Brooksley Born and Alan Greenspan

by Jon Mandle on October 9, 2008

The Times tells the story of the failed efforts of one Brooksley E. Born, the chair of the Commodities Futures Trading Association in 1997, to attempt to impose greater regulation on derivatives. “She called for greater disclosure of trades and reserves to cushion against losses.” She was fiercely opposed in this by Alan Greenspan and Robert Rubin. [ed:spelling corrected]

Rubin now says that “he favored regulating derivatives — particularly increasing potential loss reserves — but that he saw no way of doing so while he was running the Treasury. ‘All of the forces in the system were arrayed against it,’ he said. ‘The industry certainly didn’t want any increase in these requirements. There was no potential for mobilizing public opinion.’” This is somewhat less than credible. Larry Summers, Rubin’s deputy, called Born and “chastised her for taking steps he said would lead to a financial crisis.” And “On June 5, 1998, Mr. Greenspan, Mr. Rubin and Mr. Levitt called on Congress to prevent Ms. Born from acting until more senior regulators developed their own recommendations.” A year later, “they recommended that Congress permanently strip the C.F.T.C. of regulatory authority over derivatives.” This sure doesn’t sound like someone who was pressing against public opinion in an effort to institute greater oversight.

But Greenspan is the more interesting case. In a speech at Georgetown Law School on October 2, against a background of boilerplate about the wonders of the free market, he argued [pdf]:

Another important requirement for the proper functioning of market competition is also not often, if ever, covered in lists of factors contributing to economic growth and standards of living: trust in the word of others… In a market system based on trust, reputation has a significant economic value. I am therefore distressed at how far we have let concerns for reputation slip in recent years… During the past year, lack of trust in the validity of accounting records of banks and other financial institutions in the context of inadequate capital led to a massive hesitancy in lending to them. The result has been a freezing up of credit.

Okay, so he thinks that Born’s proposal (or something like it) a decade ago – “greater disclosure of trades and reserves” – would have prevented the erosion of trust, right? Not exactly. The Times quotes Greenspan thusly: “Governments and central banks could not have altered the course of the boom.” Or, presumably, the bust.

G.A. Cohen – critical of Rawls’s institutional focus – is sometimes accused of being exclusively concerned with the ethos of a society and individual behavior, rather than the background institutional structure within which individuals act. In his new book, he denies this – both are important for justice, he says. Unlike Cohen, Greenspan really does seem to be blaming the market participants rather than the regulatory regime – market players should have been more concerned about their reputations. As the Times article summarizes his view, traders “got greedy” and sacrificed their “integrity.” I’m pretty sure Greenspan, the Ayn Rand acolyte, wouldn’t quite put it this way, but still, he holds that no institutional changes could have altered the outcome.

At the same time, of course, he holds that now there’s plenty for the government to do in cleaning up the mess that irresponsible individuals have produced: “the federal government must take aggressive steps to protect workers and businesses from the harmful effects of a financial crisis. The great majority of those deserving this protection had no role in causing the crisis.” Hmm. I thought market transactions weren’t supposed to harm innocent third parties. But when they do, self-professed libertarians “urgently advocate immediate, extensive action that would … prevent a serious economic contraction.” But not, apparently, greater disclosure on market transactions.



ramster 10.09.08 at 6:40 pm

not to be pedantic but it’s Robert Rubin (with an “i”)


Jon Mandle 10.09.08 at 6:47 pm

Thanks, ramster – changed.


ramster 10.09.08 at 6:51 pm

The most amazing part of all this is Greenspan’s apparent unwavering certainty that he did nothing wrong. There’s a pretty good argument to be made that he is single-handedly responsible for the whole damn fiasco. He was certainly abetted by people who were either blatantly acting for the interests of Wall Street (e.g. Rubin, The Secretary of Goldman Sachs) or just caught up in the aura of the brilliant Chairman (e.g. Congress, Clinton, etc.). I imagine that Brooksley Born feels pretty vindicated right now.


Henry 10.09.08 at 6:52 pm

Bill Clinton mentioned Brooksley Born and her efforts in the blogger meeting that I wrote up. He regretted, as I recall, that he hadn’t done more to help her. He also tried to push the ‘Rubin wanted to do this but we didn’t have the political capital’ line – he had been talking to Rubin about this the week before the meeting. Take all this as you will.


HH 10.09.08 at 8:39 pm

Greenspan and Ayn Rand were just as stupid about the moral heroism of the entrepreneurial elite as Marx was about the moral heroism of the proletariat. People of all ranks and stations are remarkably corruptible, and it is the business of government to counteract this tendency.

Computer and communications technology vastly magnified the consequences of corruption on Wall Street. Greenspan was blind to the magnitude of this threat because he was a prisoner of Rand’s ideology of a capitalist aristocracy. Ideologies are especially destructive simplifications of reality because they are held and propagated with religious fervor. Let us hope that this spectacular collapse of kleptocratic Capitalism puts an end to Ayn Rand’s reign of error.


John Emerson 10.09.08 at 9:16 pm

“Dow 36,000” Glassman is an Undersecretary of State. “Dow 36,000” Hassett is big in the McCain campaign. People like Dick Morris, Jonah Goldberg, and William Kristol are important media figures. Greenspan can now join that immortal group. He won’t lose a thing. Once you’re on the bus, you never have to leave.


Roy Belmont 10.09.08 at 11:26 pm

“…as stupid about the moral heroism of the entrepreneurial elite as Marx was about the moral heroism of the proletariat…”

I don’t have any stats to back it up, but my sense is both of these demographics evolve very swiftly. Moral heroism can be bred for, or bred out.
What was the proletariat in Marx’s time no longer exists anywhere, and whatever “entrepreneurial elite” is meant to signify will be very differently composed very soon. So that talking about them as fixed quantities with any confidence is specious.


Martin James 10.10.08 at 12:24 am

I remember Greenspan specifically stating that more disclosure of derivatives would reduce the value of proprietary trading models in other words it would cut the profits of traders.

I don’t care too much for regulation but I’m enough of a populist to think that if you can only make money if people don’t know how you’re making it, it’s a problem.


david 10.10.08 at 2:26 am

But Delong says Rubin is an A+ guy…

This sort of story needs a megaphone, as we get Clinton and his ites advising an Obama administration. They were not for regulating derivatives, and the fact that they’re saying they were is not particularly helpful.

If only we had known about Rwanda, goes the cry.


Dan Simon 10.10.08 at 3:10 am

I don’t understand this argument. Was the problem ten years ago that the bogus-dotcom market was insufficiently regulated? Is there any evidence that it was something about the derivatives themselves–some toxic ingredient in their manufacture, perhaps–as opposed to the recklessness of the institutions that bought into them (in both senses), that caused all the trouble?

In fact, somebody who usually gets a lot of respect around here has already explained that he’d figured out the problem six years ago: for the past twenty years, every time reckless investors found themselves out of pocket enough to risk slowing the economy even a teeny, tiny bit, Alan Greenspan rode to their rescue by slashing interest rates low enough to get (almost) everybody back on their feet again. Under these circumstances, of course a bunch of dubious paper that promised huge profits was a reasonable risk for investors, and of course the entire financial industry would show no restraint in buying into it. After all, the greater the bet, the more likely the “Greenspan put” would be employed to clean up the mess afterwards, with all but the worst offenders emerging with their enormous profits only moderately dented by the crash.

In fact, as I’ve argued elsewhere, the problem may be that any macroeconomic tool for mitigating economic downturns, be it Keynsianism, monetarism, or whatever they come up with next, is doomed to fall prey to this kind of betting on expectations that the tool will be used. If so, then the basic premise of both left- and right-wing economics–that economic downturns can be mitigated using “our” policies–is mistaken, and the best solution may be simply to let the brushfires burn, so to speak, to avoid the really catastrophic conflagrations that occur when it’s been too long between them.


MQ 10.10.08 at 3:28 am

Couple of points —

* profit motivation in the market is and must be directly opposed to concern for virtue, honor, etc. Reputation itself is just supposed to be a longer-term profit concern in market models. A unilateral emphasis on profit is corrosive to other motivations, and economists have touted this as a beneficial feature of the system. The entire idea of the market as a self-regulating invisible hand is *completely* based on a concern for profit maximization *alone*.

* Rubin is not a Clintonite. If you believe that, you don’t understand how the Democratic elites work. It would be more accurate to say instead that Clinton is a Rubin-ite. So are most of the other establishment figures in the party. Obama has so far given every sign of being a cautious, establishment-oriented Rubin-ite himself. We’ll see if that changes. Rubin himself will change, I think — he’s been shaped by Wall Street, but he’s not intellectually as ideological as Greenspan.

*Dan Simon makes some really interesting points.


HH 10.10.08 at 4:06 am

The unique aspect of the present disaster is that blame has been so smoothly dispersed that a blanket amnesty has effectively been declared. It now appears that nobody will be punished under the law for the largest outbreak of financial malfeasance since the Great Depression.


Righteous Bubba 10.10.08 at 4:22 am

Was the problem ten years ago that the bogus-dotcom market was insufficiently regulated?

As I am an ignoramus, let me wonder if there should be a distinction made here between reckless decisions on the part of investors, which are natural and unavoidable, and the reckless design of financial instruments which could be made less risky.

In other words, there will always be sucker bets, but the amount of leverage on any bets, sucker or not, can be restrained and inevitable collapses based on bad bets might be less disastrous.


Abi 10.10.08 at 7:17 am

Jeffrey Frankel: “They say there are no atheists in foxholes. Perhaps, then, there are also no libertarians in financial crises.” [link]


virgil xenophon 10.10.08 at 7:27 pm

Righteous Bubba,

I don’t think the people who designed/formulated the instruments themselves were
necessairly reckless (as opposed to those who recklessly used those instruments in a devil take-the-hind-most fashion to book immediate profits) as they were imbued with excessive hubris in thinking they had mastered the art of financial statistics. My memory of what little was written in financial publications in recent years about these bundling techniques is that it was thought that financial nirvana had been achieved in that these instruments allowed new ways of liquifying fixed assets while at the same time spreading the risk and thus achieving stability as well as liquidity (and profits) through leveraging. In the event all they had really done was spread infection throughout the financial system. As the British are wont to say, they were “Too clever by half.”

All of this reminds me of the period in the thirties prior to WWII when aircraft designers were trying to wring out the last bit of speed from fighter aircraft, so developed the twin engine design which added some 30-40 mph to airspeed. What was not taken into account was the fact that, due to the state of the art of engine design, engines were both unreliable and insufficiently powered such that if one engine conked out, the aircraft could fly on one engine alone. Thus for an incremental increase in airspeed, they had doubled the risk factor of a fatal accident as they had
now twice as many moving parts subject to failure. Worse still, an aircraft with a single, “center-line” engine was at least aerodynamically controllable for an attempt at a gliding, “dead-stick” landing; whereas a twin engined aircraft with one engine out produces “asymmetrical thrust” and is virtually un-flyable. Adding to further woes, if the pilot feathered the remaining engine in time to provide stable gliding conditions, the weight of two dead engines meant that the aircraft had the gliding characteristics of a brick. Sort of reminds one of the financial system of today, doesn’t it?


MarkUp 10.10.08 at 8:08 pm

“I don’t think the people who designed/formulated the instruments themselves were
necessairly reckless…”

In some sort of crude sense, which no vulgarity, no humor, no overstatement can quite extinguish, the physicists have known sin; and this is a knowledge which they cannot lose.
~J. Robert Oppenheimer


John 10.10.08 at 9:06 pm

Derivatives are an instrument. Powered by computer technology, they can be destructive like H-bombs as someone put it. However destructive, they are neutral like all weapons. Human beings, unfortunately, are not totally above greed and lust. Enron is a case in point. Therefore, trust alone is not enough to fight the temptation of huge profits to be expected from the use of the sophisticated instrument when the integrity of the executive is below the level of the average banker in Greenspan’s mind. Leaders in the Fed and Treasury should have taken precautionary measure to guard against catastrophic explosion. Hope that the current team can be thoroughly reshuffled when the new administration comes in.


John 10.10.08 at 9:09 pm

(with minor revision on the previous one) Derivatives are an instrument. Powered by computer technology, they can be destructive like H-bombs as someone put it. However destructive, they are neutral like all weapons. Human beings, unfortunately, are not totally above greed and lust. Enron is a case in point. Therefore, trust alone is not enough to fight the temptation of huge profits to be expected from the use of the sophisticated instrument when the integrity of an executive is below the level of the average banker envisioned in Greenspan’s mind. Leaders in the Fed and Treasury should have taken precautionary measure to guard against catastrophic explosion. Hope that the current team can be thoroughly reshuffled when the new administration comes in.


Janus Daniels 10.11.08 at 10:25 pm

Many have condemned Greenspan as a slave to ideologies (capitalist, libertarian, objectivist, whatever).
His policies, over a period of decades, consistently rewarded him and his friends and associates with more power and more money.
Granted, this ongoing collapse has troubled even them, but Greenspan had no discernible foresight of that.
Can anyone cite any case of Greenspan making a decision that cost himself and his friends and associates power or money?
Calling Greenspan a slave to ideology gives him too much credit.


b-psycho 10.13.08 at 2:35 am

People of all ranks and stations are remarkably corruptible, and it is the business of government to counteract this tendency.

…and you counteract the remarkable corruptibility of government officials by ______?


nadezhda 10.13.08 at 2:56 am

Some history for context to better evaluate the claims and counterclaims re Rubin and the Clinton administration.

First, just so we’re all talking about the same things here, Clinton et al are talking about the failure to set up a regulatory scheme for financial derivatives. Asset-backed (including mortage-backed) securities like the ones Paulson wants to buy aren’t derivatives — they’re securities, subject to the various regulations on the issuance of and markets in securities (the SEC is the regulator). ABS are interests in the bundle of assets which back them. They can be further enhanced with mortgage or bond insurance. But for all their exotic structures, they’re securities and regulated as such.

Derivatives, by contrast, aren’t interests in assets. They are contracts that derive their value from something else — frex interest rate or exchange rate, the value of an index, or an event such as a credit default. The most toxic of all the financial instruments in the current crisis turn out to be not asset-backed securities (though they are indeed uncertainty involved in valuing them in a declining asset market) but the credit default swaps. Good old fashioned futures and options for pork bellies are derivatives. The Commodities Futures Trading Corp (CFTC) regulates derivatives in the commodities markets.

What was new in the 90s is that derivatives were increasingly being invented for financial markets, where the value of the asset or the event which would trigger a payment related to purely financial assets or events. Just as commodities futures and options are attractive risk management tools for the real economy, financial derivatives started out as attractive new ways to better manage risk by corporate treasuries or financial institutions.

The discussions during the Clinton administration about regulating these new things wandered confusingly over a range of topics. Were these contracts more like securities (SEC reg jurisdiction over the financial markets which were creating, buying and trading these instruments ) or like futures and options (CFTC reg jurisdication over futures and options). What were the real regulatory concerns? Bad issuers? No, no one would buy a contract that was written by a fly-by-night operation. Deceptive practices for consumers? No, this was the big boys who don’t need consumer protections since they could evaluate the terms of the contracts and assess the sellers or traders. Manipulation of the markets in financial derivatives? These were OTC among counterparties who dealt with each other regularly and extensively with, at the time, little secondary trading.

What exactly needed to be regulated? Who needed to be protected from what? At the early stages of the explosion of financial derivatives, it wasn’t at all clear what benefits regulation would bring — what should be the rules and for what instruments, who should the rules be applied to, and who should be the rule-maker and rule-enforcer.

Now enters Brooksley Born, who turned out to be a very poor ambassador for her agency’s attempt to claim regulatory jurisdication over this new and promising business. The CFTC regulated the futures and options markets where commodity derivatives were traded, and financial derivatives were being added to these markets, so for exchange-traded derivatives, the CFTC was the “natural” regulator. But the “natural” regulators of the main players — the financial institutions who were getting into this business — were the banking regulators (and the Fed) and the securities regulators. The CFTC knew wheat and porkbellies, but did it know interest rates and credit events? The CFTC didn’t have a close regulatory relationship with these institutions, who had no desire to see another agency to which they would have to report and who could examine them. We already had a huge overlapping jurisdication problem, and the CFTC would just add to the expense and confusion on both the government and industry sides.

Ms Born had some severe delusions-of-grandeur problems. I can testify personally that in public international forums she behaved as if the Chairman of the CFTC were the most important financial regulator in the world. And she was a remarkably poor communicator of her ideas. So both within the Clinton administration and in Congress, her calls for the CFTC to create and take over new regulatory duties was viewed by many as a clumsy power-grab. And any new regulation was violently opposed by two key figures — Phil Gramm and Alan Greespan — with whom the Clinton admin had to be able to work to get things done. And that, I’d be willing to bet a goodly sum, is the main reason Summers called Brooksley and read the riot act to her. She wasn’t doing her or the administration’s cause any good.

In retrospect, there are certainly aspects of financial derivatives issuance and markets that could do with some government oversight. For example, these gigantic OTC markets should have been brought into a clearing system, with central collateral controls and netting, much earlier though the process seems to be finally underway. Lehman and then AIG uncovered just how much systemic exposure was built into the huge amount of intertwining outstanding contingent liabilities. And the regulators of the financial institutions that sold and bought these instruments — the banking regulators, securities regulators, insurance regulators — should have been crawling all over these exposures that were increasing risk (at both the institutional and system levels) rather than, as advertised by Greenspan, making risk magically disappear.

But the sorts of regulations that Brooksley Born was pushing in the 90s weren’t all that relevant to where and why the derivatives became instruments of mass destruction. So Clinton’s mild regret, and Rubin’s “would have like to have done something but it wasn’t a priority that the Clinton admin could have pushed” is a pretty plausible tale, consistent with both the market at that time and with the political circumstances.

The whole derivatives story should clarify a couple of things about the artificiality of debates over regulation versus deregulation. First, the US regulatory structure is a complete mess of overlapping regulatory jurisdictions, even after it was somewhat rationalized with the overturning of Glass-Stegal (which needed to go since it no longer provided protection because disintermediation had moved so much activity from institutions to the capital markets). It has huge gaps — not just derivatives but hedge funds and non-bank financial institutions that find regulatory lacunae to thrive in. The international dimension is increasingly important but we don’t have regulatory structures adequate to deal with the incredible cross-border contagion we’ve witnessed over the past week or so. And it’s made much worse because of the state level — 50 state commissions of banking, securities, insurance, each with their own rules, examiners, etc. True, the states can offer some modest consumer protections when the federal system is insufficient or deliberately looking the other way, as under the Bush admin. But the costs of having so many different agencies responsible for bits and pieces leaves the overall health of the system at severe risk. As we are learning to our peril.

The second thing the story shows is that it’s not a matter of regulating more but regulating the right things. The most visible stuff isn’t necessarily what needs regulating. The impulse to bring financial derivatives within the US regulatory structure in the 90s probably wouldn’t have addressed the reasons why derivatives eventually blew up the system. The behavior of the SEC during the past 8 years, especially with exempting the big investment banks from the net capital requirement, shows that what matters is that the regulators are worrying about the right things.

And here, ideology does indeed make a difference. There’s no question in my mind that Rubin and Summers were far more in tune with legitimate regulatory concerns about the pros and cons of financial innovation than the folks who have been responsible for minding the store the past eight years (especially given Greenspan’s love-affair with financial innovation).

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