Saturday, May 7, 2016

An Example of Moral Courage: Brooksley Born

Brooksley Born

I have been surprised at how many women exemplify the type of courage I admire most. Moral courage.  Not the type of heroism that makes the evening news, but the kind of courage we should all be able to exhibit and to emulate. The type of courage we're all capable of. Indeed, courage of the type we are all called to exhibit in our daily lives. 

In 1996, a powerful Stanford-educated Washington lawyer named Brooksley E. Born was appointed by President Clinton to head the Commodity Futures Trading Commission (CFTC). The CFTC had been set up in 1974 to regulate the markets (trading exchanges) for agricultural commodities. In the 25 years that followed, the CFTC added stock index futures and currency options to its scope of oversight. Until Brooksley Born took over, however, the CFTC had largely ignored the fast-growing markets for derivative securities. Derivatives at that time primarily meant credit-default swaps, which were essentially insurance contracts that allowed bond investors to purchase insurance against debt default, contracts that could later be sold to investors. During the 2000's, the derivatives market exploded with the trading of new "synthetic securities" like the collatoralized debt obligations (CDO's) which were packages of "securitized" subprime-mortgages (very risky mortgages). 

When she took her new position as head of the CFTC, Brooksley Born was immediately invited to a private luncheon with Federal Reserve Chairman Alan Greenspan at his private dining room at the Fed building. At that meeting, Greenspan surprised her by letting her know that she was not expected to do her job in regulating the new markets for derivatives; those markets, he assured her, were "self-regulating". In what way? Basically, he told her that no investment broker would defraud its own clients (by misrepresenting the risks of any given investment) and if a broker did that, those clients would ensure that the broker was punished, by moving their money elsewhere. In other words, he told her that Big Business can always be trusted to do the right thing. How foolish was that belief? How monumentally stupid was that claim? We know, now, don't we? But in 1996, everyone was riding the prosperity wave. We were all going to make money without working for it; we were all going to let our money work for us instead. No one was prepared to call the emperor naked. No one, that is, but Brooksley Born. She left that meeting with the full intent of ignoring Greenspan's advice which was, basically, "don't do your job – just stick to regulating pork bellies and soybeans – but you stay out of our way.

Essentially, no one wanted to question the safety or the honesty of these new and growing markets. No one wanted government regulators ensuring that these markets were safe and honest. Why? Because they were all getting rich. In fact, they all got unbelievably rich. The whole derivative market was designed to be too complex to be understood, much less "regulated." What's the word they loved to use? It was too "exotic," they said, to regulate. The only people who really understood what they were doing were in the business of defrauding others. And then, along came Brooksley Born. 

Brooksley Born wasted no time; she began immediately studying the derivatives markets and coming to the conclusion that they were extremely vulnerable to a market collapse. She was concerned about a lack of government regulation and a lack of transparency in the trading of derivatives. She was also concerned about the risks associated with subprime mortgages, those high-risk mortgage-based derivatives (or CDOs). Her work at the CFTC was strongly opposed by Alan Greenspan (who had blocked tougher government regulations on derivatives before she took office) and those working with him inside the government:  Robert Rubin, Treasury Secretary; Larry Summer, Assistant Treasury Secretary; and Arthur Leavitt, chairman of the Securities and Exchange Commission (SEC). 

On May 7, 1998, under the direction of Brooksley Born, the Commodity Futures Trading Commission issued a "concept paper," which brought her concerns before the public, or at least to the financial world. The paper asked for input from regulators, academics, and derivatives traders on "how best to maintain adequate regulatory safeguards without impairing the ability of the OTC (Over-the-counter) derivatives market to grow and the ability of U.S. entities to remain competitive in the global financial marketplace." Greenspan and his cronies were livid. Their response was immediate. Within hours, Greenspan, Rubin and Levitt issued a joint statement condemning the CFTC for the "concept paper." They were attacking Brooksley Born for wanted to regulate the irresponsible trading of very risky financial instruments. 

Born's concept paper stated plainly that there would be no changes to existing regulatory guidelines or changes to existing exemptions from those guidelines. The fact that this relatively mild paper created so much concern in the industry is an indication that something was terribly wrong with these new markets for "exotic" securities, and they all knew it. 

On July 30, 1998, Larry Summers (as Assistant Treasury Secretary) testified before congress that "the parties to these kinds of contract are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud." In other words, he echoed Alan Greenspan's claims that these markets were too sophisticated to be properly regulated and, besides, they were "self-regulating." That was a totally bullshit claim. 

They tried to challenge the CFTC on legal grounds (though they had none). Eventually, they used their influence with the Congress of the United States to enact legislation to neuter the CFTC, first adding language to an agricultural appropriations bill to restrict the CFTC from regulating these markets; later they convinced a compliant Congress to pass the Commodity Futures Modernization Act of 2000 (oh, definitely review this page if you have time, all the players are there) which basically eliminated all federal government oversight of derivatives trading. That Act of Congress (which was passed a year after Brooksley Born left the CFTC) basically paved the way for the ramp up in mortgage-backed securities trading that led to the financial collapse of 2008. It set the stage for the general financial crisis that followed later that same year. 

With the benefit of hindsight, and knowledge of the events that followed, we now know that Larry Summers, Robert Rubin, Alan Greenspan, and Arthur Leavitt misjudged the dangers posed by derivatives contracts or misrepresented those risks to Congress. We know, beyond any doubt, that these men were wrong. And Brooksley Born was 100% right. 

The Obama Administration pledged an overhaul of the financial system, particularly in regulating the way derivatives are traded. Why did that never happen? Larry Summers, who played a key role in the financial disaster of 2008, became a key economic adviser to President Obama. And what was up with that?  What has changed since the derivatives market collapsed? Very little. Why, then, are so many people willing to believe, once again, that financial markets are "self-regulating?" 

Brooksley Born exemplifies a type of courage we can all possess. It's the courage to stand firm on principle when all those around us are abandoning their own. All they wanted her to do "go along" like everyone else. Pretend there was no elephant in the room. Accept the lie and look out for number one. Play the game.  She could've made a lot of money by not speaking the truth. Instead, Brooksley Born chose the difficult path, the dangerous path, the lonely path. That's the very rarest form of courage – a courage that leaves a person standing alone. I know. 

In May 2009, Brooksley Born was awarded the John F. Kennedy Profiles in Courage Award in recognition of the "political courage she demonstrated in sounding early warnings about conditions that contributed to the current global financial crisis". At the award ceremony, Brooksley Born took the opportunity to reiterate her warning that these un-regulated markets in derivative securities will ultimately lead to many more years of economic failure. JFK's daughter Caroline Kennedy, in presenting the award, said, "Brooksley Born recognized that the financial security of all Americans was being put at risk by the greed, negligence and opposition of powerful and well connected interests. The catastrophic financial events of recent months have proved them [Brooksley Born and the FDIC's Sheila Bair, with whom she shared the award] right."