Gents Without Cents; or, How Moe, Larry, Curly, and Shemp Upheld The Market
Picture Larry Summers trying to keep Phil Gramm from poking his eyes out. The Washington Post tells the story of the bipartisan quartet who thwarted attempts by Commodities Futures Trading Commission Chairman Chairperson Brooksley Born (pictured) to regulate derivatives: Alan Greenspan, Robert Rubin, Arthur Levitt, and Phil Gramm.
It is derivatives and other upchucks of The Free Market in finance that have transformed the mortgage crisis into a world-historic giant honking financial crisis. If you allow that the Clinton Administration was composed of Democrats, about which reasonable people may disagree, then it's a bipartisan accomplishment. One of the fruits of "The New Democrats."
A saving grace of the Dems' financial geniuses is they may have the capacity to learn, while Gabby Hayes' favorite economist Phil Gramm evidently does not:
Levitt, too, thinks about might-have-beens. "In fairness, while Summers and Rubin and I certainly gave in to this, we were not in the same camp as the Fed," he said. "The Fed was really adamantly opposed to any form of regulation whatsoever. I guess if I had to do it over again, I certainly would have pushed for some way to give greater transparency to products which turned out to be injurious to our markets."
Unfortunately, finance is like national security. When there's a catastrophe, the only people the elite media designate with the standing to fix it are the same dudes who got us into the mess in the first place. Obama's team needs some new rivals. Badly.
This financial scandal happened because the Democratic Party has gotten too much like the Republican Party. From the Republicans we get "trickle down economics". From the Democrats we get "trickle down government." This might not have happened 40 years ago when the liberals controlled the Democratic Party. But today, Schumer, Clinton, Dodd, Biden, etc. aren't going to bite the hand that feeds them. I don't even trust Barney Frank anymore.
Both parties serve their masters on Wall Street; the bankers, fund managers, real estate investors, the credit industry, Insurance etc.
No solution to this problem will cause any angst in the finanical community. The Democrats will tell the Bush gang they need to make this "bi-partisan" so they will need a bone to throw to their constituents. The Bush gang will give the Dems some picyune help with people's mortgages or
some inconsequential tax cut and the Dems will fan out in television land and bloviate on the "Bi-partisan" wonders that have been accomplished.
But the people who caused this financial train wreck will pay nothing or next to nothing. The heads of Fannie and Freddie, Merrill Lynch, Bear Sterns, AIG, etc. will walk away with their ill gotten gains and never look back.
AND, look for a truckload of patronage in this package. I think this agreement will eventually make Jack Abramoff look like the Plutarch of Populism.
The "solution" to this tragedy will guarantee the sharks will be back in 10 years and it will be deja vu all over again.
In the words of that glorious paragon of integrity, Democratic Congressman Ozzie Meyers of Philadelphia;
"Money talks and bullshit walks."
October 15, 2008 1:39 PM | Reply | Permalink
After every disaster there's always someone who pops up and says if they'd only followed my recommendations, it wouldn't have happened. The mine collapses and the union rep says he wanted those roof supports replaced -- except then, he wanted them replaced not because he thought they were a mine safety risk but because workers would be more productive if headroom were increased.
So -- with Brooksley Born and Edward M. Gramlich and John C. Gamboa and Robert L. Gnaizda.
The derivatives which are at the center of the current financial problems are credit default swaps which permit risky bonds to be "de-risked" and thereafter, treated as solid assets on bank balance sheets increasing banks' ability to loan (that is, increase leverage and profits).
There is no evidence to my knowledge that Brooksley Born, who served before June 1999 during which time CDSs were a minor part of the derivatives market, ever made an argument which described them as what Buffet would later call "derivatives of mass destruction." (Some would say she was mostly interested in soybeans)
Before we propose monuments to those who warned, let's make sure they warned of the evil which actually occurred.
October 15, 2008 2:10 PM | Reply | Permalink
In this case, of course, we don't actually know what would have been done, had Born (or anyone else) gotten their ways.
October 15, 2008 9:39 PM | Reply | Permalink
Ellen, did you read the article?
BB declined to be interviewed for the piece, so she is not exactly out there broadcasting her foresight. Maybe she mobilized a squadron of associates plus the Post to do it for her, that minx.
Second, if derivatives were not a big deal at the time, why were there meetings of the principals in question?
Third, if the case is thin, why does Levitt acknowledge fault?
October 15, 2008 2:50 PM | Reply | Permalink
I didn't mean to imply that Brooksley Born was tooting her horn (her story of her fight with Deez Boys is old news and she probably has little to add to it) anymore than Ed Gramlich, before his death, was tooting his.
My point was that the reporters* were presenting a biased history of the regulation-of-derivatives issue in order that they could tie it in to their theme of What Went Wrong -- and be able to find some heroes/heroines to give their story some human interest. We've go to be skeptical when reading reporters' historical scribblings which, in far too many news stories, might better be called "where's the 'sexy'."
Note re Levitt: He's not saying that Born was right or that the form of CDSs should have been standardized in order that they could have been traded on a public board. All he's saying is that he wished he'd pushed for "greater transparency" -- whatever he means by that generic term.
* As Brad De Long likes to say, "I give the Washington Post five years."
October 15, 2008 8:43 PM | Reply | Permalink
This is a point that we should definitely be raising now. Obama is surrounded with the same economic team that Clinton used and pushed the "New Democrats" agenda. As soon as Obama is elected we should be in the streets demanding that he purge the whole crowd. These men pushed the republican deregulation line inside the Democratic Party. They also brought us NAFTA. It is time to ask all of the elephants in donkey costumes to leave.
Correction to Ellen -- Derivatives and CDSs are not the same thing. Total positions in the derivatives market come to about $500 trillion dollars while CDSs make up about $60 trillion of that. Also we should promote BB to heroine status, at least, to set an example that beaurocrats who stand up to power can be recognized for their efforts, even if Ellen is right and BB did it for the wrong reasons.
October 15, 2008 7:33 PM | Reply | Permalink
I think you're making my point for me, syvanen.
The problem the banks and other financial institutions such as AIG are facing is not derivatives, generally -- it's a particular class of derivatives known as credit default swaps and specifically, their counterparties' solvency.
Currency swaps and interest swaps and commodity and stock and a host of other futures (what Born was interested in regulating) and no matter how large their nominal value may be just aren't the problem, currently.
N.B. I like my history "neat" without ulterior programmatic or moral lessons.
October 15, 2008 8:53 PM | Reply | Permalink
I've been thinking about the CDS problem and who in addition to the bankers themselves should be charged with the systemic failure.
While there are huge dollar values of CDSs that exist as pure gambling devices (one investor thinks XYZ is a turkey; the counterparty thinks it isn't; les jeux sont fait) and AIG appears to be in that group, the bankers' problem seems to be a different one.
Each loan is analyzed for risk and the risk level will govern how much bank capital will be tied up -- least secure, most; most secure, least. The less capital a bank has to tie up per loan the more loans (and resulting profits) it can make.
The banks purchased CDSs to convert a risky loan to one of less risk. But if the counterparty can't make good (AIG, Bear Stearns, and Lehman, for example), then, the CDS insurance fails, the loan's risk assessment has to be increased, and the bank must deleverage (that is, reduce its loan portfolio) not because the loan went bad but because it needs additional capital to back it.
The regulators of the banks and of the insurance industry (CDSs are, in all but name, insurance contracts) were the ones who fell down -- the bank regulators because they accepted these CDS contracts without asking what would happen if the counterparties couldn't make good on their contracts and the insurance regulators because they failed to require the CDS writers to put up adequate reserves.
Putting CDSs on an exchange (assuming the contracts could be written generically) and thus, generating a regular market and publicly available prices might help bank regulators determine the quality of the CDS and judge whether the banks' ownership of that CDS really was reducing the risk of loans insured by it.
In the end, though, the buck stops at the bank regulators.
October 16, 2008 4:04 AM | Reply | Permalink
The buck only stops at the regulators if they have the power to examine. In the CDS market, because of (politely so-called) clearing problems, even the insiders didn't always know which parties held how much of which risks (much less, thanks to collusion by the rating agencies, what the real risks were). The obvious solution would have been to call a halt to the whole thing until safety could be proven, but good luck keeping your job with those kinds of crazy ideas.
October 16, 2008 10:56 AM | Reply | Permalink