My Utility Level Is Lower This Morning...
Where We Are Now, in Some Historical Perspective

More on Clinton-Era Regulation of Derivatives

James Kwak writes:

What Did Robert Rubin Think About Derivatives?: First Bill Clinton said he got bad advice from Robert Rubin on derivatives. Then a Clinton adviser issued a statement essentially taking it back and blaming Alan Greenspan. (Jennifer Taub discussed some of the substantive issues on this blog.) Dan Froomkin asked Rubin, who said, “I thought we should regulate derivatives; I thought so when I was at Goldman Sachs and I thought so afterwards.” But Froomkin points out that Rubin was part of the team that suppressed Brooksley Born’s attempt to regulate derivatives back in 1998....

I think the fact of the matter is that we don’t know what Rubin thought about derivatives regulation in the mid-1990s, because somehow he managed to avoid making public statements about it at the time.... If Rubin did favor regulating OTC derivatives, why didn’t he do anything about it? That, to me, is the real question, not what Rubin may have thought in the privacy of his own mind (or the privacy of the Oval Office)...

But I think we do know: I think Norman Carleton has it right:

Rubin had proposed to Born that, instead of the CFTC asking questions about the need for regulation of the OTC derivatives market, the President’s Working Group on Financial Markets issue the questions. Born point blank refused this suggestion, thus pushing Rubin into Greenspan’s camp, much to the relief of ISDA and other Wall Street groups lobbying on this issue. They knew they had a problem with Rubin. Brooksley Born was so sure she was right in her legal position that she could not compromise in face of the practical and political realities.... [S]he has been proven right and Greenspan wrong about the dangers of the OTC derivatives market.... [But h]istory might have been different if Born had agreed to Rubin’s suggestion.

As I wrote before: As I understand things, Rubin's position on derivatives regulation in the late 1990s had five parts:

  1. Derivatives should be regulated, with proper disclosure and capital adequacy and information requirements, especially to protect unsophisticated investors.
  2. Phil Gramm is Chairman of the Senate Banking Committee, and would always rather regulate less rather than more--and the House side is even more so.
  3. Brooksley Born and her organization are the wrong people to regulate derivatives.
  4. Derivatives should be regulated with a light hand, because they are a small and specialized corner of financial markets and are simply not large enough to pose any systemic threat.
  5. The Federal Reserve has adequate powers to stem financial crisis and keep it from becoming a threat to the economy, and is also not worried about derivatives.

As I see it, Rubin was correct on (1), (2), and (3). He was correct on (4) when he was in office--when derivatives were too small to pose any systemic threat to financial stability. But that changed in the 2000s. And Rubin was completely, utterly, and totally wrong about (5) (as was I). One other place where Rubin was wrong in the late 1990s (and where I was right), was that he was not worried about the opacity of derivatives. He was confident that senior managers at large Wall Street firms could maintain control over their derivatives books, and understand what risks their firms were facing, and what risks their underlings were exposing their firms to. There he was wrong.

Let me now add a bit to that.

In the late 1990s, Phil Gramm and Jim Leach were chairmen of the Senate and House Banking Committees. They wanted to deregulate--and they had the votes to deregulate unless Clinton wanted to make it into an all-out war and assemble a coalition to back a veto, which he did not. The Treasury's task--and Rubin's and Summers's task--was to figure out what smart deregulation would be, and nudge Gramm and Leach to that outcome. They failed. They failed to identify what smart deregulation would be. And they failed to nudge Gramm and Leach to that outcome.

Rubin and Summers, as I understand it, would both have preferred (a) lobbying Gramm and Leach to regulate derivatives with a light hand in a smart manner, but accepted (b) no regulation as an acceptable outcome, and preferred no regulation to (c) having Brooksley Born regulate derivatives at the CFTC in an incomplete, haphazard, and dangerous manner because of a lack of proper and complete legal authority. Brooksley Born, as I understand it, would rather (c) have regulated derivatives herself at the CFTC under her current legal authority, but preferred (b) no regulation to (a) ceding some of the CFTC's power as part of a process of lobbying Gramm and Leach to regulate derivatives with a light hand in a smart manner.