The warning that went unheeded

Former Commodity Futures Trading Commission Chairwoman Brooksley Born.


Kai Ryssdal: Despite its name, the Commodity Futures Trading Commission does more than keep an eye on trades in pork belly futures and winter wheat prices. The CFTC is the federal agency that regulates trading in derivatives. Things like credit default swaps that you'll recognize from the days of the AIG bailout. Those swaps helped drag the whole financial system to the brink of collapse last year.

There's a lot of talk lately about coming up with new regulations for the derivatives market and the CFTC is in the financial news all the time. In the mid and late 1990s, though, most people didn't even know the CFTC existed. They probably didn't know about the warnings its chairman was giving about the dangers of derivatives trading. And they almost certainly didn't know she was ignored.

Tonight Frontline on PBS offers its documentary about that story "The Warning." Frontline's Michael Kirk reports.

MICHAEL KIRK: In 1996, the U.S. economy was on a roll. The stock market was mid-way through its greatest run in history. And in August, President Bill Clinton named a new head of the CFTC -- Brooksley Born.

Her first priority: to look into the booming new market in over-the-counter derivatives.

BROOKSLEY BORN: My staff began to say how big this was and how little information they had about it.

That year, the market in over the counter derivatives was worth roughly $20 trillion and growing at about 20 percent annually. But it wasn't the market's size or the speed of its growth that worried Born.

BORN: There was no transparency. There was no record keeping requirement imposed on participants in the market. We had no information.

Born believed the lack of transparency left the market open to fraud.

Joe Nocera's a reporter with the New York Times. He says fraud came up during Born's first meeting with the Chairman of the Federal Reserve, Alan Greenspan.

JOE NOCERA: He said something to the effect that, "Well, Brooksley, we are never going to agree on fraud. You probably think there should be rules against it." And she said, "Well, yes, I do." He said, "You know, I think the market will figure it out and take care of the fraudsters."

Instead of taking the hint, Born began investigating. She immediately ran up against opposition from the president's Working Group on financial markets. She even got an angry call from Larry Summers, the Deputy Treasury Secretary.

BORN: They were totally opposed to it. That puzzled me. You know, what was it that was in this market that had to be hidden? So, it made me very suspicious and troubled.

Summers, his boss at the Treasury Robert Rubin, and Alan Greenspan were big believers in letting the markets look after themselves.

Mark Brickell is a former derivatives banker at JPMorgan Chase, and an industry lobbyist. He says Greenspan wanted to regulate over-the-counter derivatives as little as possible.

MARK BRICKELL: He had said that he perceived derivatives to be one of the greatest innovations in recent financial history, that the contracts because they helped businesses and banks and governments manage the risks to which they were already exposed more efficiently than they could have done before, were doing something that was useful for the financial system.

Where Greenspan saw benefits, Born saw risks. She prepared a document that laid out her concerns. The president's working group discussed it at an emergency meeting in May 1998.

MICHAEL GREENBERGER: I happened to be sitting behind Brooksley and behind Greenspan.

Michael Greenberger was one of Born's aides at the time.

GREENBERGER: Greenspan turns to her, she turns to him, his face is red, and he's clearly quite upset. He was very adamant that this was a serious, serious mistake, that it would cause untold damages to the financial services market and that she should stop and not do this.

Undeterred, Brooksley Born published her list of concerns. The members of the Working Group struck back. They insisted Congress shut Born down.

Four congressional committees called on her to testify. But they weren't persuaded. Instead, they stripped the CFTC of its powers to regulate the markets. Born quit. Ten years later, she watched, appalled, as the market collapsed.

BORN: It was my worst nightmare coming true. The toxic assets of many of our biggest banks are over-the-counter derivatives and caused the economic downturn that made us lose our savings, lose our jobs, lose our homes. It was very frightening.

Despite the financial crisis, the market in over-the-counter derivatives is now more than $450 trillion in size. The House Financial Services Committee approved new rules for the market last week. But many people say the rules aren't enough to protect the economy.

In Boston, I'm Michael Kirk for Marketplace.

RYSSDAL: "The Warning," which tells the story of Brooksley Born's clash with Alan Greenspan airs tonight on PBS stations.

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Its obvious why there is no transparancy--there's nothing there to show! Its a con game, a bait and switch, and it relies on confusion on the part of the buyer--just like selling "sub prime" loans, rather than calling them by name--loans least likely to be paid back.

If people were told what a derivative really was, they'd never invest in this sucker's bet. Bets made with money that only exists in the minds of the seller. As AIG found out, selling insurance on the IDEA you might get paid money needed to back up defaults, and that there may never be enough defaults to need the money that doesn't really exist except on a trumped-up financial statement, works well in the beginning when people are paying the dues...then it falls apart when defaults start catching up to the scheme.

those who want to believe in the proven myth of Free Market, keep trying to sell this pipe dream that everyone can make money, without worrying where all this illusionary money will really come from. But one day, you can't buy on credit for the future anymore, and need to come up with the cash to pay for the credit you got in the past, on the idea you'd finally have the money by today.


---- excerpt follows ----

“Don’t get me wrong: the guys from the lower third of the class who went to Wall Street had a lot of nice qualities. Most of them were pleasant enough. They made a good impression. And now we realize that by the standards that came later, they weren’t really greedy. They just wanted a nice house in Greenwich and maybe a sailboat. A lot of them were from families that had always been on Wall Street, so they were accustomed to nice houses in Greenwich. They didn’t feel the need to leverage the entire business so they could make the sort of money that easily supports the second oceangoing yacht.”

“So what happened?”

“I told you what happened. Smart guys started going to Wall Street.” ...
“But you still haven’t told me how that brought on the financial crisis.”

“Did you ever hear the word ‘derivatives’?” he said. “Do you think our guys could have invented, say, credit default swaps? Give me a break! They couldn’t have done the math.”

“Why do I get the feeling that there’s one more step in this scenario?” I said.

“Because there is,” he said. “When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness.”

“So having smart guys there almost caused Wall Street to collapse.”...

Since we have many of the same 'foxes'retoring our economic henhouse on Wall Street and serving as govermnment advisors, we can be sure of more exotic gambling with the tax-payers' money. JS

Great expose! Greenspan is an actor though.... I do not believe that HE believes he was in any way wrong... The size of the ego's on display was appalling. & Leahy should resign! Thieving weezils all of them. & the pols are just plain stupid! We need a French styled revolution here... that would get their (US GOVT + WALL ST) attention...

Jake - if you're depressed reading history now, read "Atlas Shrugged." You'll be even more depressed about the future. @ ed p - you and Alan Greenspan got it right - we'd have lots of smaller, more stable banks. The market would have taken care of the problems and we'd be short about five or six big banks that were deemed Too Big To Fail. And finally, the CFTC regulator was right - we do need more transparency. I do not deem that 'more regulation.'

Dear Sir
Kai Ryssdal, is to be praised for the fine reporting on, The warning that was unheeded, this kind of reporting is a start in restoring my faith in the media.

I'll be watching.

Ron Stanley

Larry Summers was wrong then disagreeing with Brooksley Born and he is wrong now fighting Elizabeth Warren the TARP cop.
Both of these women fight for the US Taxpayer and Summers fights for Wall Street ...
the other thing to note is that the player back during the LTCM meltdown are the same players that President Obama has as his economic advisers ...
Just like back then ... the executive branch under Clinton had an opportunity to act against Wall Street and stand with the people and instead sided with the gangster bankers ... Obama at the start of his term had the same opportunity and sided with the banksters ... we had a shot a change and Obama supported the status quoa ..
And those of you that think that if he had not the system as we knew it would have ended ... yep you are correct and that would have been a good thing as small banks and the tax payers would ahve benefited not Wall Street ...change does not come by hiring the same folks that caused the problem ..and as history has shown in this Frontline piece ... Obama and his financial advisers are not change and do not act in the interest of the people but in the interest of Wall Street ...
Privatize profit ... socialize loss ...
same as it ever was ...
Revolution calling..

Maybe some (greedy) people will stop beating the anti-regulation drum once in a while so that they can hear the market-forces train coming at them head-on in the dark tunnel of a non-regulated environment.

My profesor at a universtiy loved Alan Greenspan. Econ.Class back in 04

It seems that the smartest guys in the room are not always guys. This story reminds me of another sad event in our recent history: Events leading up to 9/11 included a lowly female FBI agent, whose name I don't recall, who urged her superiors to focus attention on the future hijackers, but to no avail.


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