Credit Crisis Cassandra
Brooksley Born’s Unheeded Warning Is a Rueful Echo 10 Years On
From The Washington Post, May, 2009
‘A little more than a decade ago, Born foresaw a financial cataclysm, accurately predicting that exotic investments known as over-the-counter derivatives could play a crucial role in a crisis much like the one now convulsing America. Her efforts to stop that from happening ran afoul of some of the most influential men in Washington, men with names like Greenspan and Levitt and Rubin and Summers — the same Larry Summers who is now a key economic adviser to President Obama. She was the head of a tiny government agency who wanted to regulate the derivatives. They were the men who stopped her.
The same class of derivatives that preoccupied Born — including the now-infamous “credit-default swaps” — have been blamed for accelerating last fall’s financial implosion. But from 1996 to 1999, when Born was the chairman of the Commodity Futures Trading Commission, the U.S. economy was roaring and she was getting nowhere with predictions of doom.
So, upstairs in the big house in Kalorama, Born tossed and turned. She woke repeatedly “in a cold sweat,” agonizing that a financial calamity was coming, she recalled one recent afternoon.
“I was really terribly worried,” she said.
Before taking office, Born had been a high-octane attorney, an American Bar Association power player, a noted advocate of feminist causes and co-founder of the National Women’s Law Center. But none of that carried much weight when she crossed over into government; for all her legal experience, she was a woman who wasn’t adept at playing the game. She could be unyielding and coldly analytical, with a litigator’s absolute assertions of right and wrong. And she was taking on Beltway pros, masters of nuance and palace politics. She marched into congressional hearing after congressional hearing — pin neat, always with a handbag — but no one really wanted to listen.
The Wall Street Journal declared that “the nation’s top financial regulators wish Brooksley Born would just shut up.” The Bond Buyer newspaper compared her to a salmon “swimming against raging currents.”
That last one cracks her up.
“Maybe not an inappropriate analogy!” she says.
Now that she is retired and far from a position of influence, Born, 68, may be closer than ever to vindication. No longer an outlier, she attended a small, private dinner at the Treasury Department last week with current and former regulators at the invitation of Secretary Tim Geithner, according to two sources. And the Obama administration has unveiled a plan to regulate some of the derivatives she warned about, though the proposal must still get through Congress and falls short of regulating the entire over-the-counter market that kept her awake all those years ago.
Still, maybe — just maybe — her old friends say, the people in charge are beginning to realize what they thought all along: “the lady with the handbag was right.”
The Maestro Balks
Born’s baptism as a new agency head in 1996 came in the form of an invitation. Federal Reserve Chairman Alan Greenspan — routinely hailed as a “genius,” the “maestro,” the “Oracle” — wanted her to come over for lunch.
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.”
This made no sense to her. She’d spent much of the 1980s defending clients caught up in a vast conspiracy by two wealthy brothers, Nelson and William Hunt, who duped investors while trying to corner the world silver market.
“After all,” Born said, looking back, “I’m a lawyer, and I think the existence of fraud prohibitions is critically important.” But Greenspan was insistent, she said.
Finally, he said, “Well, Brooksley, I guess you and I will never agree about fraud.” (Greenspan did not respond to requests for comment. Daniel Waldman and Michael Greenberger, both top aides of Born’s, were briefed on the lunch at the time and independently confirmed Born’s recollection of the conversation.)
That was just the beginning. By early 1998, Born had also tangled with Treasury Secretary Robert Rubin, his deputy, Summers, and Securities and Exchange Commission head Arthur Levitt, not to mention members of Congress, financial industry heavyweights and business columnists. She wanted to release a “concept paper” — essentially a set of questions — that explored whether there should be regulation of over-the-counter derivatives. (Derivatives are so-named because they derive their value from something else, such as currency or bond rates.)
They warned that if she did so, the market would implode and predicted tidal waves of lawsuits. On top of that, Rubin told her, she didn’t have legal authority to regulate the derivatives anyway. She wasn’t buying any of it, and she wasn’t backing down…
The CFTC had been created in the 1970s, primarily to regulate futures contracts purchased by farmers to hedge against price fluctuations. But by the time Born took office in 1996, futures were a much more sophisticated game.
Four years earlier, the CFTC had created a giant opening for sharp market players, exempting most privately negotiated over-the-counter derivatives contracts from regulation. Waldman calls the decision “the seed” of the current financial crisis because bad bets on unregulated derivatives crippled large firms such as Bear Stearns and AIG last fall.
In the late 1990s, the seed had sprouted into a $25 trillion derivatives market and Born saw trouble coming. The mostly unregulated “dark markets” had shown signs of danger in the preceding years, such as the bankruptcy of Orange County, Calif., which lost heavily investing in derivatives. Born’s agency set its sights on a highly caffeinated market.
“I was very concerned about the dark nature of these markets,” Born said. “I didn’t think we knew enough about them. I was concerned about the lack of transparency and the lack of any tools for enforcement and the lack of prohibitions against fraud and manipulation.”
Based on her lunch with Greenspan, Born knew she would run into heavy resistance.
“Brooksley’s view was that he didn’t believe in regulation,” Waldman recounted. But Born did, and she was about to demonstrate it.
Deaf Ears
In early 1998, Born’s plan to release her concept paper was turning into a showdown. Financial industry executives howled, streaming into her office to try to talk her out of it. Summers, then the deputy Treasury secretary, mounted a campaign against it, CFTC officials recalled.
“Larry Summers expressed himself several times, very strongly, that this was something we should back down from,” Waldman recalled.
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,” recounted Greenberger, a University of Maryland law school professor who was Born’s director of the Division of Trading and Markets. Summers declined to comment for this article.
The discordant notes crescendoed in April 1998 during a tension-filled meeting of the President’s Working Group, a gathering of top financial regulators that periodically met behind closed doors at the Treasury Department. At that meeting, Greenspan and Rubin forcefully opposed Born’s plans, Waldman said.
“Greenspan was saying we shouldn’t do it,” Waldman recalled. “Rubin was saying we couldn’t do it.”
The next month, Born released her concept paper anyway.
Within weeks, she was under attack. Lauch Faircloth, then a Republican senator from North Carolina, took to the Senate floor to call her “a rogue regulator.” A Boston Herald column accused her of a “power grab. . . . She reached for that brass ring and in doing so cast a pall of legal uncertainty.” Greenspan, Rubin and Levitt jointly urged Congress to pass a moratorium on the CFTC regulating over-the-counter derivatives.
With emotions running high, Born was summoned to the office of House Banking Chairman Jim Leach, a Republican from Iowa, to meet with top officials from the Fed and the Treasury. Born raced to Capitol Hill from the bedside of her daughter, Ariel Landau, then 27, who was about to undergo knee surgery.
“The feelings in the room were very tense,” recalled Leach, who said he felt the CFTC was too small to govern over-the-counter derivatives and wanted derivatives moved to clearinghouses regulated by the Fed or the Treasury. “In my time in public life, I have never seen the executive branch so bifurcated. You had a feeling that the Fed and the Treasury didn’t have a great deal of respect for what the CFTC was made of.” …Last week, with her hair colored and the gray gone, she traveled to Boston to receive the John F. Kennedy Profiles in Courage award. Finally, though perhaps too late, everyone wanted to listen to Brooksley Born. She once again warned about the danger of Dark Markets, now grown to $680 trillion of notional value, according to the Bank for International Settlements — “more than 10 times the amount of the gross national product of all the countries in the world.
“If we fail now to take the remedial steps needed to close the regulatory gap,” Born said, “we will be haunted by our failure for years to come.”
All during her spotlight turn at the John F. Kennedy Library, of course, she clutched a handbag. http://www.washingtonpost.com/wp-dyn/content/article/2009/05/25/AR2009052502108_pf.html
What is Good for Goldman Sachs is Good for America The Origins of the Present Crisis
Author: Brenner, Robert
Publication Date: 10-02-2009
Publication Info: UC Los Angeles, Institute for Social Science Research, Center for Social Theory and Comparative History
Permalink: http://escholarship.org/uc/item/0sg0782h
Robert Brenner outlines the long-term causes of the of the present economic crisis. Rather than understanding the current downturn as merely a function of financial incompetence and miscalculation, he demonstrates that the US economy and that of the G7 has been slower growth in most of the major indices with each passing business cycle since the 1970s. In the last two cycles, asset bubbles inclined US consumers to take on more debt in order to spend and achieve limited GDP growth. Brenner outlines in detail how and why the financial sector played a key role in the creation and inflation of debt bubbles with new financial instruments. The implications for the US and the global economy are also outlined including the US current account deficit, trade
imbalances, the rise of China and the East Asian economies as well as declining investment in the real economy and overcapacity in manufacturing worldwide.
…”What suddenly turned the specter of a severe cyclical downturn or worse into the
reality of catastrophic systemic crisis was a development in the financial sector of which
few were aware, even among insiders—the rise of the “shadow banking system.”.
According to Wall Street mantra, the frenzy in the credit markets actually entailed little
systemic danger, for the great banks upon which the economy depended for credit were
ostensibly securitizing the mortgages that they had originated or purchased and selling
them far and wide, dispersing risk among thousands if not millions of separated investors.
But when the dust cleared in the aftermath of the initial credit crunch of early August
2007, it quickly became evident that the reality was just the opposite. In response to the intensifying competition and falling (risk adjusted) returns that were gripping the
financial sector—and manifesting levels of greed and over-confidence amazing even for
Wall Street–the country’s greatest financial houses had managed to hold on to a
stunningly large portion of the mortgage-backed instruments that they had issued, either
on or off balance sheet, and were, astoundingly, funding these same assets by way of the short-term credit markets.
So when the dizzying fall in housing prices had worked its way through the originate-and-securitize daisy chain, a large number of these institutions found themselves effectively deprived of their capital and without access to credit, de facto in bankruptcy. This would have been poetic justice, except for the fact that, as usual, the leading executives of these corporations managed to insulate themselves personally from the fate of their own corporations, and the horrific losses redounded primarily upon the heavily working class and minority purchasers of subprime
mortgages.
The financial market meltdown undermined banks’ capacity to advance funds to
corporations and households at a time when they had already been radically tightening
their lending standards in the face of the weakening of the economy set off by the
housing bust. In this way, it very much sped up the unfolding of the crisis of
consumption, employment, and profits in the real economy, which, by exacerbating the
fall in the prices of residential real estate and thus of securities backed by residential
mortgages, rendered the crash of the financial sector even more disastrous and less
containable. But, in the end, the cutback in the supply of credit was only part of the
story. The fundamental problem was not so much that corporations and households could not secure the credit that they needed, but that they would not or could not demand it.
Corporations had done hardly any investing or employing and therefore hardly any
borrowing for purposes of expansion throughout the entire business cycle. How could
they be expected to start now, in the face of collapsing demand and plunging profits?
Households had rescued the economy over the previous seven years with their historic
burst of borrowing, consumption, and residential investment. But, confronted by
plummeting home prices and the mountain of debt that they had accumulated, as well as a sinking labor market, how could they be expected to do anything but pull back on
borrowing and spending and, by choice or necessity, to start once again to save?. The
economy faced a self-reinforcing downward spiral of extraordinary ferocity, in which the
signals of the market told private businesses and households alike to pull back as sharply
as possible. Not just the will, but the capacity, of governments to stop the plunge would
be put to the test….
Yet if the sort of manufacturing revival that had taken place between the mid-
1980s and mid 1990s was off the agenda, what then would propel the economy forward?
This, of course, had been the question of the day, since 1995-1997, when the
manufacturing-based US economic recovery had run out of steam following the Reverse
Plaza Accord. Could the ostensible high tech miracle, in which Alan Greenspan had
placed so much faith, finally save the day by promoting a new expansion of capital
investment making for ever high levels of productivity growth and in turn profitability?
The Fed chair unquestionably continued to believe that it could. But things turned out
otherwise. The information-communication-technology producing sector itself–which
had seen its aggregate rate of return plunge by some 23 percentage points and actually go negative between 1997 and 2001–struggled to revive its profitability, and, even by 2006, it had had barely brought it back to half its level of 1997. The sector was, in any case, far
too small to have much effect by itself on the economy-wide rate of profit. As to inciting
a new wave of capital accumulation in the economy beyond the informationcommunication- technology sector, neither the promise of information technology, nor indeed any other factor, could overcome the continuing stagnation of business investment that plagued the economy as a whole for the length of the business cycle. It is true that the performance of that huge sector of the economy that was shielded from the world market and international competition did diverge significantly
from that of manufacturing.
Industries that could take advantage of the high dollar, easy
credit, or the debt-driven consumer spending made possible by the run-up in housing
values once again prospered, as the economy continued to follow the bifurcated path that had its origins in the first half of the 1980s and come into its own during the second half of the1990s. Benefiting from the unprecedented ascent in the demand for homes, the construction industry enjoyed an historic boom that found its origins before 1995. The long standing dependence of retail trade for its own expansion on the growth of domestic manufacturing had been broken by the rocketing currency and rise of East Asia during the second half of the 1990s.
Thanks to the continuing rise of private consumption expenditures, as well as the record breaking increase of imports, especially from China, it continued to do very well in the new millennium. Hotels and restaurants, too, enjoyed ongoing prosperity. These industries were disproportionately responsible for the (all too modest) increase of employment, output, and profits in the real economy throughout the
recovery that began in 2001.
But for the economy to look to them for its growth was plainly problematic, in view of the fact that they were so heavily reliant for their expansion on a housing bubble capable of delivering declining bang for the buck and with a minimal half-life. Like manufacturers, if not to the same extent, firms in the nonmanufacturing sector had experienced a sharp fall in profitability in the last years of the 1990s, and were obliged, in order to restore their rates of return, to hold back on capital accumulation and focus on cutting costs. As a consequence, over the course of the business cycle, the non-manufacturing sector sustained slower growth of GDP, employment, and plant, equipment and software than in any other comparable period since 1945, and this despite the record stimulus. As the housing price run up grew shakier with each passing year, the prospects of this huge sector of the economy for sustaining its expansion grew ever bleaker.
With the economic pie growing so slowly throughout the length of the cycle, nonfinancial businesses, including both manufacturers and non-manufacturers, were thus
compelled to attempt to revive their profit rates to an extraordinary degree by means of
redistributing income from workers to themselves. This they accomplished perhaps as
effectively as at any other time in the history of American capitalism, not simply by
holding wages down, but by imposing a brutal speed up so as to raise measured
productivity growth, if not actual economic efficiency.
In the non-financial corporate sector as a whole, from the last quarter of 2001, when the cyclical expansion began, through the third quarter of 2006, when earnings peaked, profits rose by 83.5 per cent, compensation by just 20.5 per cent. Put another way, out of the total increase in nonfinancial corporate net value added (GDP minus depreciation) that took place in this interval, profits composed an astounding 40 per cent. As a consequence, non-financial corporations were able to increase their profit share by about one-third in that brief period.
Equity Research from the Zombie Bank, Plutonomy was described by Michael Moore’s “Capitalism: A Love Story” with reference to the in-famous, and leaked, internal Citigroup memo of October 2005 (revisited in March 2006).http://jdeanicite.typepad.com/files/6674234-citigroup-oct-16-2005-plutonomy-report-part-1.pdf
Excerpt: Citigroup Memo Equity Strategy
October 16, 2005
SUMMARY
➤ The World is dividing into two blocs – the Plutonomy and the rest. The U.S.,
UK, and Canada are the key Plutonomies – economies powered by the wealthy.
Continental Europe (ex-Italy) and Japan are in the egalitarian bloc.
➤ Equity risk premium embedded in “global imbalances” are unwarranted. In
plutonomies the rich absorb a disproportionate chunk of the economy and have
a massive impact on reported aggregate numbers like savings rates, current
account deficits, consumption levels, etc. This imbalance in inequality
expresses itself in the standard scary “ global imbalances”. We worry less.
➤ There is no “average consumer” in a Plutonomy. Consensus analyses focusing
on the “average” consumer are flawed from the start. The Plutonomy Stock
Basket outperformed MSCI AC World by 6.8% per year since 1985. Does
even better if equities beat housing.
,
