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How the Clinton Team Thwarted Effort to
Regulate Derivatives
[And effected the biggest “ripoff” in
USA economic history].
In April 1998, a
decade before a historic crisis wreaked havoc on global financial markets, an
obscure regulator saw a potential gap in the government’s oversight of Wall
Street and tried to do something about it.
Now, newly released
records show just how ardently some of the Clinton administration’s most
prominent figures shot her down. The documents add to the story of how
President Bill Clinton’s team took a stance, on derivatives and other issues,
that shielded Wall Street from more aggressive oversight in the years leading
up to the 2008 financial crisis.
At the time, Brooksley Born was head of the Commodity Futures
Trading Commission (CFTC), a small agency responsible for overseeing
lesser-known corners of the markets. At the April meeting, she asked other
regulatory leaders if the government was doing enough to monitor trading in
over-the-counter (OTC) derivatives—a type of financial tool, often used to
hedge risk and place speculative bets, that would later feature prominently in
the 2008 crisis.
Born’s question was
not well received.
Treasury Secretary
Robert Rubin, who had spent most of his career at Goldman Sachs and joined Citigroup
shortly after his stint in government, said the “financial community” was
“petrified” by the notion that OTC derivatives previously exempt from CFTC
regulation would now fall under the agency’s purview, according to newly
released notes from the April meeting.
The possibility of
CFTC oversight would create “uncertainty over trillions of dollars of
transactions,” Rubin warned, adding that if Born tried to solicit the public’s
input on potential derivatives regulation, “Treasury will put out [a] statement
that CFTC has no jurisdiction,” according to the notes.
The Project On
Government Oversight found the handwritten notes, taken during a meeting of
President Bill Clinton’s Financial Markets Working Group, in a trove of
documents posted this month by the Clinton Presidential Library. The notes were
contained in files of the Clinton White House’s Council of Economic Advisers,
according to the library’s release, but it’s unclear who took the notes or if
the notes reflect the exact words spoken by the meeting participants.
Born thought that
“Rubin [was] asking CFTC not to uphold the law,” the meeting notes say. Rubin
claimed he didn’t “disagree w/ substance of CFTC’s actions” but thought there
was a “better way to proceed,” the notes say.
His views were echoed
by Larry Summers, then a deputy Treasury secretary, who likewise wondered if
there was a “better way to proceed” given that regulators and the financial
industry viewed the CFTC’s posture “as being disastrous for markets.”
Arthur Levitt, then
the head of the Securities and Exchange Commission, said it would be
“problematic” for the CFTC to publicly discuss changes to the regulation of OTC
derivatives without the support of other agencies.
And Alan Greenspan,
then the Chairman of the Federal Reserve, warned that increased regulation
could “suppress OTC derivatives business.” Once regulators began tinkering with
the rules, he said, they wouldn’t be able to “put [the] cork back in [the]
bottle,” the notes say.
Greenspan was also
concerned that derivatives trading would move overseas. “Worry, then, that OTC
derivatives market could flee to London (or Europe) if this isn’t handled
well,” the notes say. “That would be a failure on CFTC’s part.”
The notes also
attribute this assessment to Greenspan: “There are contradictions in the CEA
[Commodity Exchange Act] – but that shouldn’t induce us to do things that will
undercut the system that we are beholden to serve…”
Born’s clash with
other Clinton officials has been widely covered, including in reports by
Frontline, the Washington Post and the New York Times. The newly released
documents add to the historical record, offering a fly-on-the-wall account of a
pivotal meeting on derivatives and taking the public inside Clinton
administration discussions from that period.
Shortly after the
April 1998 meeting, the derivatives dispute boiled over.
On May 7, 1998, the
CFTC issued a concept release—a sort of regulatory trial balloon—raising a
series of broad questions about the regulation of OTC derivatives. That same
day, Rubin, Greenspan, and Levitt issued a joint statement saying they had “grave concerns” about the
concept release “and its possible consequences.” They questioned the “CFTC’s
jurisdiction in this area” and said they were worried about “reports that the
CFTC’s action may increase the legal uncertainty.”
Behind the scenes, Clinton officials lobbied to keep the CFTC on the
sidelines of derivatives oversight, according to other records newly released
by the Clinton Library.
In a June 1998 email,
a program analyst in the White House’s Office of Management Budget wrote that
“Treasury, the FED, and the SEC all object to the CFTC’s concept release, and
have drafted legislation that would prohibit the CFTC from any rulemaking until
after FY 2000, while the President’s Working Group on Financial Markets studies
the issue.” He added that “Treasury Secretary Rubin has talked with Gene
Sperling”—director of the National Economic Council under Presidents Clinton
and Obama—“concerning the legislative proposal.”
In an email commenting
on testimony Treasury had prepared about the CFTC, Sarah Rosen, then a senior
advisor on Clinton’s National Economic Council, identified weak spots in
Treasury’s argument.
“Without better
justification, sounds like Treasury wants to protect the traders from
regulation,” she wrote.
In addition, she
expressed concern about ongoing risks in the derivatives markets. “God forbid a
major pension plan loses [sic] its shirt in OTC derivatives while we are
performing this study and workers are at risk of losing [sic] retirement
benefits,” she wrote. “Wouldn’t we be better off if we had at least
acknowledged the concerns now.”
“Treasury makes only
the most cursory nod at the concerns in the OTC derivatives markets,” she
added. “Even Greenspan noted recently that these transactions have never been
tested in a down market.”
Rosen also took aim
at the concern that a CFTC regulatory concept release could be so harmful. “By
this argument, we could never discuss possible regulation of any market because
it might chill the market in anticipation of what the regulator ‘might’ do,”
she wrote.
Rosen, now president
of the Urban Institute, did not respond to POGO’s request for comment.
In September 1998,
Long-Term Capital Management, a large and opaque hedge fund that made highly
leveraged bets using OTC derivatives and other tools, found itself on the brink
of collapse. It was saved only when the Federal Reserve orchestrated a $3.6
billion private-sector bailout of the firm.
Rather than taking
the opportunity to tighten the rules for derivatives trading, Congress and the
President enacted an appropriations bill in October 1998 that included a
six-month moratorium prohibiting the CFTC from taking any action. Congress
explained in an accompanying report that it wanted to give the Financial
Markets Working Group more time to study derivatives and hedge funds.
The following year,
the Working Group issued a report on the Long-Term Capital Management episode.
The report offered a few modest reforms but stopped short of calling for
increased oversight of derivatives or direct regulation of hedge funds.
As the report was
being drafted, Douglas Elmendorf—who was serving on the Council of Economic
Advisers and is now the head of the Congressional Budget Office—recommended
wording it in a way that avoided opening the administration’s regulatory record
to criticism, according to a memo released by the Clinton Library.
“As I suggested
before, I think it’s useful to emphasize the idea that financial-market
innovation has made the existing disclosure rules and regulatory approaches inadequate,”
he wrote. “I’m not sure how much of the story this really is, but it’s a
convenient argument because it absolves us of regulating badly in the past and
neatly justifies the range of actions we’re now proposing.”
Elmendorf declined
POGO’s request for comment.
Born left the
government in June 1999. In November of that year, the Financial Markets
Working Group—with Summers, Greenspan, and Levitt serving as members—issued a
highly anticipated report on OTC derivatives.
The report concluded
that, “under many circumstances, the trading of financial derivatives…should be
excluded” from the CFTC’s oversight. “To do otherwise would perpetuate legal
uncertainty or impose unnecessary regulatory burdens and constraints upon the
development of these markets in the United States,” the report said.
The following year, Congress passed and President Clinton signed the
Commodity Futures Modernization Act, which “effectively shielded OTC
derivatives from virtually all regulation or oversight” and marked a “key
turning point in the march toward the financial crisis,” according to a 2011 report
by the Financial Crisis Inquiry Commission. (Born served as a Commission
member.)
The OTC derivatives
market expanded greatly after the bill was enacted, as detailed in the
Financial Crisis Inquiry Commission report. “At year-end 2000, when the
[Commodity Futures Modernization Act] was passed, the notional amount of OTC
derivatives outstanding globally was $95.2 trillion,” the report said. “In the
seven and a half years from then until June 2008, when the market peaked,
outstanding OTC derivatives increased more than sevenfold to a notional amount
of $672.6 trillion.”
At the height of the
financial crisis, the government approved of a maximum taxpayer bailout of
insurance giant AIG, which had a $79 billion derivatives exposure to
mortgage-related financial products that were tanking in value.
In the wake of the
crisis, President Clinton and his economic team—some of whom had been featured
as “The Committee to Save the World” in an infamous 1999 Time magazine cover
story—were often asked to explain the positions they took on derivatives
regulation in the 1990s.
Rubin told the
Financial Crisis Inquiry Commission he was “‘not opposed to the regulation of
derivatives’” but explained that “‘very strongly held views in the financial
services industry in opposition to regulation’ were insurmountable” during his
tenure as Treasury secretary.
Summers told the
commission that “while risks could not necessarily have been foreseen years
ago, ‘by 2008 our regulatory framework with respect to derivatives was
manifestly inadequate.’”
Clinton told ABC News in
2010 he shouldn’t have listened to officials who advised him against taking a
tougher stance on derivatives. “On derivatives, yeah I think they were wrong
and I think I was wrong to take [their advice],” he said. “[S]ometimes people with
a lot of money make stupid decisions and make it without transparency.”
Born told Frontline
she expected pushback from industry players when the CFTC issued its 1998
concept release, but said she was surprised to encounter resistance from her
follow regulators. “I had hoped that they would work with us to learn more
about the [derivatives] market, decide whether there was an appropriate
regulatory regime for it,” she said.
When asked why other
regulators resisted the CFTC’s action, Born had a few ideas. “[S]ome of the
people involved really were purists in terms of belief in free markets and were
absolutely, from a doctrinal point of view, opposed to regulation,” she told Frontline.
“I think others were concerned with keeping the big banks and the investment
banks happy and making sure that they were responsive to the demands of those
entities.”
Other records released
by the Clinton Library this month show how officials lobbied to undo the
Glass-Steagall Act, a Depression-era law that separated commercial banking,
which is protected by a government safety net, from investment banking and
insurance underwriting. The idea was to limit banks’ ability to put federally
insured deposits at risk.
Those records were
first highlighted in a story by the Guardian.
In a 1995 memo,
Clinton’s then-deputy assistant for economic policy, Bo Cutter, told the
President that Rubin was scheduled to testify on a proposed Glass-Steagall
repeal, and it was “therefore necessary to have an agreed-upon Administration
position” within a matter of days. Cutter did not respond to POGO’s request for
comment.
Two years later,
Rubin and other officials tried again to push through a repeal of
Glass-Steagall. In a 1997 memo to the President, Rubin explained that advancing
the proposal “would be a Treasury initiative, and would not require a
significant time commitment from the White House.”
As described in the
Financial Crisis Inquiry Commission report, “Citicorp forced the issue” the
following year “by seeking a merger with the insurance giant Travelers to form
Citigroup.” Congress soon passed and President Clinton enacted a Glass-Steagall
repeal that “adopted many of the measures Treasury had previously advocated.”
(According to The
New York Times, Citigroup’s then-CEO Sandy Weill installed in his office a
“hunk of wood – at least 4 feet wide – etched with his portrait and the words
‘The Shatterer of Glass-Steagall.’” He later changed his tune, telling CNBC in
2012: “What we should probably do is go and split up investment banking from
banking, have banks be deposit takers, have banks make commercial loans and
real estate loans, have banks do something that’s not going to risk the
taxpayer dollars, that’s not too big to fail.” )
Rubin joined
Citigroup after stepping down as Treasury Secretary, going to work for a firm
that benefited directly from the Glass-Steagall repeal.
While serving as
chairman of the Executive Committee on Citigroup’s board, Rubin “recommended
that Citigroup increase its risk taking,” according to the FCIC report.
“Citigroup’s investment bank subsidiary was a natural area for growth after the
Fed and then Congress had done away with restrictions on activities that could
be pursued by investment banks affiliated with commercial banks,” the report
said.
By the middle of the
2000s, “Citigroup was a market leader in selling CDOs”—a product that was at
the heart of the 2008 financial crisis—“often using its depositor-based
commercial bank to provide liquidity support.”
After the crisis
struck, taxpayers bailed out Citygroup to the tune of $45 billion, and the
government promised to limit Citi’s losses on a $300 billion pool of toxic
assets. The bank has since paid back the bailout money at a financial profit to
taxpayers.
Rubin stayed with
Citigroup until January 2009, and was paid more than $115 million for his work
at the bank, the Financial Crisis Inquiry Commission reported.
By: Michael Smallberg
Investigator, POGO
Investigator, POGO
At the time of
publication Michael Smallberg was an investigator for the Project On Government
Oversight.
