Brooksley Born warned that unchecked trading in the credit market
could lead to disaster, but power brokers in Washington ignored her. Now
we're all paying the price.
Shortly after she was named to head the Commodity Futures
Trading Commission in 1996, Brooksley E. Born was invited to lunch by
Federal Reserve chairman Alan Greenspan.
The influential Greenspan was an ardent proponent of unfettered
markets. Born was a powerful Washington lawyer with a track record for
activist causes. Over lunch, in his private dining room at the stately
headquarters of the Fed in Washington, Greenspan probed their
differences.
“Well, Brooksley, I guess you and I will never agree about fraud,” Born, in a recent interview, remembers Greenspan saying.
“What is there not to agree on?” Born says she replied.
“Well, you probably will always believe there should be laws against
fraud, and I don’t think there is any need for a law against fraud,”
she recalls. Greenspan, Born says, believed the market would take care
of itself.
For the incoming regulator, the meeting was a wake-up call. “That
underscored to me how absolutist Alan was in his opposition to any
regulation,” she said in the interview.
Over the next three years, Born, ’61, JD ’64, would learn first-hand
the potency of those absolutist views, confronting Greenspan and other
powerful figures in the capital over how to regulate Wall Street.
More recently, as analysts sort out the origins of what has become
the worst financial crisis since the Great Depression, Born has emerged
as a sort of modern-day Cassandra. Some people believe the debacle
could have been averted or muted had Greenspan and others followed her
advice.
As chairperson of the CFTC, Born advocated reining in the huge and
growing market for financial derivatives. Derivatives get their name
because the value is derived from fluctuations in, for example,
interest rates or foreign exchange. They started out as ways for big
corporations and banks to manage their risk across a range of
investments. One type of derivative—known as a credit-default swap—has
been a key contributor to the economy’s recent unraveling.
The swaps were sold as a kind of insurance—the insured paid a
“premium” as protection in case the creditor defaulted on the loan, and
the insurer agreed to cover the losses in exchange for that premium.
The credit-default swap market—estimated at more than $45
trillion—helped fuel the mortgage boom, allowing lenders to spread
their risk further and further, thus generating more and more loans.
But because the swaps are not regulated, no one ensured that the
parties were able to pay what they promised. When housing prices
crashed, the loans also went south, and the massive debt obligations in
the derivatives contracts wiped out banks unable to cover them.
Back in the 1990s, however, Born’s proposal stirred an almost
visceral response from other regulators in the Clinton administration,
as well as members of Congress and lobbyists. The economy was sailing
along, and the growth of derivatives was considered a sign of American
innovation and a symbol of the virtues of deregulation. The instruments
were also a growing cash cow for the Wall Street firms that peddled
them to eager takers.
Ultimately, Greenspan and the other regulators foiled Born’s
efforts, and Congress took the extraordinary step of enacting
legislation that prohibited her agency from taking any action. Born left
government and returned to her private law practice in Washington.
“History already has shown that Greenspan was wrong about virtually
everything, and Brooksley was right,” says Frank Partnoy, a former Wall
Street investment banker who is now a professor at the University of
San Diego law school. “I think she has been entirely vindicated. . . .
If there is one person we should have listened to, it was Brooksley.”
Speaking out for the first time, Born says she takes no pleasure
from the turn of events. She says she was just doing her job based on
the evidence in front of her. Looking back, she laments what she says
was the outsized influence of Wall Street lobbyists on the process, and
the refusal of her fellow regulators, especially Greenspan, to discuss
even modest reforms. “Recognizing the dangers . . . was not rocket
science, but it was contrary to the conventional wisdom and certainly
contrary to the economic interests of Wall Street at the moment,” she
says.
“I certainly am not pleased with the results,” she adds. “I think
the market grew so enormously, with so little oversight and regulation,
that it made the financial crisis much deeper and more pervasive than
it otherwise would have been.”
Greenspan, who retired from the Fed in 2006, acknowledged in
congressional testimony last October that the financial crisis, which he
described as a “once in-a-century credit tsunami,” had exposed a
“flaw” in his market-based ideology.
He says Born’s characterization of the lunch conversation she
recounted does not accurately describe his position on addressing fraud.
“This alleged conversation is wholly at variance with my decades-long
held view,” he said in an e-mail, citing an excerpt from his 2007 book
The Age of Turbulence, in which he wrote that more government involvement was needed to root out fraud. Born stands by her story.
Robert Rubin, who was treasury secretary when Born headed the CFTC,
has said that he supported closer scrutiny of financial derivatives but
did not believe it politically feasible at the time.
A third regulator opposing Born, Arthur Levitt, who was chairman of
the Securities Exchange Commission, says he also now wishes more had
been done. “I think it is fair to say that regulators should have
considered the implications . . . of the exploding derivatives market,”
Levitt told S
TANFORD.
In a way, the battle had the look and feel of a classic Washington turf war.
The CFTC was created in the ’70s to regulate agricultural
commodities markets. By the ’90s, its main business had become
overseeing financial products such as stock index futures and currency
options, but some in Washington thought it should stick to pork bellies
and soybeans. Born’s push for regulation posed a threat to the
authority of more established cops on the beat.
“She certainly was not in their league in terms of prominence and
stature,” says a lawyer who has known Born for years and requested
anonymity to avoid appearing critical of her. “They probably thought,
‘Here is a little person from one of these agencies trying to
assertively expand her jurisdiction.’”
Some of the other regulators have said they had problems with Born’s
personal style and found her hard to work with. “I thought it was
counterproductive. If you want to move forward . . . you engage with
parties in a constructive way,” Rubin told the
Washington Post. “My recollection was . . . this was done in a more strident way.” Levitt says Born was “characterized as being abrasive.”
Her supporters, while acknowledging that Born can be uncompromising
when she believes she is right, say those are excuses of people who
simply did not want to hear what she had to say.
“She was serious, professional, and she held her ground against
those who were not sympathetic to her position,” says Michael
Greenberger, a Washington lawyer who was a top aide to Born at the CFTC.
“I don’t think that the failure to be ‘charming’ should be translated
into a depiction of stridency.”
Others find a whiff of sexism in the pushback. “The messenger wore a
skirt,” says Marna Tucker, a Washington lawyer and a longtime friend
of Born. “Could Alan Greenspan take that?”
Greenspan dismisses the notion that he had problems with Born
because she is a woman. He points out that when he took a leave from his
consulting firm in the 1970s to accept a job in the Ford
administration, he placed an all-female executive team in charge.
It was not the first time that Born, 68, had pushed back against convention.
Her doggedness over a career spanning more than 40 years propelled
her into the halls of power in Washington. She was a top commercial
lawyer at a major firm, as well as a towering figure in the area of
women’s rights, and a role model for women lawyers. She was on Bill
Clinton’s short list for attorney general.
One of seven women in the Class of 1964 at Stanford Law School, she
graduated at the top of her class, and was elected president of the law
review, the first woman to hold either distinction. She is credited
with being the first woman to edit a major American law review.
In the early 1970s, at a time when women had few role models at
major law firms, she became a partner at the Washington, D.C., firm of
Arnold & Porter, despite working part time while raising her
children.
She helped establish some of the first public-interest firms in the
country focused on issues of gender discrimination. She helped rewrite
American Bar Association rules that made it possible for more women and
minorities to sit on the federal bench, and she prodded the group into
taking stands against private clubs that discriminated against women
or blacks.
She was used to people trying to push her around, or being perceived
as a potential troublemaker. She remembers being shouted down during
an ABA meeting in the 1970s when she proposed that the organization
take a position supporting equal rights for gay and lesbian workers. A
former ABA president stood up and said, “that the subject was so
unsavory that it should not be discussed . . . and was not germane to
the purposes of the ABA,” she recalls. She lost that fight, although
the group reversed its stand years later.
“She looks at things not just from a technical perspective or the
perspective of an insider. She looks at the perspective of outsiders
and how people without power are going to be affected,” says Esther
Lardent, a Washington lawyer who worked with Born on various ABA
matters. “That is a theme constantly running through her life and
career.”
“She is a very polite and low-key person but she is never somebody
who steps back from a disagreement or a fight if it is a matter of
importance to her,” Lardent adds. “Did that make people uncomfortable?
Did that make the men who dominated the leadership fail to take her
seriously enough? I am sure that was the case.”
She was born in San Francisco. Her mother, an English teacher, and
her father, the head of the city’s public welfare department, were both
Stanford graduates.
An early mentor was her mother’s best friend from Stanford, Miriam
E. Wolff, JD ’40, who became a deputy state attorney general and judge
and the first woman to ever head a major port.
Born entered Stanford with the thought of being a doctor, but
switched majors after a career counselor interpreted her answers on a
series of vocational tests. In those days, women were assessed for their
interest in nursing or teaching, men for the professional jobs,
including law and medicine. The tests were even color coded—pink for
women, blue for men.
Born says she insisted on taking both. Her mother, who had a
master’s degree in psychology, felt that was the only way her daughter’s
professional interests could be evaluated properly.
She scored high on being a doctor—and low on being a nurse. But
rather than suggest she pursue a career as a physician, the counselor
said the test proved that her interest in medicine was not genuine and
that she was really only interested in making a lot of money. Born quit
premed and majored in English.
“It was a turning point. What can I say? I was 18 years old. I
didn’t know any better,” Born says. “Unfortunately, I was, you know, a
member of the society as it was then. I was hurt by the advice, and kind
of believed in it. I don’t believe in it now. It is ridiculous in
retrospect.”
A decade later, one of the public-interest firms she founded challenged the tests as discriminatory.
Law school was welcoming and intellectually stimulating, even if
some people were still getting used to the idea of having women around.
Male law students got their own dormitory; women were left to make
their own housing arrangements in off-campus boarding houses or
apartments. “I also had . . . one student in my class tell me I was
taking the place of a man who had to go to Vietnam and was risking his
life because of me, which was sobering to say the least,” she recalls.
Making a mark in the classroom could also be a challenge. Some
professors refused to call on women, thinking it rude or unbecoming. She
remembers an episode in her first year when her professor appeared to
have the class stumped after quizzing several men about a problem. “The
little girl has it!” she recalls the professor declaring, after she
blurted out the right answer.
“I was very worried that I would not do well and that I would
disgrace myself, and women,” Born says. “I worked very hard during my
first year because I was afraid I would flunk out.” In those Darwinian
times in law schools, that was not an idle concern: professors tried to
weed out all but the most qualified students, and about a third were
dismissed from school after the first year. That would not be her fate.
“She was off the charts,” says Pamela Ann Rymer, JD ’64, a judge on
the federal appeals court in Pasadena. “Brooksley never wore it on her
sleeve. She is not quiet, but she is a very unpretentious kind of
person, just plainly and obviously with a brilliant mind.”
Despite her grades, Born was passed over for a clerkship on the U.S.
Supreme Court, the most coveted opportunity for a young lawyer.
Stanford’s top students were good candidates for the clerkships, but a
faculty committee decided to recommend two men for the positions even
though Born had a superior academic record. It was a bitter introduction
to a gender-biased legal culture. “They were sure I would understand
that it would be unseemly for women to be clerks on the Supreme Court,”
she says of the committee members. “I felt very disappointed and
angry.”
Undaunted, she headed to Washington, and arranged an interview on
her own with Arthur Goldberg, then one of the most liberal members of
the high court. Goldberg would not hire her either but recommended her
to a judge on the federal appeals court in Washington. Henry Edgerton,
who wrote an opinion that became a basis for the landmark Supreme Court
decision in the
Brown v. Board of Education school desegregation case, gave her a clerkship. (Law school professor emerita Barbara Babcock also clerked for Edgerton.)
A year later, taken with the Washington scene and its place on the
front lines of the civil rights movement, Born scrapped plans to return
to San Francisco. “I wanted in,” she says. Arnold & Porter, a firm
with a liberal tradition of public service, offered her a job, and she
started work the same day that a former name partner of the firm, Abe
Fortas, was sworn in as a justice of the Supreme Court.
The firm was one of a few that were beginning to hire women and
treat them on par with men. But there were challenges, especially for
those interested in a career and a family. Many firms up to that point
refused to hire women who were married or who were interested in
children.
The lone woman partner at Arnold & Porter at the time was
married to Fortas and was renowned for her “misanthropic toughness,”
including a preference for “thick cigars,” according to Charles Halpern,
an associate with Born at the firm in the 1960s. “Our swimming pool
has two deep ends,” Halpern recalls her once saying, “so that people
aren’t tempted to drop by with their small children for a swim on a hot
summer day.”
Born soon faced a difficult choice. She took a one-year leave when
her then-husband got a Nieman fellowship at Harvard, where her first
child was born. Returning to Washington, she tried to juggle full-time
work and child rearing but it quickly became apparent that the
arrangement didn’t work.
“I went to the partner I was working with the most and said I just
didn’t think I could do this,” she says. “I thought I had to resign.”
To her surprise, the partner suggested she work three days a week with
the understanding she would not be considered for partner until she
returned full time.
In 1974, when she had a 4-year-old and a 2-year-old, she was still
working part time. The firm promoted her anyway. The family-friendly
development was a stunning breakthrough at a time when law firms were
focused on billable hours and the bottom line, and little else. It
further raised her profile.
“When I met her I was in awe of her because the idea that she could
be a partner in that firm was just unbelievable,” says Tucker, her
longtime friend. The women bonded after being asked to teach a course
on women and the law at two Washington-area law schools, and being
horrified at what they found during their research. “We were surprised
to find the degree to which discrimination was embodied in the law,”
Born says. “It was a real consciousness-raising experience.”
Lawyer Marcia Greenberger sought out Born in the 1970s when she was
named to start a new women’s rights project in Washington. Born agreed
to chair an advisory board for the project, and became a guiding force,
mentor and opener of doors, leveraging her contacts and credibility,
Greenberger says. One of the first broad-based challenges to how
universities were implementing Title IX—the 1972 law requiring equal
programs and activities for women and men—was brought after Born passed
along the name of a colleague who was incensed at the poor athletic
facilities his daughter was forced to use at her school. Born also
helped win Ford Foundation grants that enabled the project to hire its
second lawyer. What is now called the National Women’s Law Center today
has a staff approaching 60 and a budget of almost $10 million. Born
remains chair of its board of directors.
Clinton named her to head the CFTC in 1996. She was not without
experience: at Arnold & Porter she had represented the London
Futures Exchange in rule making and other matters before the commodities
agency.
She also knew how markets could be manipulated, having represented a
major Swiss bank in litigation stemming from an attempt by the Hunt
family of Dallas to corner the silver market in the 1980s.
“Brooksley had the advantage of knowing the law and understanding
the fragility of the system if it weren’t regulated,” says Michael
Greenberger, her former adviser at the CFTC. “She could see that the
data points, by lack of regulation, were heading the country into a
serious set of calamities, each calamity worse than the one before.”
Under a Republican predecessor, the CFTC had in 1993 largely
exempted from regulation more exotic derivatives that involved just two
parties. The thinking was that sophisticated entities negotiating
individually tailored derivatives could look out for themselves. More
generic derivatives still had to be traded on exchanges, which were
subject to regulation.
By 1997, the over-the-counter derivatives market had more than
doubled in size, by one measure, reaching an estimated $28 trillion,
based on the value of the instruments underlying the contracts. (It has
now reached an estimated $600 trillion.)
And some cracks were already surfacing in the landscape. Several
customers of Bankers Trust, including Procter & Gamble, sued for
fraud and racketeering in connection with several OTC derivative deals.
Orange County, Calif., had gone bankrupt in part because of an OTC
derivative-trading scheme gone awry.
What is more, all the growth had taken place at a time of economic
prosperity. Some people were beginning to ask what would happen if the
market suffered a major reversal.
“The exposures were very, very big and if it was your job to worry
about things that could go wrong, and I think it was, this is one of
the things you couldn’t help but notice,” says Daniel Waldman, a
Washington lawyer who was the CFTC general counsel under Born. “It was
only your blind faith in the participants that could give you much
comfort because you really did not know much about the real risks.”
‘There was no transparency of these
markets at all. No market oversight. No regulator knew what was
happening,” Born says. “There was no reporting to anybody.’
She chose what she thought was a middle ground, circulating a draft
“concept release,” to regulators and trade associations, which was
intended to gather information about how the markets operated. She and
her staff suspected the industry was trying to exploit the earlier
regulatory exemption.
But even the modest proposal got a vituperative response. The dozen
or so large banks that wrote most of the OTC derivative contracts saw
the move as a threat to a major profit center. Greenspan and his
deregulation-minded brain trust saw no need to upset the status quo. The
sheer act of contemplating regulation, they maintained, would cause
widespread chaos in markets around the world.
“We would go to conferences and it would be viciously attacked,”
Waldman says. “They would just be stomping their feet and pounding the
tables.” With Born unlikely to change her mind, the industry focused on
working through the other regulators.
Born recalls taking a phone call from Lawrence Summers, then Rubin’s
top deputy at the Treasury Department, complaining about the proposal,
and mentioning that he was taking heat from industry lobbyists. She
was not dissuaded. “Of course, we were an independent regulatory
agency,” she says.
The debate came to a head April 21, 1998. In a Treasury Department
meeting of a presidential working group that included Born and the
other top regulators, Greenspan and Rubin took turns attempting to
change her mind. Rubin took the lead, she recalls.
“I was told by the secretary of the treasury that the CFTC had no
jurisdiction, and for that reason and that reason alone, we should not
go forward,” Born says. “I told him . . . that I had never heard anyone
assert that we didn’t have statutory jurisdiction . . . and I would be
happy to see the legal analysis he was basing his position on.”
She says she was never supplied one. “They didn’t have one because it was not a legitimate legal position,” she says.
Greenspan followed. “He maintained that merely inquiring about the
field would drive important and expanding and creative financial
business offshore,” she says. CFTC economists later checked for any
signs of that, and came up with no evidence, Born says.
“It seemed totally inexplicable to me,” Born says of the seeming
disinterest her counterparts showed in how the markets were operating.
“It was as though the other financial regulators were saying, ‘We don’t
want to know.’”
She formally launched the proposal on May 7, and within hours,
Greenspan, Rubin and Levitt issued a joint statement condemning Born and
the CFTC, expressing “grave concern about this action and its possible
consequences.” They announced a plan to ask for legislation to stop
the CFTC in its tracks.
At congressional hearings that summer, Greenspan and others warned
of dire consequences; Born and the CFTC were cast as a loose cannon.
Reverting to a theme Born claims he raised at their earlier lunch,
Greenspan testified there was no need for government oversight, because
the derivatives market involved Wall Street “professionals” who could
patrol themselves.
Summers, Rubin’s deputy (and now director of the National Economic
Council), said the memo had “cast the shadow of regulatory uncertainty
over an otherwise thriving market, raising risks for the stability and
competitiveness of American derivative trading.”
Born assailed the legislation, calling it an unprecedented move to
undermine the independence of a federal agency. In eerily prescient
testimony, she warned of potentially disastrous and widespread
consequences for the public. “Losses resulting from misuse of OTC
derivatives instruments or from sales practice abuses in the OTC
derivatives market can affect many Americans,” she testified that July.
“Many of us have interests in the corporations, mutual funds, pension
funds, insurance companies, municipalities and other entities trading in
these instruments.”
That September, seemingly bolstering her case, the Federal Reserve
Bank of New York was forced to organize a rescue of a large private
investment firm, Long Term Capital Management, which was a big player
in the OTC derivatives market. Fed officials said they acted to avoid a
meltdown that could have impacted the wider economy.
But the tide of opinion that had risen up against Born was
irreversible. Language was slipped into an agriculture appropriations
bill barring the CFTC from taking action in the six months left in her
term.
“I felt as though that, at least, relieved me and the commission of
any public responsibility for what was happening,” she says. Clinton
aides sounded her out about a second term, but she said she wasn’t
interested and left the agency in June 1999.
A year later, Congress enacted the Commodity Futures Modernization
Act, which effectively gutted the ability of the CFTC to regulate OTC
derivatives. With no other agency picking up the slack, the market
grew, unchecked.
Some observers say now the episode and infighting showed how even a
decade ago a patchwork system of regulating Wall Street was badly in
need of reform.
“The fact that the . . . issue created such a threat to the
marketplace to me confirmed the fact that something was not right,” says
Richard Miller, a lawyer and editor of a widely read newsletter on
derivatives. “How could we have a system that hangs together by such a
narrow thread?” Miller testified at the time that the idea Born
proffered should at least have been considered.
The Obama administration has pledged an overhaul of the financial
system, including the way derivatives are regulated. Worrisome to some
observers is the fact that his economic team includes some former
Treasury officials who were lined up in opposition to Born a decade ago.
Born, who retired from her law firm in 2003, is not playing a formal
role in the process. An outdoor enthusiast, she was planning a trip to
Antarctica this winter, as the Obama team was settling in. “The
important thing,” she advises, “is that the new administration should
not be listening to just one point of view.”
RICK SCHMITT,
a former staff writer for the Los Angeles Times
and the Wall Street Journal,
is a freelance writer based in Washington, D.C.
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