!
Mission accomplished ~ I suppose…
I have never figured out why we need policemen and courts.
The Bill of Rights gives us the right to bear arms. If somebody is going to mug you or steal from you, you figure it out ahead of time and then just shoot them. That solves the problem and it means that they won’t bother other people in the future. It also should act as a pretty good deterrent.
It worked well in the western US until they started messing it up by sending in US Marshalls and the like which caused the system to be less efficient and less stable. Self-regualtion seemed to work well in distributing water and grazing rights in the 1800s. Today, it seems to be working well in most inner cities where the police don’t like to go in, so the population can regulate themselves.
It is a logical extension to assume that the same concepts would work well in the financial markets where the people are much more civilized, have much less larceny in their hearts, and are far more rational than the average citizen.
I knew Marshall Matt Dillon was the start of this blasted, confounded mess. Why people want to blame this on the banking industry is beyond me. Oh, confound it!!!
—written anonymously from Backwards Grove, SC
You’re the most tongue-in-cheek commentator here. (Are you related to the squash-playing Khans?)
Aside from that the FDIC temporarily takes over banks almost every weekend lately, and that there has never been a real free market in any realm (without government-backed regulations favoring the politically dominant side at the time), will you go without our “socialized” police & fire departments, air-traffic controllers, and all the other examples? We will continue tweaking our mixed system, some more regulation here, some less there, as our experience leads us to. The entire “capitalist” financial industry has been indelibly shamed by their failing us all. See, for example, Michael Edesess’ blog http://www.thebiginvestmentlie.com/
Ok, you’re on a yacht, miles from land, a banker and a lawyer fall overboard. Neither can swim. You have time to save only one. Do you:
a) read the newspaper,
or
b) have lunch?
Even on a site like this, broadly sympathetic to the need for banks and others to be regulated, more or less, the debate has a tendency to be oddly out of focus, at least to my eye.
Is there no common understanding that regulating Banks is not popular with bankers and never will be? Bulls do not knowingly line up to become steers.
That Larry and the Bankers were opposed to to reform should not surprise anyone over 15. Banking Reform does not help bankers. It helps the customers of bankers.
Any set of regulations designed by bankers and enforced by Bankers on other Bankers will guarantee that the interest of Bankers will be paramount. That is not cynicism but common sense.
And where did the money go to ?
Or, did Madoff get planted many years ago to take down the economy just when the BANKERS wanted him to show up as a disastrous jolt to the economy…he was in position planned for just when to torpedo the economy.To keep- all of the stupid American taxpayers under the thumb of the Federal Reserve Dictators