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Note: This is the cipro new rep firm main page and timeline for a series on the (mostly) legislative history of financial deregulation that has contributed to our current financial and economic crisis. To read the entire series, see the individual posts listed below (additional links will be added as more posts in the series are written – as time and interest permit). Please use the comments to contribute links and other information. Thanks, selise.

  1. Series Introduction
  2. OTC Derivatives (Which Idiot Decided Not to Regulate Credit Default Swaps?)
  3. Too Big to Fail (Which Idiot Decided to Repeal Glass-Steagall?)
  4. 4 Million,.1 Billion
  5. 15 Years ago Charles Bowsher’s Warning was Ignored. Let’s Not Make the Same Mistake Today


Regulation TIMELINE and notes:

June 7, 1987 – The NYT reports "Treasury now favors creation of huge banks".

Top officials at the Treasury Department have concluded that the Government should encourage creation of very large banks that could better compete with financial institutions in Japan and Europe.

The Treasury plan, which would permit the acquisition of banks by large industrial companies, was also endorsed by Alan Greenspan, in an interview before President Reagan nominated him this week to be chairman of the Federal Reserve Board.

Mr. Greenspan said the plan would provide multibillion-dollar pools of investment capital for a banking industry that was ‘’severely undercapitalized.” Mr. Greenspan has declined to be interviewed while he awaits confirmation by the Senate.

No formal policy or legislative agenda has been adopted by the Administration, but George D. Gould, Under Secretary of the Treasury, said in interviews that he favored creating 5 to 10 giant banks that would rival in size the largest banks in Japan, West Germany, Britain and France.

The Two Laws Involved

Formation of such large banks has been hampered by two of the nation’s principal banking laws: the Glass-Steagall Act of 1934, which separates underwriting and commercial banking, and the Bank Holding Company Act of 1956, which prohibits nonbanking companies from owning banks.

The only avenue left open to banks has been to merge among themselves. But state laws have historically prohibited interstate banking, and only recently have state legislatures begun to open their borders to out-of-state banks. These deals have usually involved a large out-of-state bank’s buying a smaller institution. Mergers, interstate or otherwise, among the giant banks could raise antitrust questions, and none of the few such deals attempted ever progressed very far.

In the Administration, the hope is that Congress can be persuaded to loosen the regulations. The banking industry, which has considerable political influence, is divided: The largest banks strongly support the changes while smaller banks fear they would be put out of business.

Thirty years ago the United States had 15 of the world’s largest banking institutions, but global dominance by American banks has slipped dramatically. Only two United States banking companies, Citicorp and BankAmerica, are now ranked in the world’s 25 largest. Japan has 14, including the world’s four largest banks. Two German, three British and four French banks complete the list.

”If we are going to be competitive in a globalized financial-services world, we are going to have to change our views on the size of American institutions,” Mr. Gould said. ”People are going to have to accept that some big American financial institutions will need more capital to be competitive.”

Mr. Gould acknowledged that any policy promoting the creation of very large financial institutions encounters deep-seated sentiments that date from the founding of the Republic. But he thinks the nomination of Mr. Greenspan could provide an important stimulus for change. Mr. Greenspan contends that many of the laws restricting commercial banks severely limit their ability to adapt to a changing marketplace.

Frequent Frustration For Deregulation Efforts

The Reagan Administration has met frustration in its efforts to lessen regulation of banking, largely because Paul A. Volcker, the current Federal Reserve chairman, has firmly opposed any move that would begin to break down the barriers that prohibit large nonbanking companies from owning banks. Mr. Volcker has also been rather grudging in his support of changes that would allow interstate banking and the underwriting of securities by banks.

Mr. Volcker has strong ties to prominent legislators, particularly Senator William Proxmire, Democrat of Wisconsin, chairman of the Senate Banking Committee, who believes that a decentralized system with 14,000 commercial banks helps assure competitiveness within the United States.

But after Mr. Volcker departs in August, the Federal Government’s major regulators will be speaking with a nearly unified voice. Both Robert L. Clarke, Comptroller of the Currency, and L. William Seidman, chairman of the Federal Deposit Insurance Corporation, support in principle the Gould approach, as do several Fed governors.

In the interview, Mr. Greenspan said ”the separation of commerce and banking at this stage is simply not helpful” because it cuts off one important source of new capital. He added that the declining profits of the leading American banks had hampered their ability to raise capital in stock offerings. That leaves them only one practical source for large injections of funds: the industrial sector of the economy.

Given the current banking environment, Mr. Greenspan said, ”I do not have a fear of undue concentration of banking powers.”

June 29, 1987 – The Congressional Research Service released (or updated?) it’s short report, "Glass-Steagall Act: Commercial vs. Investment Banking." From the summary:

Debate over reform of the Nation’s financial structure in the 100th Congress includes re-examination of "the separation of banking and commerce." This separation was mandated by the Glass-Steagall Act (part of the Banking Act of 1933); and was carried forward into the Bank Holding Company Act of 1956, as amended in 1970 and thereafter. The resulting isolation of banking from securities was designed to (1) maintain the integrity of the banking system; (2) prevent self-dealing and other financial abuses; and (3) limit stock market speculation. By half a century later, the "wall" it created seemed to be crumbling, as bankers created new financial products resembling securities, and securities firms innovated new financial products resembling loans and deposits. The ongoing process of "financial deregulationw has evoked calls for Congress to give depository institutions new powers, especially in the securities field. Financial deregulation in the United Kingdom, Canada, and Japan has put additional pressure on Congress to re-examine this Act. Concerns over a seemingly fragile system of depositary institutions persist, however, tending to place counter-pressure on Congress to maintain the Act.

August 11, 1987 – Alan Greenspan was sworn in as Chairman of the Federal Reserve. As reported recently in the NYT:

“Proposals to bring even minimalist regulation were basically rebuffed by Greenspan and various people in the Treasury,” recalled Alan S. Blinder, a former Federal Reserve board member and an economist at Princeton University. “I think of him as consistently cheerleading on derivatives.”

Arthur Levitt Jr., a former chairman of the Securities and Exchange Commission, says Mr. Greenspan opposes regulating derivatives because of a fundamental disdain for government.

For more than a decade, the former Federal Reserve Chairman Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street. “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,” Mr. Greenspan told the Senate Banking Committee in 2003. “We think it would be a mistake” to more deeply regulate the contracts, he added.

August 26, 1987 – Congressman Charles Schumer’s oped, "Don’t Let Banks Become Casinos," is published in the NYT.

Citing the pressures of rigorous worldwide competition in financial services, large American banks are pleading for the repeal of the Glass-Steagall Act, a law that keeps banks out of the more volatile and risky world of securities transactions. Their entreaties should be resisted. The reasons the act was passed are still valid, and it has not interfered with our ability to compete internationally.

The Glass-Steagall Act of 1933 evolved from the bitter experience of the Depression, when American banking was in shambles. Left free to speculate in the 1920’s, banks naturally looked where profits seemed highest, and were inevitably drawn into risky propositions. When a few banks failed, depositors nationwide panicked. Runs on banks pushed this country over the brink of financial disaster.

Stability was restored only years later, after the Federal Government insured depositors’ money and imposed tough limits on the kind of risks a bank can undertake.

Today’s bankers promise they will be more careful. But to accept their assurances runs counter to the simple principles of fairness and common sense. Banks want to keep the Federal insurance that attracts depositors and then use that capital to compete against traditional, unsubsidized securities firms.

No one could complain if banks renounced their Federal insurance and then competed evenly against securities firms. But the banks simply should not be allowed to gamble with taxpayer insured dollars.

The banks’ proposals also defy common sense. Given the chance to speculate, some institutions are going to gamble poorly. This in turn will undermine confidence in the whole banking system. The recent experience of the thrift industry reinforces this lesson. Congress stepped in with.8 billion to bail out the thrift industry. A bailout of the much larger commercial banking sector, if it got into a similar problem, would make the recapitalization for thrifts seem insignificant.

Critics of the Glass-Steagall Act prefer to downplay the risks to the Federal Government and instead focus on the internationalization of the marketplace. They argue that they are unable to compete because foreign banks are free to violate the principles of Glass-Steagall. It is true that seven of the 10 largest banks are Japanese, but this has nothing to do with the Glass-Steagall Act.

Indeed, the Japanese operate under a law imposed after World War II by Gen. Douglas MacArthur that is, if anything, more restrictive than Glass-Steagall. Japanese banks are bigger because of the decline of the dollar, the healthy rate of Japanese savings and the absence of full-throttled competition within Japan.

The Japanese version of the Glass-Steagall law has not inhibited Japanese banks from successful competition abroad. Very few American consumers or businesses refuse to patronize a Japanese bank with more competitive interest rates simply because a type of Glass-Steagall law exists in Japan.

Moreover, the tremendous size of the Japanese banks is misleading. American banks complain that Glass-Steagall inhibits profitability, yet from 1983 through 1986 American banks enjoyed greater profitability than their Japanese competitors. While American banks have emphasized profits at the expense of growth, the Japanese have pursued a policy that has favored size over profits.

Japanese banks have been able to grow so large not because of a freedom to speculate but because of barriers that protect them from foreign competition. With a protected profit base at home, Japanese banks can engage in sharp competition abroad.

To help our banking and financial system, we should insist that the Japanese open their banking markets to foreigners, just as we have done in the United States. A level playing field is the best assistance we can give our banks in the world of international competition.

To understand what our financial industry would be like without the Glass-Steagall Act, we need only look to West Germany, where no such restrictions exist. The West German financial system is dominated by a few large banks. Like most large corporations, they are risk-averse. Capital for any risky venture is scarce.

As a result, West German banks are superb at lending to established institutions. But entrepreneurs with new ideas often have to come to the United States to find financing. The Glass-Steagall legislation is therefore a competitive advantage in a world where entrepreneurs require ready access to capital.

The solution to the problem of internationalization is not the abolition of the Glass-Steagall Act but an approach that would protect the integrity of the federally insured program, continue to guarantee and separate stable pools of both high- and low-risk capital and open foreign markets to American banks. How do banks respond when the need for these important protections are cited? They suggest that walls be built within their organizations that would keep their risky activities separate from traditional banking activities. Numerous experts have noted the difficulty of separating such operations, particularly when decisions about whether to buy a subsidiary’s securities – decisions that are theoretically objective -can mean a profit of millions of dollars.

Even if these decisions are made objectively, one must wonder why it is the duty of the Federal Government to insure banks that provide capital to risk-takers when that can already be handled by an increasingly competitive worldwide securities industry.

The answer, of course, is that banks see big profits in securities. But if a bank thinks it can make more money as a securities firm, let it become one. Let’s not destroy a stable structure that, since the Depression, has provided capital for entrepreneurs, confidence for depositors and healthy profits for America’s financial service companies.

November 19, 1987 – Greenspan Calls for Repeal Of Glass-Steagall Bank Law:

Warning that banks will become the dinosaurs of financial services if the Depression-era law is not repealed, [Alan Greenspan] said that the Fed believes banking can be tied to securities underwriting without subjecting federally insured deposits at banks to the risks inherent in the stock market.

The Fed favors allowing a parent holding company to own both banks and securities firms rather than allowing banks and securities firms to buy and own each other directly, Greenspan said. The holding company structure would be the best way to ensure that, if a securities firm fails, a court would not try to "pierce the corporate veil" by seeking to get at federally insured deposits in the bank subsidiary, he said.

Greenspan said the Fed is not yet ready to recommend how far banks should be allowed to expand into insurance and real estate. Instead, he said, he would welcome legislation from Congress that would give the Fed guidelines.

February 10, 1988 – GAO issues report, "Issues Related to Repeal of the Glass-Steagall Act."

GAO discussed issues related to the repeal of the Glass-Steagall Act. GAO found that: (1) the banking and securities industries now offer similar products and have expanded their activities due to electronics, communications, and regulatory changes; (2) there is no legal or regulatory structure reflecting the realities of today’s financial marketplace; (3) if Congress repeals the act, the present mechanism for preserving the banking system’s soundness and protecting consumer interests will no longer exist; (4) both industries would need to maintain a level of capital sufficient to support losses resulting from expanded activities; (5) the bank holding structure is the logical entity to organize banking and securities activities, with the Federal Reserve System providing comprehensive oversight; (6) holding companies should maintain sufficient levels of capital to support their commercial banking units, since it would not be appropriate to extend lender-of-last-resort services to the nonbank parts of a holding company; and (7) expanded banking powers could hinder regulators’ ability to oversee bank safety and soundness. GAO believes that Congress may wish to phase in Glass-Steagall modernizations in order to develop the resources to oversee the industries.

March 23, 1989 – From the NYT: Talking Deals; Citicorp Strategy On Glass-Steagall

October 28, 1992 – H.R.707, the Futures Trading Practices Act of 1992 was signed into law. This bill "granted the Commission the authority to exempt over-the-counter (OTC) derivative and other transactions for CFTC regulation" (see January 22, 1993).

1992 – Congressmember Ed Markey, as chair of the House Subcommittee on Telecommunications and Finance, asked the General Accounting Office (GAO) to report on the potential risk due to the growing use of derivatives. The report was released 2 years later in May of 1994.

January 20, 1993 – Lloyd Bentsen became United States Secretary of the Treasury. Recall that Bentsen was Clinton’s nominee while both houses of congress were still controlled by the Democrats. Bentsen was no friend of liberals when it came to economic policy:

Bentsen was known as a moderate Democrat. His support for abortion rights, the Equal Rights Amendment, and civil rights was balanced by his endorsement of public school prayer, capital punishment, tax cuts, and deregulation of industry. He generally supported business interests in the arena of economic policy and swiftly rose to become a power to be reckoned with on the Senate Finance Committee.

Bentsen’s reputation as a moderate Democrat served to alienate him not only from supporters of Ralph Yarborough, but from prominent national liberals, as well. Indeed, during the 1970 Senate race, the Keynesian economist John Kenneth Galbraith endorsed George Bush, arguing that if Bentsen were elected to the Senate, he would invariably become the face of a new, more conservative Texas Democratic Party, and that the long-term interests of Texas liberalism demanded Bentsen’s defeat.

January 22, 1993 – The CFTC exempted "certain swap agreements and hybrid instruments from regulation under the Commodity Exchange Act." This was Wendy Gramm’s last day as Chair of the Commission, although her term did not expire until 1995. It was, however, two days after the inauguration of Bill Clinton as POTUS.

July 1993 – Group of Thirty Global Derivatives Study Group published Derivatives: Practices and Principles

The recommendations, which the Steering Committee has endorsed unanimously, were formulated by the Working Group–a diverse cross-section of end-users, dealers, academics, accountants, and lawyers involved in derivatives. Input also came from a detailed Survey of Industry Practice among 80 dealers and 72 end-users worldwide, involving both questionnaires and in-depth interviews.

In addition, there are four recommendations for legislators, regulators, and supervisors. To help strengthen the financial infrastructure for derivatives activities, officials are called upon to:

  • Recognize close-out netting arrangements and amend the Basle Accord to reflect their benefits in bank capital regulations.
  • Work with market participants to remove legal and regulatory uncertainties regarding derivatives.
  • Amend tax regulations that disadvantage the economic use of derivatives.
  • Provide comprehensive and consistent guidance on accounting and reporting of derivatives and other financial instruments.

Group of Thirty Current Members include: Paul Volcker, Timothy Geithner, Larry Summers. It would be interesting to know who were members in 1993.

Group of Thirty wikipedia entry:

The Group of Thirty, often abbreviated to G30, is an international body of leading financiers and academics which aims to deepen understanding of economic and financial issues and to examine consequences of decisions made in the public and private sectors related to these issues.

The group consists of thirty members and includes the heads of major private banks and central banks, as well as members from academia and international institutions. It holds two full meetings each year and also organises seminars, symposia, and study groups. It is based in Washington, D.C.

The Group of Thirty was founded in 1978 by Geoffrey Bell at the initiative of the Rockefeller Foundation,[1] which also provided initial funding for the body. Its first chairman was Johannes Witteveen, the former managing director of the International Monetary Fund. Its current chairman of trustees is Paul Volcker.

The Group of Thirty establishes study groups to analyze issues of particular or systemic importance to the global financial markets.

July 27, 1993 – Arthur Levitt was appointed Chairman of the U.S. Securities and Exchange Commission. From wikipedia (my emphasis and added link):

At the time Levitt came to the SEC, the Financial Accounting Standards Board (FASB) had proposed requiring companies to record stock options on their income statements, which split the accounting industry and was opposed by many in the American business community. According to a Merrill Lynch study, expensing stock options would have reduced profits among leading high-tech companies by 60% on average. Congress began to exert pressure on the FASB, and on May 3, 1994, the Senate, led by Democratic Senator Joe Lieberman, offered a non-binding resolution urging FASB not to adopt the proposed rule; the vote in favor was 88-9. Concerned that insensitivity to this sentiment in Congress might threaten FASB as an independent standard setter, Levitt urged the FASB to not go ahead with the rule proposal. He later said this "was probably the single biggest mistake I made in my years at the SEC."[2]

As Levitt tells the story:

When I arrived at the Securities & Exchange Commission in mid-1993, I found nearly all of Corporate America lined up against the "gnomes of Norwalk," otherwise known as the Financial Accounting Standards Board. The controversy raged over whether companies should treat stock options as an expense against earnings on their income statements, just as they treat salaries, bonuses, and other forms of compensation. Corporations insisted they should not, since no money actually flowed from company coffers. The FASB, the independent, private-sector body located in Norwalk, Conn., that sets accounting standards, said they should. To the FASB, options had real value to their owners, and involved real costs to shareholders. In June, 1993, it voted unanimously to seek comment on a rule that would make companies put a fair value on their stock option grants and record that number as an expense.

Corporate lobbyists, outraged by the FASB’s perfidy, persuaded Congress to hold hearings. The pressure from Silicon Valley’s high-tech companies, whose lack of revenues and weak profits made cash compensation difficult, was intense. Even the Clinton administration opposed the rule.

Senator Joe Lieberman, the Connecticut Democrat who would become Al Gore’s running mate in 2000, led the charge. He introduced legislation to bar the SEC from enforcing the rule. In addition, Lieberman wanted to strip the FASB of authority by requiring the SEC to ratify each of its decisions, in effect relegating private-sector standards to mere recommendations.

Lieberman didn’t stop there. He also sponsored a Senate resolution that declared the FASB proposal a cockamamie idea that would have "grave consequences for America’s entrepreneurs." Joining him were numerous Republicans and a smaller group of so-called New Democrats who prided themselves for their pro-business positions, especially toward Silicon Valley, the fount of large campaign contributions. By saying that stock options were essential to one particular segment of the economy, they were arguing, in effect, that transparent financial statements should be secondary to other political and economic goals.

While Lieberman’s bill did not pass, his resolution did–by an overwhelming 88-9. Though it was nonbinding, it was an unmistakable signal that Lieberman had the votes to stop the FASB if it pushed ahead. I, too, was lobbied hard. In my first few months in Washington, I spent about one-third of my time being threatened and cajoled by legions of business people. I recall a discussion with Home Depot (HD ) Chairman Bernard Marcus, who became increasingly animated throughout our meeting, at the end of which he warned: "This will be a terrible blow to the free enterprise system. It will make it impossible to start up new businesses."

Such arguments did not sway me. Politics did, however. The controversy dragged on through the November, 1994, elections, which put the Republicans in charge of the House of Representatives and vaulted Newt Gingrich, the conservative lawmaker from Georgia, into the Speaker’s chair. I concluded that the rule would not survive in this atmosphere. I also worried that disgruntled companies would press Congress to end the FASB’s role as a standard-setter. To me, that would have been worse than going without the stock option rule.

At a December, 1994, meeting with FASB members in Norwalk, I urged them to retreat. I warned that if they adopted the new standard, the SEC would not enforce it. The FASB soon backed down in favor of the current, weaker rule that requires companies to disclose stock option grants in the footnotes to income statements. In retrospect, I was wrong. I know the FASB would have stuck to its guns had I not pushed it to surrender. I consider this my biggest mistake as SEC chairman.

February 24, 1994 – Long-Term Capital Management (LTCM) began trading.

May 11, 1994 – E. Gerald Corrigan, Dennis Weatherstone and Richard C. Breeden testify before the Subcommittee on Telecommunications and Finance:

From the NYT, May 11, 1994 – Panel Is Told Derivatives Are No Cause for Alarm

E. Gerald Corrigan, who as president of the Federal Reserve Bank of New York was the senior bank regulator most responsible for raising warnings about the risks of financial products called derivatives, told a Congressional subcommittee today that the potential for problems had diminished and that no new legislation was needed.

"I am hard pressed to think of sensible things that might be done through legislation that would better equip the Fed or other bodies to cope with a financial disruption of consequence," said Mr. Corrigan, who is now a senior executive with Goldman, Sachs & Company, a major dealer in derivatives.

Mr. Corrigan’s view that no new legislation is needed was echoed by the two other financial executives at today’s hearing: Dennis Weatherstone, the chairman of J. P. Morgan & Company, one of the largest derivatives dealers, and Richard C. Breeden, the chairman of the financial services practice of Coopers & Lybrand and former chairman of the Securities and Exchange Commission.

Today’s session was the first of several Congressional hearings scheduled to consider potential regulation of derivatives.

The executives’ testimony, how-ever, did not seem to ease the concerns of Representative Edward J. Markey, a Massachusetts Democrat who is chairman of the Subcommittee on Telecommunications and Finance, which held today’s hearing.

May 18, 1994 – The General Accounting Office released it’s study (GGD-94-133) on derivatives. From the executive summary:

Much OTC derivatives activity in the United States is concentrated among 15 major U.S. dealers that are extensively linked to one another, end-users, and the exchange-traded markets. This combination of global involvement, concentration, and linkages means that the sudden failure or abrupt withdrawal from trading of any of these large dealers could cause liquidity problems in the markets and could also pose risks to the others, including federally insured banks and the financial system as a whole.

GAO found that no comprehensive industry or federal regulatory requirements existed to ensure that U.S. OTC derivatives dealers followed good risk-management practices.

Federal regulators have begun to address derivatives activities through a variety of means, but significant gaps and weaknesses exist in the f regulation of many mdor OTC derivatives dealers.

Further compounding the regulators’ problems and contributing to the lack of knowledge by investors, creditors, and other market participants are inadequate rules for fanancial reporting of derivatives activity. GAO found that accounting standards for derivatives, particularly those used for hedging purposes by end-users, were incomplete and inconsistent and have not kept pace with business practices. Insufficient accounting rules for derivatives increase the likelihood that financial reports will not fairly represent the substance and risk of these complex activities.

GAO believes that innovation and creativity are strengths of the U.S. financial services industry and that these strengths should not be eroded by excessive regulation. However, GAO also believes the regulatory gaps and weaknesses that presently exist must be addressed, especially considering the rapid growth in derivatives activity, The issue is one of striking a proper balance between (1) allowing the U.S. financial services industry to grow and innovate and (2) protecting the safety and soundness of the nation’s financial system. Achieving this balance will require unprecedented cooperation among U.S. and foreign regulators, market participants, and members of the accounting profession GAO makes recommendations designed to help Congress, the regulators, and the industry address this issue.

If one of these large OTC dealers failed, the failure could pose risks to other firms-including federally insured depository institutions-and the financial system as a whole. Financial linkages among firms and markets could heighten this risk. Derivatives clearly have expanded the financial linkages among the institutions that use them an&he markets in which they trade. Various studies of the October 1987 market crash showed linkages between markets for equities and their derivatives. According to those studies, prices in the stock, options, and futures markets were related, so that disruptions in one were associated with disruptions in the others.

The concentration of OTC derivatives activities among a relatively few dealers could also heighten the risk of liquidity problems in the OTC derivatives markets, which in turn could pose risks to the financial system. Because the same reIatively few major OTC derivatives dealers now account for a large portion of trading in a number of markets, the abrupt failure or withdrawal fiorn trading of one of these dealers could undermine stability in several markets simultaneously, which could lead to a chain of market withdrawals, possible fhn failures, and a systemic crisis, The federal government would not necessarily intervene just to keep a major OTC derivatives dealer from failing, but to avert a crisis, the Federal Reserve may be required to serve as lender of last resort to any major U.S. OTC derivatives dealer, whether regulated or unregulated. Two past major fmancial disruptions have already shown liquidity problems involving securities, foreign exchange, and derivatives markets-the 1987 market crash and the 1992 turmoil in European currency markets.

The interrelationships among OTC derivatives dealers and markets worldwide increase the likelihood that a crisis involving derivatives will be global.

May 19, 1994 – Charles A. Bowsher, Comptroller General of the United States, testified before the House Subcommittee on Telecommunications and Finance and the Senate Committee on Banking, Housing, and Urban Affairs on "FINANCIAL DERIVATIVES, Actions Needed to Protect the Financial System." From his statements (T-GGD-94-150, T-GGD-94-151):

Given the gaps and weaknesses that impede regulatory preparedness for dealing with a financial crisis associated with derivatives, we recommend that Congress require federal regulation of the safety and soundness of all major U.S. OTC derivatives dealers. The immediate need is for Congress to bring the currently unregulated OTC derivatives activities of securities and insurance firm affiliates under the purview of one or more of the existing federal financial regulators and to ensure that derivatives regulation is consistent and comprehensive across regulatory agencies. We also recommend that the financial regulators take specific actions to improve their capabilities to oversee OTC activities and to anticipate or respond to any financial crisis involving derivatives.

NYT, May 19, 1994 – G.A.O. Seeks Sweeping Rules for Derivatives

A two-year Congressional study of the explosive growth in financial derivatives that was released yesterday calls for sweeping new regulation of the companies that create these often complex financial products and the companies that use them.

The General Accounting Office said the banks, brokerage firms and insurance companies that deal in derivatives should be subject to uniform rules on how to manage the risk of their trading positions, how much capital to keep to cushion against losses, and how to disclose data about their derivatives activity.

Representative Edward J. Markey, the Massachusetts Democrat who is the chairman of the House subcommittee that requested the report, endorsed its recommendations. "It is a tour de force, blistering, scalding indictment of the deficiencies in the current regulatory safeguards," he said. "They identified a regulatory black hole when it comes to derivatives."

Mr. Markey said he endorsed all the recommendations and he expected to introduce a bill to enact them this year in his subcommittee on telecommunications and finance, which oversees brokerage firms. The House banking committee is working on a separate bill to strengthen regulation of derivatives activities by banks. Congressional aides say that none of the bills are likely to pass this year.

NYT, October 9, 2008 – Taking Hard New Look at a Greenspan Legacy

“The sudden failure or abrupt withdrawal from trading of any of these large U.S. dealers could cause liquidity problems in the markets and could also pose risks to others, including federally insured banks and the financial system as a whole,” Charles A. Bowsher, head of the accounting office, said when he testified before Mr. Markey’s committee in 1994. “In some cases intervention has and could result in a financial bailout paid for or guaranteed by taxpayers.”

May 25, 1994 – Greenspan testified before the House Subcommittee on Telecommunications and Finance on the GAO report.

NYT, May 26, 1994 – Derivatives Get a Key Supporter

Strongly disagreeing with a new Congressional study, the chairman of the Federal Reserve Board, Alan Greenspan, said today there was "negligible" risk that the rapidly growing market for financial derivatives might someday require a taxpayer bailout.

In testimony before a House subcommittee, Mr. Greenspan and other senior financial regulators said there was no need for new legislation to supervise derivatives.

Derivatives are highly profitable products offered by banks and brokerage firms to corporations and investors. They are contracts with cash values that are tied to, or "derived" from, the price of financial assets like stocks, bonds, commodities or currencies. Variety of Uses

Most often, derivatives are used by companies as a form of financial insurance; they can, for example, help protect against a decline in the dollar’s value that would raise the cost of a company’s imports. Derivatives can also be used by investors as a substitute for owning securities.

Several large companies recently reported losses from unusual derivative transactions that combined normal hedging of risks with speculative bets on interest rates.

Last week, the General Accounting Office, an arm of Congress, released a study that called for vastly expanded regulation of the dealers and users of derivatives. In particular, the G.A.O. called for much closer supervision of the derivatives activities of brokerage firms and insurance companies, which are not regulated as tightly as federally insured banks.

Fears of a Bailout

The G.A.O. said that because derivatives activity was concentrated in a few big banks and brokerage firms, there was an increased possibility of a market crisis leading to a taxpayer-financed bailout that might have to be extended even to uninsured brokerage firms.

Mr. Greenspan challenged the G.A.O.’s assertion that the Government could be at financial risk. He noted that brokerage firms can borrow from the Federal Reserve’s discount window in case of emergency but he emphasized that such loans are backed by collateral and, in his view, pose virtually no risk to the Government.

Moreover, Mr. Greenspan played down the risk of derivatives to commercial banks. "There is no presumption that the major thrust of derivatives activities is any riskier, indeed it may very well be less risky, than commercial lending," he said.

Mr. Greenspan argued repeatedly that additional Government regulation was not necessary because of "private regulation" by investors, credit rating agencies and others that insist on financial soundness in those with whom they do business.

June 15, 1994 – Markey sent Levitt a letter requesting information on derivative use by mutual funds. The SEC replied on September 26, 1994.

NYT, June 16, 1994 – S.E.C. Asked to Study Derivatives in Funds

Reacting to recent sharp price drops for several supposedly low-risk mutual funds, the chairman of the House subcommittee with securities oversight asked the Securities and Exchange Commission yesterday for a comprehensive study of such funds’ use of the complex financial instruments known as derivatives.

Representative Edward J. Markey, a Massachusetts Democrat who heads the House subcommittee on telecommunications and finance, has recently held a series of hearings into the regulatory issues posed by the growth of derivatives.

Derivatives are a broad family of new financial products whose value is based on, or derived from, the movement in a financial market, such as stocks, bonds, currencies and commodities. Mutual funds often substitute derivatives for other investments, often in the form of structured notes, which are bonds whose value is linked to an index of the stock market, or some other asset.

Most mutual funds that have gotten into trouble recently have held mortgage derivatives, which are complex bonds backed by pools of home mortgages. Many of these securities were offered with unusually high interest rates, but their principal value has eroded substantially in recent months as interest rates have risen.

For example, the Paine Webber short-term government bond fund fell 4 percent in one day, mainly because of illiquid mortgage derivatives.

He also asked whether funds were taking too much risk to raise their yield, and whether derivatives posed problems because they were hard to value and were sometimes hard to sell and more leveraged than was generally permitted for mutual funds.

July 1994 – From the CPA Journal: Derivative financial instruments: time for better disclosure.

The growing size and complexity of the derivatives market has prompted calls for improved reporting of information about derivative activities. Derivatives, such as swaps, forwards, futures, calls, floors, collars and puts, are financial instruments that derive their values from an underlying asset, reference rate or index. They are often used by government entities, corporations, financial institutions, institutional investors and nonprofit organizations to manage exposures stemming from their asset and liability mix. In response to rising public concern about these very complex products, the FASB has embarked on a limited-scope project on derivative activity disclosures. As part of this project, the Board has issued the exposure draft, ‘Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,’ to enhance such disclosures and make technical improvements to the disclosures in time for 1994 year-end reporting.

July 13, 1994 – Markey introduced H.R.4745, "To provide a framework for Securities and Exchange Commission supervision and regulation of derivatives activities, and for other purposes." (co-sponsor Mike Synar). From the CRS summary:

Derivatives Dealers Act of 1994 – Amends the Securities Exchange Act of 1934 (the Act) to define "derivatives dealer," "material associated person," and "person associated with a derivatives dealer" so as to include derivatives dealers affiliated with securities and insurance firms.

Title I: Derivatives Dealers – Sets forth: (1) registration and notice requirements for derivatives broker/dealers and material associated persons of such broker/dealers; (2) Securities and Exchange Commission (SEC) rulemaking authority over derivatives dealers; and (3) membership requirements in a registered securities association for derivatives dealers.

Title II: Broker-Dealer Oversight Reforms – Authorizes national securities exchanges and registered securities associations to prescribe internal rules and enforcement guidelines for members engaged in derivatives transactions and for material associated persons.

Requires SEC financial responsibility rules to include maintenance of sufficient capital levels taking into account selected activities of any registered derivatives dealer that is a material associated person of a broker or dealer.

Includes within SEC risk assessment guidelines the derivatives transactions of government and municipal securities broker/dealers, and of registered broker/dealers.

September 26, 1994 – The SEC responded (pdf) to Markey’s letter of June 15, 1994:

Mutual funds are the investment vehicle of choice for funding Americans’ essential needs — for educating their children, for retiring with dignity. The Commission considers the protection of mutual fund investors absolutely essential. We have been, and will be, vigilant in addressing the issues raised by mutual fund use of derivatives, and we look forward to working with you in this endeavor.

This memorandum makes a number of recommendations for further action by the Commission to address mutual fund use of derivatives. The principal recommendations are the following:

  • The Commission should consider requiring some form of quantitative risk measure in mutual fund prospectuses and should seek public comment on this topic no later than early 1995.
  • The Commission should promptly consider reducing the ceiling on fund illiquid holdings. In addition, the Commission should continue to evaluate liquidity and pricing issues raised by derivatives through the mutual fund inspection process. If it appears appropriate as a result of these inspections, the Commission should consider issuing rules to address matters such as proper procedures for mutual fund pricing and liquidity determinations.
  • The Commission should reexamine the application of the leverage restrictions of the Investment Company Act of 1940 ("Investment Company Act" or "Act") -[7]- to derivative instruments and should seek public comment on whether regulatory and legislative solutions are necessary to address the leverage created by mutual fund use of derivatives.
  • The Commission should recommend that Congress enact legislation to enhance the Commission’s ability to obtain information required to monitor fund use of derivatives.

September 26, 1994 – Financial Economists Roundtable release Statement on Derivative Markets and Financial Risk

In response to the GAO Report, Rep. Edward Markey (D., Mass.) has introduced legislation that would require unregulated derivatives dealers, such as those affiliated with securities and insurance companies, to register with the SEC. The SEC would set capital and other standards for these dealers, conduct inspections or examinations of the dealers, and receive periodic financial reports from them. In addition, by amending the definition of the term "security" to include derivatives based on the value of any security, this bill would enlarge the SEC’s regulatory purview. Other proposed legislation, introduced by Rep. Henry B. Gonzales (D., Tex.) and Rep. Jim Leach (R., Iowa), respectively the chairman and ranking Republican of the House Banking Committee, would expand regulation of financial institutions engaged in derivatives activities.

Do OTC derivatives justify the concern which underlies the GAO Report and the proposed legislation? While one cannot rule out the possibility of a systemic crisis in almost any financial market, the Financial Economists Roundtable believes that the use of OTC derivatives does not justify the current fear that they might cause a systemic meltdown. Moreover, members of the Roundtable worry that precipitous and unnecessary government intervention directed at preventing such a possibility may create rigidities that impede the responsiveness of markets in times of stress.

The best discipline against systemic risk in any market, including derivatives, is to foster a market in which participants have an incentive to manage themselves prudently and can respond quickly and innovatively to market conditions.

The signatories are an amazing list of economists, with some amusing entries for example, Myron Scholes and Robert C. Merton, Nobel Memorial Prize winners and co-founders of Long Term Capital Management. What is not so amusing is some of the advice they gave to Congress and to the regulatory agencies.

November 1994 elections – the Democrats lost control of both the House and Senate.

December 6, 1994 – Orange County, California was forced to declare bankruptcy due to the loss of over.5 billion in derivatives by treasurer Robert Citron.

NYT, December 8, 1994 – ORANGE COUNTY’S BANKRUPTCY: THE TEMPTATIONS; The Search for Municipal ‘Cowboys’

The securities creating most of the problems at municipalities around the country are mortgage-backed derivatives. These are tailor-made securities created by dividing pools of mortgages into newly repackaged instruments, some of which move in the same direction as interest rates, some in the opposite direction.

In all cases, though, their central attraction is that they take simple interest rate swings and accelerate the moves.

Best of all from Wall Street’s point of view, these derivatives are highly profitable products for brokers to sell to local officials, who, many now say, did not fully understand what they were buying.

"All major Wall Street firms sold this stuff and anyone who now says they didn’t handle derivatives is not telling you the truth," said Guy Cecalla, publisher of Inside Mortgage Securities, an industry newsletter.

January 11, 1995 – Robert Rubin became United States Secretary of the Treasury. From wikipedia’s entry on Rubinomics:

During the early 1990’s, long-term interest rates remained stubbornly high even as the Federal Reserve cut the Federal Funds rate. Rubin and most other economists (including Alan Greenspan) attributed this high yield curve to an "inflation premium" that bond-traders were demanding. Reducing interest rates, Rubin argued, would lead to increased private sector investment and consumption and, therefore, stronger growth. Clinton, who had campaigned on the promise to put people first and invest in human capital, accepted Rubin’s reasoning and put deficit reduction at the forefront of his economic plan, to the chagrin of more liberal advisers such as Robert Reich and Joseph Stiglitz. In particular, Stiglitz (recipient of the 2001 Nobel Prize in Economics) was not opposed to Clinton’s plan to reduce the deficit, but suggested that Clinton put less money into deficit reduction and more into research and development, technology, infrastructure, and education, quoting "given the high returns for these investments, GDP in 2000 would have been even higher, and the economy’s growth potential would have been stronger."

February 27, 1995 – Representative James A. Leach introduced H.R.1062 ("Financial Services Competitiveness Act of 1995" to modernize Glass-Steagall) a revised version of H.R. 18 which had been introduced on January 4, 1995. After hearings (June 6, 1995 and March 15, 1995) it died in committee.

March 1995 – The Derivatives Policy Group representing CS First Boston (William P. Bowden, Jr.), Goldman Sachs (E. Gerald Corrigan, Jacob D. Goldfield), Morgan Stanley (Peter Karches), Merrill Lynch (John G. Heimann, David H. Komansky), Salomon Brothers (John G. Macfarlane, III), and Lehman Brothers (Thomas A. Russo) released their report, Framework for Voluntary Oversight:

The "Derivatives Policy Group" (DPG) was formed at the suggestion of Chairman Arthur Levitt of the SEC in August, 1994. Shortly after its inception, Mary L. Schapiro, Chairman of the Commodity Futures Trading Commission, joined Chairman Levitt as the principal official sector contacts for the DPG.

The DPG was organized to respond to the interest that has been expressed by Congress, agencies and others with respect to public policy issues raised by the OTC derivatives activities of unregulated affiliates of SEC-registered broker-dealers and CFTC-registered futures commission merchants. These issues include the understandable interest in more meaningful information regarding the risk profile of professional intermediaries and the quality of their internal controls as well as a clearer articulation of the nature of their relationships with nonprofessional counterparties and related transactional responsibilities. The DPG’s objective has been to formulate a voluntary oversight framework intended to address these public policy issues.

March 1995 – Less than 2 months after becoming Secretary of the Treasury, Rubin asked Congress to repeal the Glass-Steagall Act and to change the Bank Holding Company Act of 1956.

White House Is Joining in Efforts To Loosen the Limits on Banking

The Clinton Administration plans to call this week for legislation that would allow commercial banks, securities firms and insurance companies to merge, forming giant financial services companies that would offer everything from checking accounts to mutual funds and life insurance, Federal officials say.

In a speech prepared for delivery in New York on Monday and in Congressional testimony scheduled for Wednesday, Treasury Secretary Robert E. Rubin will urge Congress to repeal the Depression-era Glass-Steagall Act, the officials said. For more than 60 years, the law has forced financial concerns to choose between owning commercial banks or owning securities companies like brokerage firms and investment banks, but not both.

Mr. Rubin also plans to call for broad changes in the Bank Holding Company Act of 1956, which has effectively barred most financial concerns from owning both commercial banks and insurance companies, said the Federal officials, who spoke on condition of anonymity. Mr. Rubin’s speech will represent the first time that the Administration has taken a position on eliminating the legal and regulatory barriers among financial industries.

Regulatory changes in recent years have already allowed commercial banks, like Citibank, to begin selling stocks and mutual funds on a limited basis. But the Glass-Steagall Act still bars Citibank, for example, from merging with a brokerage firm like Merrill Lynch or an investment bank like Goldman, Sachs, which provides corporate investment advice and helps companies issue stock. The Bank Holding Company Act bars Citibank fom merging with a big insurance company like Prudential.

Rubin stayed at Treasury until his retirement in 1999. He was the “greatest secretary of the Treasury since Alexander Hamilton,” according to Clinton. Also in 1999, Rubin joined Citigroup. From wikipedia:

Of note, the supermerger between Travelers Group and Citicorp was facilitated by the repeal of the Glass Steagall Act (Gramm-Leach-Bliley Act).

October 1995 – CME funded report is published, Derivatives: State of the Debate

November 21, 1995 – Financial Economists Roundtable releases Statement on Accounting Disclosure About Derivative Financial Instruments. Included in their recommendations:

All financial assets and liabilities should be recorded at "fair value", i.e. marked to market, except for derivative positions established to hedge cash flows related to nonfinancial assets or to future expenditures. When prices cannot be directly observed in the market by reference to liquid instruments, marking to market entails the use of models to infer fair value.

From wikipedia:

During their early development, OTC derivatives such as interest rate swaps were not marked to market frequently. Deals were monitored on a quarterly or annual basis, when gains or losses would be acknowledged or payments exchanged.

As the practice of marking to market caught on in corporations and banks, some of them seem to have discovered that this was a tempting way to commit accounting fraud, especially when the market price could not be objectively determined (because there was no real day-to-day market available), so assets were being ‘marked to model’ using estimated valuations derived from financial modeling, and sometimes marked to spurious valuations. See Enron and the Enron scandal.

March 4, 1997 – The Senate Banking Committee Subcommittee on Securities (chaired by Gramm) held a hearing on "SEC and FASB Derivatives Accounting Rules." Witnesses were: Thomas D. Logan (Basic American, Inc. and Treasury Management Association), Patrick M. Montgomery (Ullico and Treasury Management Association), Kenneth Lehn (Former Chief Economist, SEC), William P. Miller II (Association for Investment Management and Research), Joseph Bauman (ISDA) and Steven M. H. Wallman (SEC).

From Wallman’s prepared statement:

I am pleased to appear today to testify on behalf of the Securities and Exchange Commission ("Commission" or "SEC") regarding rules, adopted by the Commission on January 28, 1997, that require certain disclosures about market risk sensitive instruments. These disclosures are an important step in improving investor understanding of the market risks facing public companies and how individual companies manage those risks.

During the last several years, the use of market risk sensitive instruments increased substantially. Indeed, these instruments are more common now than ever before for companies in many different industries. Illustrative of this increased use is the growth of worldwide notional/contract amounts for derivatives from.1 trillion in 1989 to.9 trillion in 1995.

The Commission recognizes that derivatives often are used as effective tools for managing exposures to market risk. over the past several years, these instruments have been used to mitigate the potential losses to American businesses from significant changes in interest rates, foreign currency exchange rates, and commodity prices. Derivatives allow companies to change their market risk profile in an effective and efficient manner by shifting a specific risk from themselves to others who seek to accept and manage that risk.

Due to the growth in the use of derivatives, the Commission believes it has become more important to discern from current disclosures the risk profile of a registrant. Moreover, the last time there were major movements in interest rate and foreign currency markets, several headline stories about losses from derivatives and other market risk sensitive instruments by corporate end-users and dealers alike surprised investors and the markets. These stories include the losses incurred by Bankers Trust, Dell Computers, Gibson Greetings, and Proctor & Gamble, among others. The surprise accompanying such losses demonstrates the need for more public disclosure of what market risks are and how the registrants in which the public invests its money are managing those risks.

March 1997 – Levitt’s SEC exempted some of Enron’s partnerships from accounting controls of the depression era Investment Company Act of 1940.

NYT, "ENRON’S COLLAPSE: REGULATIONS; Exemption Won In ‘97 Set Stage For Enron Woes."

Enron’s initial efforts in 1996 to persuade Congress to change the law were thwarted by opposition from a powerful trade group and some federal regulators. The company responded by hiring the former boss of a leading staff official at the Securities and Exchange Commission to represent it in negotiations with the agency. In an unheralded five-paragraph order in March 1997, the S.E.C. official, Barry P. Barbash, gave Enron’s foreign operations a broad exemption from the law — the Investment Company Act of 1940.

How Enron came to get its exemption from the severe restrictions of the law clearly illustrates the ways the company lobbied Washington and the response by the regulatory system. That system was devised during the Depression to protect investors and customers of utilities from a wide range of corporate abuses that investigators think ultimately took place at Enron.

Arthur Levitt, who was the chairman of the S.E.C. when the 1997 exemption was granted, said today that he had no recollection of it. But he said it could be a potentially significant part of the agency’s role in failing to oversee Enron.

April 15-17, 1997 – The House Committee on Agriculture Subcommittee on Risk Management and Specialty Crops held a three day hearing to "Review Reform of the Commodity Exchange Act and provisions of H.R. 467, the Commodity Exchange Act Amendments of 1997." Witnesses included Born (CFTC).

June 27, 1997 – President Clinton nominated Gary Gensler, managing director at Goldman Sachs, to Assistant Secretary for Financial Markets of the Treasury.

October 22, 1997 – The House Committee on Agriculture Subcommittee on Risk Management and Specialty Crops held a hearing to "Review The Commodity Futures Trading Commission’s Government Performance Results Act Plan." Witnesses included Born (CFTC).

April 21, 1998 – Brooksley Born meeting with Rubin, Greenspan and other regulators. As described in the NYT (also see below):

Opaque trading and hard-to-value derivatives tied to mortgage loans and other forms of credit have been one of the underlying causes of the current financial crisis. One former commodities commission official argues that a different approach to derivatives regulation in 1998 would have helped avert the worst of today’s credit crisis.

“Stopping this let the momentum build and led to subprime as well as soaring commodity prices today because unregulated derivatives trading soared after that,” says Michael Greenberger, then director of trading and markets at the Commodity Futures Trading Commission and now a professor of law at the University of Maryland.

At an April 21, 1998, meeting with Brooksley Born, the chairwoman of the commodities commission, Mr. Rubin made no secret of his feelings about her proposal. “It was controlled anger. He was very tough,” Mr. Greenberger recalls. “I was at several meetings with him, and I’ve never seen him like that before or after.” Ms. Born didn’t return calls for comment.

Mr. Rubin says he was against the proposal because he feared it could create chaos in the markets, rather than actually improve oversight of derivatives. He says he believes that the financial system could benefit from better regulation of derivatives, perhaps in the form of more disclosure and new rules requiring individuals and firms to put more money down when they trade.

But during his time in Washington, he says, “the politics would have made this impossible. Even if I’d taken a placard and walked up and down Pennsylvania Avenue saying the financial system would come to an end without strict regulation of derivatives, I would have had no traction.”

Mr. Greenberger is unbowed: “What do we have now, if not chaos in the markets?”

April 29, 1998 – The House Committee on Banking and Financial Services, chaired by Leach, held a hearing on banking mergers, including Citicorp-Travelers.

May 7, 1998 – From the history of the CFTC in the 1990’s:

The CFTC issues a "concept release" seeking public comments to assist it in reexamining its approach to the over-the-counter (OTC) derivatives market. After an extended public comment period and much discussion among the members of the Working Group, Congress passes legislation (part of an October 1998 appropriations bill) temporarily preventing the CFTC from taking further action. Congress eventually creates legal certainty for OTC derivatives in the Commodity Futures Modernization Act of 2000. (CFTC Press Release 4142-98, May 7, 1998)

Comments submitted to the CFTC in response to their "concept release" have been made available to the public.

Also on May 7, 1998, and in response to the CFTC concept release, Rubin, Greenspan and Levitt issued a joint statement expressing "grave concerns about this action and its possible consequences."

From the NYT:

Ms. Born was concerned that unfettered, opaque trading could “threaten our regulated markets or, indeed, our economy without any federal agency knowing about it,” she said in Congressional testimony. She called for greater disclosure of trades and reserves to cushion against losses.

Ms. Born’s views incited fierce opposition from Mr. Greenspan and Robert E. Rubin, the Treasury secretary then. Treasury lawyers concluded that merely discussing new rules threatened the derivatives market. Mr. Greenspan warned that too many rules would damage Wall Street, prompting traders to take their business overseas.

“Greenspan told Brooksley that she essentially didn’t know what she was doing and she’d cause a financial crisis,” said Michael Greenberger, who was a senior director at the commission. “Brooksley was this woman who was not playing tennis with these guys and not having lunch with these guys. There was a little bit of the feeling that this woman was not of Wall Street.”

In early 1998, Mr. Rubin’s deputy, Lawrence H. Summers, called Ms. Born and chastised her for taking steps he said would lead to a financial crisis, according to Mr. Greenberger. Mr. Summers said he could not recall the conversation but agreed with Mr. Greenspan and Mr. Rubin that Ms. Born’s proposal was “highly problematic.”

On April 21, 1998, senior federal financial regulators convened in a wood-paneled conference room at the Treasury to discuss Ms. Born’s proposal. Mr. Rubin and Mr. Greenspan implored her to reconsider, according to both Mr. Greenberger and Mr. Levitt.

Ms. Born pushed ahead. 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. Mr. Levitt says he now regrets that decision. Mr. Greenspan and Mr. Rubin were “joined at the hip on this,” he said. “They were certainly very fiercely opposed to this and persuaded me that this would cause chaos.

Ms. Born soon gained a potent example. In the fall of 1998, the hedge fund Long Term Capital Management nearly collapsed, dragged down by disastrous bets on, among other things, derivatives. More than a dozen banks pooled.6 billion for a private rescue to prevent the fund from slipping into bankruptcy and endangering other firms.

Despite that event, Congress froze the Commodity Futures Trading Commission’s regulatory authority for six months. The following year, Ms. Born departed.

In November 1999, senior regulators — including Mr. Greenspan and Mr. Rubin — recommended that Congress permanently strip the C.F.T.C. of regulatory authority over derivatives.”

June 16, 1998 – In response to the CFTC concept release, Congress also acted. H.R. 4062, "The Financial Derivatives Supervisory Improvement Act of 1998" was introduced by James Leach (co-sponsors: Spencer Bachus, Paul Kanjorski, John LaFalce, Bob Riley, Marge Roukema, Vince Snowbarger) and hearings were immediately held.

July 17, 1998 – The House Committee on Banking and Financial Services, chaired by Leach, held the first of two hearings on H.R. 4062, "The Financial Derivatives Supervisory Improvement Act of 1998" and H.R. 4062, "The Financial Contract Netting Improvement Act."

From Dennis Oakley’s opening statement (an example of the threats Congress was getting about the industry moving out of the USA):

Dennis Oakley, and I am a Managing Director of the Chase Manhattan Bank with responsibility for the mitigation of Chase’s risk in foreign exchange and derivatives markets. Chase Manhattan, with 6 billion in assets, is the Nation’s largest bank holding company. I am pleased to have this opportunity to be here today to discuss new legal risk to the derivatives market raised by recent actions of the Commodity Futures Trading Commission.

Derivatives are financial contracts that allow banks, corporations and other entities to hedge various risks, such as interest rate and currency risk, equity or commodity risk. To meet our customers’ needs, we are a dealer of over-the-counter derivatives which are structured to precisely hedge those risks the customer does not wish to bear. We hold the world’s largest portfolio of FX and derivatives measured by notional principal amount which, as of March 31, 1998, stood at.2 trillion.

The reason I am here today is that while we are confident of our ability to manage the financial risk of derivatives, actions taken by the CFTC have brought into question our ability to manage the legal risk in one of our primary booking locations, the United States. Chase, with a large portion of its derivatives portfolio booked in the United States, cannot remain complacent about new risk. We owe it to our depositors and shareholders to take any necessary action to minimize risk.

Let me be frank. If the legal uncertainty posed by CFTC assertions of jurisdiction is not removed, Chase will be forced to move this business to another location, probably London, where we don’t have the specter of legal jeopardy that has been raised by the CFTC. A substantial portion of this business is mobile. In the case of products done with individual customers, if the customers are in the U.S. and we can’t avoid the legal uncertainty by booking the business outside the U.S., we may stop doing the business with U.S. customers. That will make certain risk management products unavailable to them. In the case of clearing systems, if U.S. law makes it unattractive to locate the facilities in the United States, we will support siting them in London and use them from our London branch.

We at Chase are pleased with the actions taken by the Chairman of the Federal Reserve, the Secretary of Treasury and the Chairman of the Securities and Exchange Commission on these issues. We supported their initial expression of concern and their proposed legislation when the CFTC first issued their Concept Release. We especially appreciate the approach taken by you, Mr. Chairman, in H.R. 4062 and your prior efforts attempting to avoid both this hearing today and the need for any legislation through a written agreement between the appropriate Federal agencies

From Wendy Gramm’s opening statement:

The observations I have come from two perspectives. As former Chairman of the CFTC, when the regulations, laws and policy statements concerning swaps, hybrids and other derivatives were written, and currently as Director of the Public Interest Comment Program at the James Buchanan Center for Political Economy, whose objective is to provide policymakers with information about the impact of regulations on society. The first point I want to make today is that regulations impose costs, in the form of the added costs of doing business or in indirect form by creating uncertainty, inhibiting legitimate and beneficial activity, or stifling innovation. If these regulatory costs exceed the benefits, firms will be less able to compete effectively on world markets.

Financial markets, especially derivatives markets, are extremely sensitive to unnecessary regulatory cost since technology and competition have made it easy for firms anywhere in the world to develop and offer products and services to customers regardless of national boundaries. There are many good examples of how regulatory uncertainty can and has affected the derivatives business, and my written testimony gives some. One example also provides some important history for the current debate.

In December 1987, the CFTC issued an advance notice of proposed rule-making suggesting that the Commodity Exchange Act applied to swaps and hybrid instruments. As a result of this release and an accompanying enforcement case concerning oil swaps, the U.S. commodities swap business went overseas.

There was also much uncertainty in the interest rate swap market which prevailed until the CFTC published its swaps policy statement in July of 1989 that removed some of the regulatory uncertainty by establishing a safe harbor for swaps. The uncertainty was further reduced with rule-makings, statutory interpretations and, of course, reauthorization—the Futures Trading Practices Act of 1992 and its implementing regulations. This set the stage for the return of the commodity swaps business back to the United States and to further development of the over-the-counter derivatives and swaps markets in the U.S.

Now, much has been said about the growth of the OTC swaps market since 1993, and the CFTC has stated in its recent Concept Release that it is reviewing all these regulations in part because of the rapid growth and changes in this market during the past five years. But the growth in this market is not surprising; it is what was expected to happen. The whole point of all the rule-makings and the law was to provide regulatory certainty through safe harbors within which these markets could develop. Indeed, we would have been surprised if these markets had not grown.

And as for change, of course markets and conditions change. That is a fact of life in a competitive and dynamic world. I thus question why the CFTC feels the need to raise questions concerning the regulation of swaps.

July 24, 1998 – The House Committee on Banking and Financial Services, chaired by Leach, held the second of two hearings on H.R. 4062, "The Financial Derivatives Supervisory Improvement Act of 1998" and H.R. 4062, "The Financial Contract Netting Improvement Act." Witnesses included both Greenspan (Fed) and Born (CFTC).

From Leach’s opening statement:

I would just like to say just by opening that this is one of the most unusual circumstances I have ever confronted as a Member of Congress. What we have is a disorderly institutional situation coupled with the potential of market disorder in one of the most extraordinary areas of commerce the world has ever known.

In terms of institutional disorder, we have three significant institutions of regulation, the United States Department of the Treasury, the Federal Reserve Board and the Securities and Exchange Commission, which are in disagreement with a fourth regulator, the Commodity Futures Trading Commission.

From Greenspan’s opening statement:

…the Board continues to believe that aside from safety and soundness regulation of derivative dealers under the banking or securities laws, regulation of derivatives transactions that are privately negotiated by professionals is unnecessary. Regulation that serves no useful purpose hinders the efficiency of markets to enlarge standards of living.

From Born’s opening statement:

The Commodity Exchange Act vests the CFTC with exclusive jurisdiction over futures and commodity option transactions. The reach of the Act extends to both exchange-traded futures and those that are sold over-the-counter, as well as options both on and off exchange.

The Act generally contemplates that futures and commodity options are to be sold through Commission-regulated exchanges. Transactions in OTC futures and options, in contrast, generally have been prohibited unless explicitly exempted from the exchange trading requirement of the CEA.

The CEA itself specifically exempts certain types of OTC derivatives from the requirements of the Act. It also authorizes the Commission to grant additional exemptions subject to such terms and conditions as are appropriate in the public interest. Pursuant to this statutory authority, the Commission adopted regulations in 1993 exempting certain swap agreements and hybrid instruments from some, but not all, provisions of the Act subject to specified terms and conditions.

The Commission’s regulations exempt certain swaps from provisions of the Act other than the antifraud provisions, the antimanipulation provisions, and Section 2(a)(1)(B). To be eligible for exemptive treatment, a swap must be a customized bilateral agreement between financially sophisticated persons or institutions. Exempt swaps may not, under the regulations, be traded on an exchange or be cleared through a clearinghouse.

In order to examine whether its regulatory framework relating to OTC derivatives remains appropriate in light of these recent market developments, the Commission issued a Concept Release on OTC derivatives on May 7, 1998. The Concept Release seeks public comment on whether the Commission’s current exemptions for swaps and hybrid instruments remain appropriate as to the definitions of eligible transactions and eligible participants and the prohibitions against swaps clearing and exchange trading. It asked whether the current prohibitions on fraud and manipulation in swaps transactions are adequate to protect the public interest, or whether the Commission should consider additional terms and conditions such as registration, sales practice provisions, recordkeeping or reporting.

The Concept Release does not propose any modification in the Commission’s regulations, nor does it presuppose that any modification is needed. It merely poses questions for public comment by OTC derivatives dealers, end-users, futures and option exchanges, other Federal regulatory agencies and other interested persons. The Commission states in its Concept Release that it is open to evidence in support of broadening its exemptions, evidence indicating a need for additional safeguards and evidence for maintaining the status quo.

In the event the Commission were eventually to determine that regulatory changes were needed, proposed changes would first be published for public comment before any final rules would be considered for adoption. Moreover, as the Concept Release states, any changes which impose new regulatory obligations or restrictions would be applied prospectively only.

The Concept Release explicitly states that it does not in any way alter the current status of any transaction under the CEA or the Commission’s regulations. All currently applicable exemptions, interpretations and policy statements issued by the Commission regarding OTC derivatives remain in effect and may be relied upon by market participants.[my emphasis -s]

Finally, there is no emergency. The Commission’s Concept Release did not alter the legal status of any OTC derivative instruments. It has not proposed any action whatsoever, and it has not caused market disruption.

Some comments from the testimony:

Ms. BORN. That is the position of the Commission. It voted unanimously this morning to take that position. Maybe it would be useful to just state that essentially what the Commission has decided is that it will not propose or issue new regulations to regulate swaps and hybrid instruments prior to Congress’ reconvening in 1999, except as necessary in an emergency.

Mr. GREENSPAN. I might add that I happen to agree with the Under Secretary, but we ought to make certain that Brooksley Born gets three times the time that any of the three of us get, because this is scarcely an even balance, if I may point out.

I am concerned that we are dealing with a situation which reminds me of the emergence of the Eurodollar market many, many decades ago, which essentially occurred as a result of a regulatory action on the part of the United States, and set up the beginnings of a market abroad which, once it got started, it didn’t turn around.

So what my concern would be is that if we essentially create an exodus of derivative activities from the United States, I think it will be exceptionally difficult to get them back, no matter what we do. And it may well be that this concept letter is merely raising hypothetical issues, but if somebody says to me, I’m contemplating punching you in the nose, I don’t presume that that is a wholly neutral statement. My inclination is to pack up and move to another neighborhood.

Ms. BORN. If I my just add, I think what we are saying is, in——

Mr. LAFALCE. You don’t intend to punch Dr. Greenspan in the nose, do you, Ms. Born?

Ms. BORN. It is more correctly stated, do you think you need a punch in the nose? That is the question that is being asked.

Mr. GREENSPAN. I will yield to your interpretation.

Mr. HAWKE. I would say that the implication is that if the answer to that question is yes, then the Commission has said it has the full authority to administer that punch.

Ms. BORN. Let me just add that our economists who follow the OTC derivatives markets have been looking for any empirical evidence of disruption in the markets or flow of transactions offshore and have not seen any ascertainable evidence of that to date. They have been watching this since the beginning of the year.

Ms. BORN. Addressing your last issue first, Mr. LaFalce, competitive regulatory laxity as a problem, let me just say that shortly after we issued our Concept Release in May, I was contacted by a number of foreign regulators of derivatives. You know, all of us are members of IOSCO, the International Organization of Securities Commissions, to say how much they welcomed our raising these questions about these markets.

They said they, too, felt that it was very important to study these markets carefully and to think about the appropriate regulatory regime. A number of them suggested to me that this was a particularly appropriate thing for international regulators to raise because they stated that whenever they had raised issues in their own country, participants in the market in that country said they would move overseas if those questions were raised.

With respect to the effectiveness of the working group, I, too, was at the meeting of the working group where Secretary Rubin and Chairman Greenspan stated opposition to our issuance of the Concept Release. Secretary Rubin stated we should not issue it because we had no statutory authority relating to any off-exchange transactions.

I asked for the legal analysis that was the basis of that opinion. The Treasury Department said they would provide that to us. We waited for about three weeks, and never yet received any legal analysis, including legal analysis that could form the basis for the statement that the Commission has no off-exchange authority. Indeed, we have been bringing enforcement actions against illegal off-exchange transactions for decades.

Mr. HINCHEY. I remember as a new member of the State Legislative Banking Committee in Albany seeing how some very large banks took the opportunity during the New York City financial crisis, when the city was about to go into bankruptcy, to sell city instruments to unsuspecting customers, and I think that is at the heart of questions that are being raised here with regard to these instruments. Is it possible that somebody could be hurt.

Now, Ms. Born raised the issue of Orange County and Procter & Gamble, and if the Chairman would allow me another few seconds, I would ask you, Ms. Born, who was hurt by the Procter & Gamble situation? Who lost money? A lot of money changed hands in that situation.

Ms. BORN. It was the shareholders, and with respect to Orange County, it was the taxpayers of Orange County whose money was lost. These are pension funds that are being invested in these markets. These are insurance funds that are being invested in these markets. These are mutual funds that at this point most of us have some interest in.

Mr. HINCHEY. In other words, in many cases the life savings of ordinary people?

Ms. BORN. Exactly.

Mr. HINCHEY. Which are increasingly being placed in jeopardy, and they have nothing to say about the manner in which that is being done and they have no one to turn to to represent their interests in these particular transactions; is that an accurate statement?

Ms. BORN. Yes.

Mr. BENTSEN. I am curious why you didn’t, and maybe you didn’t think that this would cause the firestorm that it did, but I am curious why you didn’t maybe do this in conjunction with your fellow regulators, much like they have done with respect to CRA or TELA or RESPA or any of the other financial acronyms that we have so that there would be some broad ownership and we wouldn’t get into this jurisdictional question.

Ms. BORN. Let me respond by first reminding you that in March the other regulators through the President’s Working Group said they did not want to do a study as a group of these issues.

Second, in our Concept Release we have made it very clear that in areas where other regulators are operating and operating well, such as prudential oversight of some of the institutions that are in these markets by the banking regulators and the SEC, we proposed that we should defer to them and ask for comment on that as well, and that certainly would be my personal predisposition.

The problem is that there are many, many, many other participants in these markets who are not commercial banks, who are not broker-dealers, who are not subject to the oversight of any of the financial regulators.

July 30, 1998 – The Senate Committee on Agriculture, Nutrition, and Forestry held a hearing "Concerning the Regulation of the Over-the-Counter Derivatives Market and Hybrid Instruments."

Note: I’d like to read the transcript for this hearing, but can’t seem to find it (I think the number is: 105-0998, if anyone can get me a copy – thanks!).

From Levitt’s written statement:

The recent concept release on OTC derivative instruments issued by the Commodity Futures Trading Commission ("CFTC") represents a significant departure from the careful approach taken by the SEC and other regulators to the OTC derivatives market.2 In its concept release, the CFTC raises the possibility of applying a comprehensive regulatory regime to transactions involving swaps and hybrids as a condition for exempting such products from the requirements of the Commodity Exchange Act ("CEA"). Such a regulatory regime would necessarily be based on the CFTC’s conclusion that swaps and hybrids are futures contracts or commodity options and, as such, are subject to CFTC jurisdiction under the CEA.

I joined the other members of the President’s Working Group — Treasury Secretary Rubin and Chairman Greenspan of the Federal Reserve Board — in objecting to the issuance of the CFTC’s concept release, citing grave concerns about the possible consequences of the CFTC’s action.3 In particular, these concerns focus on the risk that the CFTC’s action may increase the legal uncertainty concerning swaps and other OTC derivative instruments and, thus, destabilize what has become a significant global financial market. Uncertainty created by the CFTC’s concept release and concerns about the imposition of new regulatory costs also may stifle innovation and push transactions offshore.

August 10, 1998 – From the month’s CRS Report for Congress Banking and Finance: Legislative Initiatives in the 105th Congress, Second Session:

Regulation of Futures and Derivatives Markets Current interest focuses on the existence of two competing markets: the exchange-traded futures and options market, regulated by the Commodity Futures Trading Commission (CFTC), and the over-the-counter (OTC) derivatives, or swaps market,which is largely unregulated. The most popular contracts in both markets are financial instruments that gain and lose value as interest rates change. Two paths are being considered: to deregulate the exchange market, or to increase regulation of the OTC market. H.R. 467 and S. 257 would permit the exchanges to create unregulated “professional” markets, to allow them to compete with swaps on a level playing field. In May 1998, the CFTC published a “concept release” exploring the possibility of bringing the swaps market under its regulation. This initiative drew protests from other regulators: H.R. 4062 directs the CFTC not to pursue its unilateral investigation of the market but to cooperate with other regulators to study the adequacy of current supervision of the swapsmarket.

During this time, the CFTC was pressured not only by senior members of the Clinton administration and Congress, but also from industry sources. One such example was the The International Swaps and Derivatives Association, Inc. (ISDA), a trade organization representing primary members such as Bank of American and Bank of Boston.

September 23, 1998 – The International Swaps and Derivatives Association, Inc. (ISDA) wrote to the CFTC to claim that:

Swaps are not subject to regulation under the CEA because they are not futures contracts. The mere clearing of privately-negotiated swapsdoes not convert them into futures contracts subject to the CEA. Accordingly, ISDA believes that to the extent the LCH petition provides merely for the clearing of swaps, the Commission has no jurisdiction

September 1998 – After losing.6 billion in less than four months, Long-Term Capital Management, was bailed out in a deal organized by the Federal Reserve Bank of New York.

October 8, 1998 – President Clinton nominated Gary Gensler to Under Secretary for Domestic Finance of the Treasury:

Mr. Gary Gensler, of Baltimore, Maryland, currently serves at the Treasury Department as Assistant Secretary for Financial Markets. In that role, he is a senior advisor to the Secretary of the Treasury in developing and implementing the federal government’s policies for debt management and the sale of U.S. government securities. Prior to joining the Treasury Department, Mr. Gensler was a partner of The Goldman Sachs Group, L.P. Mr. Gensler joined Goldman Sachs in 1979, in the Mergers & Acquisitions Department. In 1984, he assumed responsibility for the firm’s efforts in advising media companies, and was elected a partner in 1988. Mr. Gensler subsequently joined the firm’s Fixed Income Division and directed their Fixed Income and Currency trading efforts in Tokyo. From 1995 to 1997, Mr. Gensler was Co-head of Finance for Goldman Sachs worldwide.

Mr. Gensler graduated summa cum laude from the University of Pennsylvania’s Wharton School in 1978, with a Bachelor of Science in Economics. He received a Master of Business Administration from the Wharton School’s graduate division in 1979.

The Under Secretary of the Treasury for Domestic Finance advises and assists the Secretary of the Treasury and the Deputy Secretary on all aspects of domestic finance. Specifically, the office is responsible for formulating policy and legislation in the areas of financial institutions, public debt management, capital markets, government financial management services, federal lending, fiscal affairs, government sponsored enterprises, and community development. As Under Secretary, Gensler will serve on the board of the Securities Investor Protection Corporation, and will chair the Advanced Counterfeit Deterrence Steering Committee.

October 8, 1998 – The House Committee on Agriculture Subcommittee on Risk Management and Specialty Crops held a hearing on "The Commodity Futures Trading commission’s Fiscal Year 2000 Budget Estimate and Annual Performance Plan." Witnesses included Born (CFTC).

October 21, 1998 – H.R.4328 (Making omnibus consolidated and emergency appropriations for the fiscal year ending September 30, 1999, and for other purposes.) is signed into law.

Note: I think the language in H.R.4328 regulating the CFTC is in section 760, which includes: "During the restraint period, the Commission may not propose or issue any rule or regulation, or issue any interpretation or policy statement, that restricts or regulates activity in a qualifying hybrid instrument or swap agreement" was added in conference. The conference report passed 333 – 95 in the House and 65 – 29 in the Senate.

December 15, 1998 – Reported in the NYT: Who’s in Charge? Agency Infighting and Regulatory Uncertainty:

Regulators and lawmakers have been tussling behind the scenes over who, if anyone, might oversee the growing market for derivatives.

The fray is expected to continue tomorrow when the Senate Agriculture Committee opens its hearings on derivatives and the near collapse of Long-Term Capital Management.

In the hot seat will be Brooksley E. Born, the chairwoman of the Commodity Futures Trading Commission — which regulates the futures and options market. In May, she issued a statement seeking public comment on the derivatives market, viewed by many in the industry as a possible first step toward regulating the rest of the derivatives market.

But the nation’s top regulators blasted her the same day. The leaders of the Federal Reserve Board, the Securities and Exchange Commission and the Treasury Department issued a joint statement with the Presidential working group on financial markets. ”We have grave concerns about this action and its possible consequences,” the statement said. ”We seriously question the scope of the C.F.T.C.’s jurisdiction in this area, and we are very concerned about reports that the C.F.T.C.’s action may increase the legal uncertainty concerning certain types of O.T.C. derivatives.”

Since then, these financial regulators have all expressed concern that further moves to regulate either hedge funds or derivatives could prove harmful or inadequate.

Hedge funds could just as easily move offshore, escaping any regulation, said Alan Greenspan, the Fed chairman. New rules or regulatory oversight could increase legal uncertainty in a thriving global marketplace, said Robert E. Rubin, Secretary of the Treasury. And Arthur Levitt, chairman of the Securities and Exchange Commission, has said that he would be hesitant to ”inject government into the private sector unless it’s absolutely necessary.”

The three are not entirely opposed to regulation, their spokesmen say, but they would like the entire regulatory community to evaluate carefully any proposal.

Ms. Born, by contrast, has called for action. ”Swift regulatory responses may well be needed to protect the U.S. and world economy,” she said this fall.

Absent any new requirements, banks and other derivatives dealers say they are taking steps to protect themselves from losses. ”The way we deal with hedge funds has already changed,” said Mark C. Brickell, a board member of the International Swaps and Derivatives Association and a managing director at J. P. Morgan. ”At the end of the day, market forces are the regulations everyone must obey.”

December 16, 1998 – Senate Committee on Agriculture, Nutrition, and Forestry held a hearing on OTC Derivatives in the U.S. Financial Markets. I didn’t find the transcript, but there was a report from Derivatives Strategy, "Senate Eyes on the OTC Market", and here are some of the prepared statements: Lindsey (SEC), Newsome, Holum, Born, Spears and Tull (CFTC), Harkin.

December 17, 1998 – Reported by the NYT, A Warning To Banks: Scrutinize Hedge Funds.

A Federal Reserve official warned today that regulators might need to insist that banks scrutinize more closely — and lend less freely — to hedge funds to avoid such crises as the near-failure in September of Long-Term Capital Management.

”Private market discipline seems to have largely broken down” in that case, said Patrick M. Parkinson, who is associate director of the Fed’s division of research and statistics, forcing the Fed to organize a.5 billion rescue operation by the hedge fund’s creditors to avert any threat to the global financial system.

”Weaknesses in risk management practices clearly need to be addressed,” Mr. Parkinson told the Senate Agriculture Committee, which was convened to monitor the progress of an interagency group studying derivative products, as well as hedge funds. The group is made up of officials from the Fed, the Treasury, the Securities and Exchange Commission and the Commodity Futures Trading Commission.

The committee also heard suggestions of possible moves to shore up or impose regulation by the Treasury and the S.E.C. This was seen by some as a softening of earlier stances.

”There now appears to be a willingness among all the players to look at a number of issues in the over-the-counter market, particularly in the areas of transparency and disclosure,” said John Phillips, a spokesman for the C.F.T.C.

The head of the C.F.T.C., Brooksley E. Born, has angered key members of Congress, other regulators and some of her fellow commissioners by refusing to agree to delay possible new regulation of derivatives until Congress is able to provide direction.

January 6, 1999 – H.R.10, "To enhance competition in the financial services industry by providing a prudential framework for the affiliation of banks, securities firms, and other financial service providers, and for other purposes." (the "Financial Services Act of 1999"), was introduced in the House by James Leach (co-sponsored by Spencer Bachus, Richard H. Baker, Michael N. Castle, Merrill Cook, Sue W. Kelly, Peter T. King, Steven C. LaTourette, Rick Lazio, James H. Maloney, Bill McCollum, Robert W. Ney and Marge Roukema). H.R.10 was eventually superceded by S.900.

January 20, 1999 – Brooksley E. Born, chair of the CFTC, announced her resignation:

The announcement came just a few months before President Clinton would have decided on whether to reappoint Ms. Born to a second five-year term. Administration officials say there was little expectation that she would have been reappointed because Ms. Born openly broke ranks with some of the Administration’s top economic advisers — including Treasury Secretary Robert E. Rubin. The issue was her edging toward tighter regulation of the market in over-the-counter derivatives.

February 23, 1999 – The Senate Banking Committee (chaired by Gramm) held a hearing on (in part) "Financial Services Legislation" with Greenspan the sole witness. From his prepared statement:

…we support removal of the legislative barriers that prohibit the straightforward integration of banking, insurance and securities activities. There is virtual unanimity among all concerned–private and public alike–that these barriers should be removed.

In designing financial modernization legislation, we firmly believe that the Congress should focus on achieving two essential and indivisible objectives: removing outdated, competitively stifling restrictions on financial affiliations, and, most importantly, adopting a framework for this modernization that promotes the safety and soundness of our banking and financial system and prevents the extension of the federal subsidy.

The first objective is achieved by amending the Glass-Steagall Act and the Bank Holding Company Act to permit financial affiliations and broader financial activities.

February 24, 1999 – The Senate Banking Committee (chaired by Gramm) continued their series of hearings on "Financial Services Modernization." Among the witnesses were Rubin (Treasury) and Levitt (SEC).

From Rubin’s prepared statement:

I appreciate the opportunity to discuss the Administration’s views on financial modernization, including the draft bill circulated by the Chairman last week.

The bill, rightly in our view, takes the fundamental actions necessary to modernize our financial system by repealing the Glass-Steagall Act’s prohibitions on banks affiliating with securities firms and repealing the Bank Holding Company Act prohibitions on insurance underwriting. The bill also continues to allow bank insurance sales unencumbered by anti-competitive restrictions. I believe we could construct a bipartisan consensus on these provisions.

That said, the draft bill and its appendix of "undecided issues" contain significant provisions that are unacceptable to the Administration, and we would oppose the bill in its current form. We have five basic objections to the draft bill and its appendix — its prohibition on the use of subsidiaries by larger banks; its weakening of the effects of the Community Reinvestment Act (CRA); its extensive mixing of banking and commerce; its provisions with respect to the Federal Home Loan Bank System; and what we view as inadequate consumer protections.

From Levitt’s prepared statement:

The Commission has reviewed the staff discussion draft of financial modernization legislation that the Senate Banking Committee released last week. Unfortunately, I believe that, in its current form, the bill runs the risk of dramatically undermining investor protection and the integrity of U.S. securities markets. The Commission understands that the discussion draft is very much a work-in-progress, but it cannot possibly support the discussion draft in its current form.

By repealing provisions of the Glass-Steagall Act without removing the bank exemptions from federal securities laws, this draft bill would create a dangerously bifurcated system of regulation. A significant portion of securities activities would take place outside the protections of the securities laws. The bank exemptions to federal securities law were, in part, premised on the very existence of the barriers that the Glass-Steagall Act had erected. For the sake and safety of our capital markets, we should not contemplate removing outdated restrictions without also removing outdated exemptions.

February 25, 1999 – The Senate Banking Committee (chaired by Gramm) continued their series of hearings on "Financial Services Modernization" with back to back hearings with witnesses representing the financial industry and consumer groups and community organizations.

April 1, 1999 – The temporary moratorium (in H.R.4328) that prevented the CFTC from regulating OTC derivatives expired.

April 28, 1999 – S.900, "An Act to enhance competition in the financial services industry by providing a prudential framework for the affiliation of banks, securities firms, and other financial service providers, and for other purposes" (the Gramm-Leach-Bliley Act), was introduced in the Senate by Phil Gramm (no cosponsors).

May 6, 1999 – S.900, "An Act to enhance competition in the financial services industry by providing a prudential framework for the affiliation of banks, securities firms, and other financial service providers, and for other purposes" (the Gramm-Leach-Bliley Act), was passed in the Senate 54-44.

May 18-20, 1999 and June 8, 1999 – The House Agriculture Committee Subcommittee on Risk Management, Research, and Specialty Crops held a four day hearing on the Reauthorization of the CFTC. Witnesses included: Born, Holum, Spears and Newsome (CTFC), Gensler (Treasury), Nazareth (SEC) and Parkinson (Fed).

from pages 69&70 of the May 18, 1999 hearing transcript:

Mr. CHAMBLISS. Thank you, Mr. Chairman. Mr. Gensler, I want to direct this to you and, Mr. Parkinson, I would also like you to comment on this if you will, please? Mr. Gensler, in his testimony before the Senate Agriculture Committee on June 30, 1998, Deputy Treasury Secretary Larry Summers testified that advocates of greater regulation of off exchange derivatives bear the burden of proof that such regulations are needed when he said, ”To date, there has been no clear evidence of a need for additional regulation of the institutional OTC derivatives market, and we would submit that proponents of such regulation must bear the burden of demonstrating that need.” First of all, do you agree with Mr. Summers’ statement. And also, since he is your boss, I guess I know the answer to that, but I would still like it on the record. [Laughter.]

Second, do you agree that these are the principles that will guide the Treasury as it considers the possibility of any new regulation? And, Mr. Parkinson, I would sort of like the Fed’s position on that too, please?

Mr. GENSLER. I am glad to respond and answer in that positively, unambiguously I concur with Larry Summers on this.

Mr. CHAMBLISS. You may keep your job then.

Mr. GENSLER. Thank you. Thank you. But I think they are good parameters to guide us. This market, while large, it is trillion of worldwide derivatives, shows the vibrancy and the importance of this market for all sorts of participants to hedge their risks and transfer risks. That could be a grain producer transferring the risk, it could be a homeowner that is able to borrow more cheaply because their mortgage that they are borrowing has mortgage derivatives behind it. The homeowner never even sees those derivatives, but gets cheaper funding for their home. That large and vibrant market is part of, I believe, the American success. And we should recognize that and put the burden on those who are suggesting changes and further regulation, put the burden on them before we tamper on some of the successes of this marketplace for the economy.

Mr. CHAMBLISS. Mr. Parkinson.

Mr. PARKINSON. Well, Larry Summers is not my boss, but that quotation sounds a lot like my boss. So I think I can wholeheartedly endorse that.

Mr. CHAMBLISS. OK. And I will direct this to whoever wants to answer it, the SEC has suggested excluding swaps from the Commodity Exchange Act in an effort to provide legal certainty for these products. And if that should happen, who would regulate these transactions? Would the SEC step in and regulate them?

Ms. NAZARETH. I think, as you know, the President’s Working Group will be studying over-the-counter derivatives and as part of that study, we will be discussing what kind of oversight, if any, would be appropriate for over-the-counter derivatives, which would include securities-based swaps. When we are asking for the exclusion from the Commodity Exchange Act, we are not asking for jurisdiction over those products at this time.

Mr. GENSLER. If I might just add, currently there is some ambiguity and uncertainty in how the act is written and how the exemption is written. And that uncertainty, we believe, does not promote the economy as much as clarifying it, taking the uncertainty out of the statute and therefore promoting the markets. I think probably all three of the participants up here and their agencies would concur on this approach, on clarifying that legal uncertainty. And that probably would be, if there was one overall theme from Treasury, that would be the theme that I would hope that we have left here with you today, which is to clarify and lessen that uncertainty in these markets, these such important and vital markets.

July 1, 1999 – H.R.10 (the House version of S.900, the Gramm-Leach-Bliley Act) was passed in the House by 343-86.

NYT, July 3, 1999, New Phase Under Way In Battle Over Banking Law

Now comes the endgame in the 20 Years War between Democrats and Republicans, Treasury Secretaries and Federal Reserve chairmen, and lobbyists from three of the nation’s most powerful industries over legislation to overhaul the financial system.

Business interests and Government agencies, in a situation reminiscent of the trench warfare of an earlier era, spent years fighting to a stalemate over the legislation. The lawmakers benefited mightily in the process, using the battle among insurers, bankers and securities firms to enrich their campaign coffers by hundreds of millions of dollars. Until two months ago, they had delivered very little in return.

Now, however, the financial industry’s investment may be paying off. With the House of Representatives’ overwhelming approval on Thursday of a banking bill that would repeal 65 years of laws intended to bar banks, insurers and securities underwriters from entering one another’s businesses, there is a growing consensus that this year might be different. The Clinton Administration generally likes the House legislation, and that increases the odds that a new law will be passed.

”We were very pleased with the bill, the overwhelming majority that supported it and the clear sign of what can happen when the Administration works with both sides of the aisle,” said Gary Gensler, a Treasury Under Secretary. ”There is finally a real chance for meaningful reform.”

But it will still take what was once unthinkable for the legislation to become reality: an agreement between Senator Phil Gramm, the Texas Republican who heads the Senate Banking Committee, and President Clinton.

Last fall Mr. Gramm blocked a Senate measure, robbing Senator Alfonse M. D’Amato of New York, who was the committee chairman at the time, of a significant legislative victory. After he failed to win re-election, Mr. D’Amato was succeeded as head of the banking committee by Mr. Gramm, who, bucking the predictions of many on Wall Street, quickly and effectively won approval of his own version of the legislation two months ago.

The bill he produced has two provisions that the White House says would lead President Clinton to veto it. One provision gives a decided preference to the Federal Reserve over the Treasury as a top regulator for banks. The other exempts thousands of banks from requirements that they make loans to minorities and others traditionally denied access to credit.

That provision is expected to be highlighted by Mr. Clinton as he embarks on a nationwide tour next week to areas of poverty and high unemployment, in an attempt to encourage investment in some of the poorest communities.

Neither of the provisions objectionable to the White House is in the House bill, which was approved late Thursday evening by a 343-to-86 vote.

The House bill’s passage was a setback for Alan Greenspan, the chairman of the Federal Reserve. He has been unyielding in his view that any new banking legislation must include a provision that organizes financial conglomerates so that banks and securities firms are affiliates of a holding company.

The practical significance of Mr. Greenspan’s preference is that under such a corporate structure the Federal Reserve would become the dominant regulatory agency, and the Treasury would lose much of the authority it now has as overseer of nationally chartered institutions. Mr. Greenspan has testified that he feels so strongly about the point that he would rather see no new legislation than legislation that takes the approach favored by the Treasury, which would preserve a role for the Administration as a regulator.

The House legislation follows the Treasury’s approach, while the Senate bill takes the Greenspan position.

Lawmakers say a Congressional conference to iron out the differences between the House and Senate measures may begin later this month or in August. The most positive force pushing for a law is undoubtedly the remarkable unity of the insurers, the bankers and the securities underwriters.

July 2, 1999 – Rubin retired and Lawrence Summers became United States Secretary of the Treasury. Clinton would, in 2001, award Rubin the Presidential Citizens Medal:

Leaving a brilliant career on Wall Street to serve as Director of the National Economic Council and Secretary of the Treasury, Robert Rubin played a pivotal role in creating America’s longest economic expansion. He forged a new team approach that produced an economic framework based on fiscal discipline, investment in opportunity, and expanded trade, while exhibiting exceptional leadership in ensuring global financial stability. His efforts helped countless Americans share in an era of unprecedented prosperity.

July 20, 1999 – S.900, "An Act to enhance competition in the financial services industry by providing a prudential framework for the affiliation of banks, securities firms, and other financial service providers, and for other purposes" (the Gramm-Leach-Bliley Act), was passed in the House without objection.

August 5, 1999 – The House Agriculture Committee Subcommittee on Risk Management, Research, and Specialty Crops held a hearing to "Review the Commodity Futures Trading Commissions’ Authority to Provide U.S. Futures Exchanges With Regulatory Relief."

October 18, 1999 – Rubin joined Citigroup. From the WSJ:

On October 18, 1999, Citigroup announced that former Treasury Secretary Robert E. Rubin was joining the firm. But what exactly would Mr. Rubin do at Citigroup? Citi’s SEC filing eight days later noted that Mr. Rubin would be joining the bank’s board of directors. After that, the message to investors began to get murky. Citi said that Mr. Rubin "will serve as Chairman of the Executive Committee of the Board and will work with Mr. [John] Reed and Mr. [Sanford] Weill, Chairmen and Co-Chief Executive Officers, in a newly constituted three-person office of the Chairman."

Was Mr. Rubin to be primarily a member of the board overseeing management, or a part of the management reporting to the board? Things became even murkier when Messrs. Weill and Reed described Mr. Rubin’s job: "Bob will participate in strategic managerial and operational matters of the Company, but will have no line responsibilities."

As a great man of finance, Mr. Rubin would be paid CEO money — a total of 5 million since 1999, not including stock options — but without having to run a business or be accountable for the results. For years, journalists tried to figure out exactly what Mr. Rubin’s job was at Citigroup, and perhaps even his fellow Citi directors weren’t entirely sure.

October 29, 1999 – GAO released it’s report, Long-Term Capital Management (LTCM): Regulators Need to Focus Greater Attention on Systemic Risk.

Between January and September 1998, LTCM, one of the largest U.S. hedge funds, lost almost 90 percent of its capital. In September 1998, the Federal Reserve determined that rapid liquidation of LTCM’s trading positions and related positions of other market participants might pose a significant threat to already unsettled global financial markets. Thus, the Federal Reserve facilitated a private sector recapitalization to prevent LTCM’s collapse. Although the crisis involved a hedge fund, the circumstances surrounding LTCM’s near-collapse and recapitalization raised questions that go beyond the activities of LTCM and hedge funds to how federal financial regulators fulfill their supervisory responsibilities and whether all regulators have the necessary tools to identify and address potential threats to the financial system.

LTCM was able to establish leveraged trading positions of a size that posed potential systemic risk, primarily because the banks and securities and futures firms that were its creditors and counterparties failed to enforce their own risk management standards. Other market participants and federal regulators relied upon these large banks and securities and futures firms to follow sound risk management practices in providing LTCM credit. However, weaknesses in the risk management practices of these creditors and counterparties allowed LTCM’s size and use of leverage to grow unrestrained. According to federal financial regulators, these weaknesses, at least in part, resulted from overreliance on the reputations of LTCM’s principals, the relaxing of credit standards that typically occurs during periods of sustained economic prosperity, and competition between banks and securities and futures firms for hedge fund business.

Lack of authority over certain affiliates of securities and futures firms limits the ability of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) to identify the kind of systemic risk that LTCM posed. Although SEC and CFTC regulate registered broker-dealers and futures commission merchants (FCMs), they do not have the authority to regulate unregistered affiliates of broker-dealers and FCMs except for limited authority to gather certain information. This lack of authority, or regulatory “gap,” has become more significant as the percentage of assets held outside the regulated entities has grown; for example, almost half of the total assets of four major securities and futures firms are held outside the registered broker-dealers. These unregistered affiliates often have large positions in such markets as over-the-counter derivatives and can be major providers of leverage in the markets, as they were in the LTCM case. How they manage their own risks, as well as their provision of leverage to counterparties, can affect the financial system.

The President’s Working Group report recognized this regulatory gap and recommended that Congress provide SEC and CFTC expanded authority to obtain and verify information from unregistered affiliates of broker-dealers and FCMs. However, this recommendation may not go far enough in enabling SEC and CFTC to more quickly identify and respond to the next potential systemic crisis. The Working Group recommendation would still leave important providers of credit and leverage in the financial system without firmwide risk management oversight by financial regulators.

Expanding SEC’s and CFTC’s regulatory authority over unregistered affiliates of broker-dealers and FCMs to include the ability to examine, set capital standards, and take enforcement actions, raises controversial issues and operational considerations that would have to be recognized and addressed. For example, some believe that expanding SEC’s and CFTC’s authority would undermine market discipline. However, we believe that expanded authorities would not lessen the role of effective market discipline and that imprudent behavior could result in a firm’s failure with creditors and investors suffering losses. It also would require that SEC and CFTC evaluate their operational and resource capacities to accommodate any expanded authority. However, the number of firms that are likely to be of concern is limited and thus should not involve a significant resource commitment. In order to identify and prevent potential future crises, we are suggesting that Congress consider providing SEC and CFTC authority to regulate affiliates of broker-dealers and FCMs.

November 2, 1999 – Robert Scheer, writing about negotiations on the Gramm-Leach-Bliley Act in the LA Times:

Only last week, as the bill was being pushed through a congressional conference committee, Treasury Secretary Lawrence H. Summers rushed back from a trip to China to huddle with lobbyists representing Citigroup, Goldman Sachs, Merrill Lynch and other financial giants. The meeting was closed to the media and public, but one participant told the New York Times that Summers lectured the lobbyists on how to spin this bill so it appears to be in the public interest. "He said it would be very unfortunate if any financial institution were to suggest that they do not see the broad public purpose of this legislation," the lobbyist reported.

November 4, 1999 – Conference report of S.900, "An Act to enhance competition in the financial services industry by providing a prudential framework for the affiliation of banks, securities firms, and other financial service providers, and for other purposes" (the Gramm-Leach-Bliley Act), was passed in the Senate 90-8 and in the House 362 – 57.

From wikipedia:

The Gramm-Leach-Bliley Act, also known as the Gramm-Leach-Bliley Financial Services Modernization Act, Pub.L. 106-102, 113 Stat. 1338, enacted November 12, 1999, is an Act of the United States Congress which repealed part of the Glass-Steagall Act of 1933, opening up competition among banks, securities companies and insurance companies. The Glass-Steagall Act prohibited a bank from offering investment, commercial banking, and insurance services.

The Gramm-Leach-Bliley Act (GLBA) allowed commercial and investment banks to consolidate. For example, Citibank merged with Travelers Group, an insurance company, and in 1998 formed the conglomerate Citigroup, a corporation combining banking and insurance underwriting services under brands including Smith-Barney, Shearson, Primerica and Travelers Insurance Corporation. This combination, announced in 1993 and finalized in 1994, would have violated the Glass-Steagall Act and the Bank Holding Company Act by combining insurance and securities companies, if not for a temporary waiver process [1]. The law was passed to legalize these mergers on a permanent basis. Historically, the combined industry has been known as the financial services industry.

Democrats agreed to support the bill after Republicans agreed to strengthen provisions of the anti-redlining Community Reinvestment Act and address certain privacy concerns; the conference committee then finished its work by the beginning of November.

From ralphbon (in FDL comments)

Here’s Charles Schumer, from his 1999 press release lauding Gramm-Leach-Bliley, which paved the way to today’s toxic deregulatory environment:

From Glass-Steagall to Gramm-Leach, from the Great Depression to the Golden Age, from isolationists to internationalists, from underdogs to champions, this bill, in my opinion, Mr. President, is an American success story for our economy, for our financial institutions, for our communities and consumers and for my state of New York. And I was proud to have played a role with so many others in ensuring its passage.

Note also that in 1982, as a congressman, Schumer co-sponsored (with Steny Hoyer) the Garn-St. Germain Act, which deregulated the S&L’s and set the stage for that earlier scandal.

I’ve always found it puzzingly (OK, not so much) and infuriating that Schumer has paid no discernible price for repeatedly and gleefully marching taxpayers to the precipice of ruin.

More from Senator Schumer’s press release:

I first want to thank Chairman Gramm and Senator Sarbanes, Chairman Leach, Representative LaFalce, and all of my colleagues who worked so long and hard on this legislation. Particular thanks to Senators Dodd and Edwards, who worked with us in the late-night hours to come up with a compromise that eventually helped get this bill passed. Mr. President, this is a historic moment. We’ve been working towards it for 18 years.

The one thing that has dominated my thinking in this area is that we not repeat an S&L crisis, we not allow insured deposits to be used for risky activities. I am proud to say that the compromise between Treasury and Federal Reserve and the structure of the bill here makes sure that when insured dollars are used for anything that might be slightly risky, that the capital requirements and fire walls will make virtually certain that we will not repeat the kind of S&L crisis that we have had in the past.

From President Clinton’s press release:

You heard Senator Gramm characterize this bill as a victory for freedom and free markets. And Congressman LaFalce characterized this bill as a victory for consumer protection. And both of them are right. And I have always believed that one required the other. It is true that the Glass-Steagall law is no longer appropriate for the economy in which we live.

This is a very good day for the United States. Again, I thank all of you for making sure that we have done right by the American people and that we have increased the chances of making the next century an American century.

Treasury Secretary Summers:

With this bill, the American financial system takes a major step forward towards the 21st century, one that will benefit American consumers, business, and the national economy for many years to come. This is the culmination of years of effort by many, many people, reflects the work of presidents, Treasury officials, members of Congress, those in the private sector, from both parties, and dedicated professionals, both inside and outside the government. With their help, I believe we have all found the right framework for America’s future financial system.

NYT, November 13, 1999, Clinton Signs Legislation Overhauling Banking Laws

President Clinton signed into law today a sweeping overhaul of Depression-era banking laws. The measure lifts barriers in the industry and allows banks, securities firms and insurance companies to merge and to sell each other’s products.

”This legislation is truly historic,” President Clinton told a packed audience of lawmakers and top financial regulators. ”We have done right by the American people.”

The Senate approved the final bill by 90 to 8 on Nov. 4 and the House followed suit by a vote of 362 to 57. Congress had previously made almost a dozen unsuccessful attempts over the last 25 years to revise the statutes, which had increasingly come to be viewed as anachronisms.

”The world changes, and Congress and the laws have to change with it,” said Senator Phil Gramm of Texas, chairman of the Banking Committee and one of the bill’s prime sponsors.

Supporters of the legislation say it will also benefit consumers, providing them with greater choice and convenience and spurring competition that will lead to lower prices.

”With this bill,” Treasury Secretary Lawrence H. Summers said, ”the American financial system takes a major step forward toward the 21st Century — one that will benefit American consumers, business and the national economy.” Opponents said it would have the opposite effect, creating behemoths that will raise fees, violate customers’ privacy by sharing and selling their personal data, and put the stability of the financial system at risk.

The privacy issue was a key focus in the long and often heated negotiations that produced a compromise bill, and President Clinton made clear he still wanted to see more done to safeguard consumers’ personal financial information.

President Clinton said the Treasury and White House would put together a legislative proposal to take to Congress next year that would extend the privacy provisions of the legislation.

November 9, 1999 – President’s Working Group on Financial Markets (Treasury, Fed, SEC, CFTC) submitted their OTC Derivatives Report to Congress. The report recommended:

  • Creating an exclusion from the CEA for swaps agreements that are bilateral agreements between eligible parties on a principal-to-principal basis. (The exclusion does not extend to agreements involving non-financial commodities with finite supplies).
  • Creating an exclusion from the CEA for electronic trading systems that limit participation to sophisticated parties trading for their own accounts. (Again, the exclusion does not apply to systems used to trade contracts that involve non-financial commodities with a finite supply.)

November 15, 1999 – Editorial from The Nation:

This article presents information regarding the merger of Citicorp Inc. and Travelers Corp. that set the stage for U.S. Congress’s effective revocation of the Glass-Steagall Act in late October 1999. For their money, the finance industry bought not only the end of the Glass-Steagall Act but also the partial repeal of the Bank Holding Company Act. These landmark pieces of legislation, recognizing the inherent dangers of too great a concentration of financial power, barred common ownership of banks, insurance companies and securities firms and erected a wall of separation between banks and nonfinancial companies. Now the ban on common ownership has been lifted-and the wall separating banking and commerce is likely soon to be breached.

Feb. 10, 2000 – The Senate Committee on Agriculture, Nutrition, and Forestry (chaired by Lugar) held a hearing on The President’s Working Group Report of OTC Derivatives — CEA Re-athorization." Witnesses were Summers and Sachs (Treasury), Greenspan (Fed), Rainer (CFTC), Nazareth (SEC)

From Summers’ statement:

OTC derivatives now represent more than trillion in notional value. They perform a crucial function in helping to share and allocate risk around our nation’s economy. This confers a number of benefits. It helps businesses and financial institutions to hedge risks and lower their costs, thereby reducing prices for American businesses and consumers. It promotes more efficient allocation of capital across different sectors of the economy. It encourages better information with respect to the risks of various contingencies and promotes transparency which leads to better planning, and it permits the development of more imortive financial products by allowing for wider sharing of risk.

Feb. 15, 2000 – The House Committee on Agriculture Subcommittee on Risk Management, Research and Specialty Crops held a hearing, "The President’s Working Group on Financial Markets Report on Over-the-Counter Derivative Markets and the Commodity Exchange Act." Witnesses were Sachs (Treasury), Paul (CFTC), Parkinson (Fed) and Nazareth (SEC).

April 11, 2000 – The House Committee on Banking and Financial Services held a hearing on "Netting of Financial Contracts, Hedge Fund Disclosure, and Over-the-Counter Derivatives Transactions." From Annette L. Nazareth’s statement:

Regulators have focused on the treatment of swaps for over a decade. In 1989, the CFTC issued a Policy Statement, noting that "most swap transactions, although possessing elements of futures or options contracts, are not appropriately regulated as such under the [CEA] and regulations."8 After receiving exemptive authority under the Futures Trading Practices Act of 1992,9 the CFTC followed up with its 1993 Swap Exemption.10 Notwithstanding the exemption’s relief for some transactions, concerns arose about its scope. Because Congress did not explicitly determine whether swaps fell under the CEA absent such an exemption, the status of swaps remains unclear.

In light of this legal uncertainty, the OTC Derivatives Report recommends that Congress amend the CEA to exclude bilateral swap agreements (other than transactions involving non-financial commodities with finite supplies) between eligible swap participants, acting on a principal-to-principal basis, provided that the transactions are not conducted on a multilateral transaction execution facility ("MTEF").11 The Commission believes that excluding qualifying instruments from the CEA should create greater legal certainty than the current approach that merely provides for the possibility of exemption, thus leaving open the question of whether such instruments are futures.

May 25, 2000 – H.R.4541, "To reauthorize and amend the Commodity Exchange Act to promote legal certainty, enhance competition, and reduce systemic risk in markets for futures and over-the-counter derivatives, and for other purposes" was introduced in the House by Thomas Ewing (cosponsored by Bill Barrett, Saxby Chambliss and Gil Gutknecht).

June 8, 2000 – S.2697, "A bill to reauthorize and amend the Commodity Exchange Act to promote legal certainty, enhance competition, and reduce systemic risk in markets for futures and over-the-counter derivatives, and for other purposes" was introduced in the Senate by Richard Lugar (cosponsored by Peter Fitzgerald and Phil Gramm).

In response to the introduction of S.2697, the ISDA issues a press release:

The International Swaps and Derivatives Association welcomed the formal introduction on June 8, 2000 in the United States Senate of S. 2697, the proposed "Commodity Futures Modernization Act of 2000". S. 2697 was introduced jointly by Senator Richard Lugar, the Chair of the Senate Committee on Agriculture, Nutrition and Forestry, Senator Phil Gramm, the Chair of the Senate Committee on Banking, Housing and Urban Affairs, and Senator Peter Fitzgerald of Illinois.

"ISDA has previously urged Congress to develop legislation that builds upon the unanimous recommendations of the President’s Working Group on Financial Markets and this legislation contains important provisions intended to remove the Commodity Exchange Act as a source of legal uncertainty for OTC derivatives transactions", said Rick Grove, ISDA’s Chief Executive Officer and Executive Director.

June 14, 2000 – The House Agriculture Committee Subcommittee on Risk Management, Research, and Specialty Crop held a hearing on H.R. 4541 The Commodity Futures Modernization Act of 2000.

June 21, 2000 – A joint hearing of the Senate Committee on Agriculture, Nutrition, and Forestry (chaired by Lugar) and the Senate Committee on Banking, Housing, and Urban Affairs (chaired by Gramm) was held on the S.2697, The Commodity Futures Modernization Act of 2000. Greenspan (Fed), Summers (Treasury), Levitt (SEC) and Rainer (CFTC) testified (pdf).

From Lugar’s opening statement:

Our legislation has been several years in the making. The Senate Agriculture Committee held a two-day roundtable of 19 industry experts in February 1999 to discuss the policies surrounding CFTC reauthorization. Asked to prioritize the issues of importance, most panelists thought legal certainty to be the most pressing issue. Others suggested repeal of the Shad-Johnson Accord and that testimony included Phil Johnson, former CFTC chairman and one-half of the accord’s namesake, and several mentioned regulatory relief for the futures exchanges as an important priority.

Today’s hearing representing our committee’s fifth public forum on CFTC reauthorization in the last 18-months will hear testimony regarding how all of these issues are addressed in our legislation.

Signed into law in 1974, the modern Commodity Exchange Act requires that futures contracts be traded on a regulated exchange. As a result, a futures contract that is traded off an exchange is illegal and unenforceable in a court of law. When Congress enacted this act, the meaning of the terms “future” and “exchange” were relatively apparent and the over-the-counter derivatives business was in its in infancy.

In the 26-years since the statute’s creation, however, the definitions of a swap and a future began to blur. In 1998 the CFTC released its concept release on over-the-counter derivatives, which was perceived by many as a precursor to regulating those instruments as futures. Just the possibility of reaching this conclusion threatened to move significant portions of the business overseas. This led the Treasury Department, the Federal Reserve and the SEC to ask Congress to enact a moratorium on the CFTC’s ability to regulate these instruments until after the President’s Working Group could complete a study of the issue.

As a result, Congress passed a 6-month moratorium and in November 1999 the President’s Working Group completed its unanimous recommendations on derivatives and presented Congress with those findings.

The goal of the legislation is to ensure that the United States remains a global leader in the derivatives marketplace. Already the United States has lost much of its leadership role in the exchange-traded futures markets in Europe and the over-the-counter market may not be far behind. Congress has a good opportunity at this point to reverse this tide by enacting sound legislation this year.

From Gramm’s opening statement:

We want legal certainty for swaps. Most people do not know what swaps are. I am almost incapable of fathoming the volume of swaps in dollar value. When I heard the number as we first started discussing this issue, I was convinced that an error had been made and that someone had mistakenly said trillions instead of billions; I was wrong. This is a huge, critically important markets, and we cannot allow uncertainty about the enforceability of these contracts to stand.

We are all aware that uncertainty occurs because of the off-exchange trading prohibition in the Commodities Exchange Act. If the Commodities Futures Trading Commission deemed these swaps to be futures, that would create this legal uncertainty.

From Summers’ opening statement:

I believe it is a matter of great importance to the future of our financial system and to the future of our economy to move ahead with legislation that provides legal certainty for swaps and OTC derivatives transactions. And I believe that such legislation is now within our grasp, with the unanimous agreement of the President’s Working Group and the very substantial consensus that has formed in the central area of legal certainty for OTC derivatives among members of these committees, members of the House of Representatives and the various constituencies.

I believe that if anything, the events of the last year, as we have seen dramatic increases in competition in the financial services area across countries, only go to emphasize the importance of the United States moving to provide legal certainty.

So it is our very great hope that it will be possible to move this year on legislation that, in a suitable way, goes to create legal certainty for OTC derivatives while, at the same time, reducing systemic risk, protecting retail customers, and maintaining U.S. competitiveness.

And it is our belief that the central provisions contained in this bill with respect to OTC derivatives make great progress in achieving these goals and are provisions that we can support as they follow very largely the recommendations of the President’s Working Group.

From Greenspan’s opening statement:

In my remarks today I shall focus on three of the areas that the legislation covers: first, legal certainty for OTC derivatives; second, regulatory relief for U.S. futures exchanges; and third, of course, repeal of Shad-Johnson restrictions on the trading of single-stock futures.

In its November 1999 report, the President’s Working Group concluded that OTC derivatives transactions should be subject to the CEA only if necessary to achieve the public policy objectives of the act, deterring market manipulation and protecting investors against fraud and other unfair practices. In the case of financial derivatives transactions involving professional counterparties, the Working Group concluded that regulation was unnecessary for these purposes because financial derivatives generally are not readily susceptible to manipulation and because professional counterparties can protect themselves against fraud and unfair practices. Consequently, the Working Group recommended that financial OTC derivatives transactions between professional counterparties be excluded from coverage of the CEA.

From Levitt’s opening statement(cf written statement):

The bill before you, consistent with the Working Group’s recommendations, goes a long way towards providing greater legal certainty for over-the-counter derivatives by excluding certain products from the Commodity Exchange Act.

The bill, however, goes well beyond this objective. Indeed, it would place all swap agreements beyond the reach of the securities laws. In doing so, it might result in a wholesale removal of SEC oversight of a wide array of securities products.

For example, one could potentially avoid long-established investor and market integrity protections applicable to equity securities by merely documenting an equity transaction as a "swap.” In my judgment, the risk of this regulatory approach is simply unacceptable for America’s investors. Moreover, I think there is no apparent public policy justification for this far-reaching provision.

July 12, 2000 – The House Committee on Commerce Subcommittee on Finance and Hazardous Materials held a hearing on H.R. 4541, The Commodity futures Modernization Act of 2000. Witnesses included were Levitt (SEC), Parkinson (Fed), Robert (CFTC), Sachs (Treasury).

October 19, 2000 – The House passed H.R.4541 377 – 4.

WaPo: The House passed the bill Oct. 19, but then the legislation stalled. Gramm was holding out for stronger language that would bar both the CFTC and the SEC from meddling in the swaps market. Alarmed, SEC lawyers argued that the agency at least needed to retain its authority over fraud and insider trading. What if a trader, armed with inside knowledge, engaged in a swap on a stock? Treasury Undersecretary Gary Gensler brokered a compromise: The SEC would retain its antifraud authority but without any new rulemaking power.

December 14, 2000 – The "Commodity Futures Modernization Act of 2000" was introduced by Thomas Ewing, (cosponsored by Tom Bliley, Larry Combest, John LaFalce, and James Leach) in the House as H.R.5660 – "To reauthorize and amend the Commodity Exchange Act to promote legal certainty, enhance competition, and reduce systemic risk in markets for futures and over-the-counter derivatives, and for other purposes."

December 15, 2000 – S.3283, was introduced by Senator Lugar (cosponsored by Peter Fitzgerald, Phil Gramm, Chuck Hagel, Tom Harkin and Tim Johnson).

Negotiations on Omnibus Spending Bill Conference Report for H.R. 4577, the "Consolidated Appropriations Act 2001", continued through most of the day. In the Senate, apparently Senator Biden threatened to filibuster the bill unless authority for Amtrak to issue tax credit bonds for capital improvements was included and much of the discussion on the Senate Floor involved this issue.

At 4:48pm the conference report for H.R. 4577, H. Rept. 106-1033, was filed. In a statement from the House floor, just prior to the vote, Representative Thomas Ewing briefly described H.R.5660 and it’s inclusion in H.R. 4577. The video of his statement is available in CSPAN’s archives. The conference report on H.R. 4577 was passed 292 – 60 at 6:38pm. Democrats voted 157 to 9 and the Republicans 133 to 51 in favor of passage.

In watching the CSPAN archive for December 15, 2000 (Senate and House), it appears that the bill was agreed to by unanimous consent before the Senate had even received the conference report. At 5:48pm:

Mr. LOTT. Mr. President, I ask unanimous consent that not withstanding the receipt of the papers, the Senate now proceed to the debate relative to the appropriations conference report and that there be up to 40 minutes for explanation to be divided between the two leaders, with 45 additional minutes under the control of Senator GRAHAM of Florida, an additional 20 minutes under the control of Senator BYRD, and an additional 10 minutes under the control of Senator SPECTER. I further ask unanimous consent that once the Senate receives the conference report, the conference report be considered agreed to and the motion to reconsider be laid upon the table

Conference managers for H.R. 4577 were, for the House: John Edward Porter, C.W. Bill Young, Henry Bonilla, Ernest J. Istook, Jr., Dan Miller, Jay Dickey, Roger F. Wicker, Anne M. Northup, Randy `Duke’ Cunningham, David R. Obey, Steny H. Hoyer, Nancy Pelosi, Nita M. Lowey, Rosa L. DeLauro, and Jesse L. Jackson, Jr. and, for the Senate: Arlen Specter, Thad Cochran, Slade Gorton, Judd Gregg, Kay Bailey Hutchison, Ted Stevens, Pete V. Domenici, Tom Harkin, Ernest F. Hollings, Daniel K. Inouye, Harry Reid, Herb Kohl, Patty Murray, Dianne Feinstein, and Robert C. Byrd

Press Release from the CFTC:

Congress, in passing this law, has effectively implemented the recommendations set forth in the President’s Working Group on Financial Markets’ Report on Over-the-Counter Derivatives Markets and the Commodity Exchange Act

December 21, 2000 – H.R. 4577 was signed by President Clinton and the NYT reported:

At the eleventh hour last Friday night, Congress passed a measure that will benefit Wall Street at the expense of the average investor. This bill should raise a few eyebrows this holiday season, when investment bankers and brokers are cashing hefty bonus checks just as the holdings of many small investors are entering free fall.

The bill, the Commodity Futures Modernization Act of 2000, which passed after an intense push by Wall Street lobbyists, changes the financial markets in two ways. First, it lifts a longstanding ban on futures trading in individual stocks, thus allowing investors to buy shares through brokers with very little money down. Second, it protects a lucrative business for bankers — the private financial contracts known as swaps — from being regulated, for the most part. Investors are affected by swaps because they are used by many mutual funds and publicly traded companies. (In a swap, one party bets that an economic variable — interest rates, for instance — will go up, while the other bets on its going down.)

The first change — trading in single-stock futures — might sound like a cheap way for investors to have fun. Under existing federal rules, you are required to ante up at least half of the purchase price when you buy a stock. For example, if you want to buy,000 worth of Yahoo (just to pick on a company that lost about 0 billion in value this year), you could pay just,000, with your broker lending you the extra money. Of course, if the stock drops too much, you get a ”margin call” from your broker, demanding repayment. Under the new provisions, you can buy stock futures with very little cash up front. For,000, you might buy,000 worth of stock futures, or even more.

It’s not surprising that Wall Street lobbied for the new rules. The major banks and investment houses, chock-full of investment bankers, brokers and traders, will earn big commissions and trading profits on single-stock futures contracts. As always, they will make money regardless of whether their customers do.

January 20, 2001 – From George W. Bush’s Inaugural Address:

It is the American story–a story of flawed and fallible people, united across the generations by grand and enduring ideals.

The grandest of these ideals is an unfolding American promise that everyone belongs, that everyone deserves a chance, that no insignificant person was ever born.

And this is my solemn pledge: I will work to build a single nation of justice and opportunity.

January 20, 2001 – Paul O’Neill became United States Secretary of the Treasury

August 3, 2001 – Harvey L. Pitt was appointed Chairman of the United States Securities and Exchange Commission.

NYT, July 26, 2002, CORPORATE CONDUCT: ACCOUNTING; New Rules on Accountants, but Also Questions

The legislative agreement approved today by a vote of 423 to 3 in the House of Representatives and 99 to 0 in the Senate sets up a new and potentially far-reaching regulatory apparatus for the accounting profession. But it leaves crucial details to the discretion of the Securities and Exchange Commission, which is about to undergo a potentially stormy transition.

The authors of the legislation say one of its most important provisions calls for creating a regulatory body no longer captive to the profession. In recent decades the biggest accounting firms have dominated and largely controlled the regulatory machinery, leading to toothless supervision. All that is supposed to change under a new system that gives the S.E.C. tighter control over a board that is supposed to be more independent of the profession.

The commission must, for instance, appoint the chairman and the four other members of the Public Company Accounting Oversight Board, as it is called, and generally must ratify whatever ethics and auditing standards the new board proposes. The S.E.C. has the authority to approve the board’s budget, which is then collected from an assessment on publicly traded companies.

The commission can increase or reduce any sanctions that the new board imposes on an accounting firm.

These and other major decisions about the board will be at the top of the agenda of the commission, an agency that is undergoing a major transformation of its own.

”The commission’s role is pivotal in terms of the selection of the five members and then over time, the support it gives for its actions,” said Gary Gensler, a former Treasury undersecretary in the Clinton administration and adviser to the Senate Banking Committee as it wrote the law. ”As an oversight group, if the commission supports rather than second-guesses the board, then you get strength.”

Mr. Gensler said that, in fashioning the legislation, Senator Paul S. Sarbanes, Democrat of Maryland, modeled many provisions after a 1938 law, the Maloney Act, which established the close relationship between the commission and the National Association of Securities Dealers. But in the case of today’s legislation, the commission has even greater authority over the accounting board than it does over the N.A.S.D.

The composition of the commission is on the verge of a big change. This evening the Senate unanimously confirmed four new commissioners: Paul S. Atkins, Roel C. Campos, Cynthia A. Glassman and Harvey J. Goldschmid. They will soon join Harvey L. Pitt, the agency’s chairman and the only member of the commission who had been confirmed since President Bush came to Washington 18 months ago.

At the S.E.C., like other independent agencies, the agenda is largely set by the chairman. The other commissioners typically play a secondary role. But Mr. Pitt has come under increasing political assault for his handling of the market crisis, and he will now face the delicate task of forging consensus with a fully staffed commission of widely differing views.

Complicating Mr. Pitt’s role is the fact that he and two of the nominees, Ms. Glassman and Mr. Atkins, have strong previous ties to the accounting profession. These two nominees both worked as top executives at Big Four firms, and Mr. Pitt represented all of the firms as well as the profession’s main lobbying organization before joining the agency.

Some tension has already surfaced between the four nominees and Mr. Pitt. At their confirmation hearings in recent days, the four agreed in their testimony that the board that sets accounting standards ought to re-examine the accounting rules governing the treatment of stock options granted to corporate executives.

Mr. Pitt, by contrast, has repeatedly said that there is no reason to revisit the issue.

Perhaps the single most important issue confronting the commission will be the selection of the chairman and the other four members of the new board.

”The quality of the people selected will be the No. 1 issue,” said Charles Bowsher, the former comptroller general and former head of an accounting oversight board whose members resigned in protest of Mr. Pitt’s initial oversight proposal. ”What I worry about is Pitt and the accounting firms picking some friends that will just want to do what they’ve been doing. In the past, they basically controlled the process. This will now succeed or fail based on who is in these jobs.”

February 3, 2003 – John Snow became United States Secretary of the Treasury.

February 18, 2003 – William H. Donaldson became Chairman of the U.S. Securities and Exchange Commission

April 2003 – as reported in Businessweek:

"More than five years ago, in April 2003, the attorneys general of two small states traveled to Washington with a stern warning for the nation’s top bank regulator. Sitting in the spacious Office of the Comptroller of the Currency, with its panoramic view of the capital, the AGs from North Carolina and Iowa said lenders were pushing increasingly risky mortgages. Their host, John D. Hawke Jr., expressed skepticism.

Roy Cooper of North Carolina and Tom Miller of Iowa headed a committee of state officials concerned about new forms of "predatory" lending. They urged Hawke to give states more latitude to limit exorbitant interest rates and fine-print fees. "People out there are struggling with oppressive loans," Cooper recalls saying.

Hawke, a veteran banking industry lawyer appointed to head the OCC by President Bill Clinton in 1998, wouldn’t budge. He said he would reinforce federal policies that hindered states from reining in lenders.

This was but one of many instances of state posses sounding early alarms about the irresponsible lending at the heart of the current financial crisis. Federal officials brushed aside their concerns. The OCC and its sister agency, the Office of Thrift Supervision (OTS), instead sided with lenders.

July 22, 2003 – House Committee on Energy and Commerce, Subcommittee on Commerce, Trade, and Consumer Protection hearing on "FASB Derivative Accounting Standards."

April 28, 2004 – meeting of the SEC on the net capital rule:

…was held at the request of the major Wall Street investment houses, including Goldman Sachs, then headed by future Treasury Secretary Henry M. Paulson, Jr.. The firms requested that the SEC release them from the so-called "net capital rule", or responsibility to hold capital reserves in their brokerage units. The complaint that was put forth by the investment banks was of increasingly onerous regulatory requirements — in this case, not U.S. regulator oversight, but European Union regulation of the foreign operations of US investment groups. As at other agencies during the George W. Bush administration, the deregulatory request was received favorably by the SEC. The Commissioners voted unanimously to change the regulation.

In the immediate lead-up to the decision, EU regulators also acceded to US pressure, and agreed not to scrutinize foreign firms’ reserve holdings if the SEC agreed to do so instead. A 1999 law, however, put the parent holding company of each of the big American brokerages beyond SEC oversight. In order for the agreement to go ahead, the investment banks lobbied for a decision that would allow "voluntary" inspection of their parent and subsidiary holdings by the SEC.

Yet in the amendment taken up by the Commission, the SEC stepped back from direct oversight of the performance of the firms and adequacy of their reserve holdings. Instead, the Commission deferred to the investment houses, and decided to rely on the firms’ own computer models for determining the riskiness of investments, "essentially outsourcing the job of monitoring risk to the banks themselves."[4]

The only briefing the Commission received that criticized the regulatory change proposed for adoption came from Leonard D. Bole, an information technology consultant, who found the risk models used by investors no better in 2004 than during the 1998 failure and bailout of the hedge fund, Long-Term Capital Management. The SEC’s oversight arm took no action to contact Mr. Bole to follow up on the briefing that he submitted.[5]

According to one of the SEC Commissioners of the period, Harvey J. Goldschmid, "the 2004 rule making gave us the ability to get information that would have been critical to sensible monitoring, and yet the S.E.C. didn’t oversee well enough."[6] Many of these failures to follow through on oversight responsibility are further documented in SEC Office of the Inspector General reports.[7][8]

August 3, 2005 – Christopher Cox was sworn in as Chairman of the Securities and Exchange Commission

November 15, 2005 – The Senate Committee on Banking, Housing, and Urban Affairs, hold nomination hearing for Ben Bernanke. From his written statement:

First, central bankers in the United States and around the world have come to understand that ensuring long-run price stability is essential for achieving maximum employment and overall economic stability. In recent decades, the variability of output and employment has decreased markedly, and recessions have been less frequent and less severe. I believe that the Federal Reserve’s success in reducing and stabilizing inflation and inflation expectations is a major reason for this improved economic performance. If I am confirmed, I am confident that my colleagues on the Federal Open Market Committee (FOMC) and I will maintain the focus on long-term price stability as monetary policy’s greatest contribution to general economic prosperity and maximum employment.

Second, monetary policy at the Fed has been executed with both careful judgment and flexibility. To cite one prominent example, Chairman Greenspan’s risk-management policy approach attempts to take into account the possible consequences of not only the most likely forecast outcomes but also of a range of lower-probability outcomes. Implementing this approach requires sophisticated judgments about possible risks to the economy as well as the flexibility to respond quickly to new information or unexpected developments. Risk analysis of this type is a necessary component of successful monetary policymaking. To be sure, the need for flexibility does not imply that good policy is undisciplined, as Chairman Greenspan himself has emphasized. Monetary policy is most effective when it is as coherent, consistent, and predictable as possible, while at all times leaving full scope for flexibility and the use of judgment as conditions may require.

Finally, under Chairman Greenspan, monetary policy has become increasingly transparent to the public and the financial markets, a trend that I strongly support. A more transparent policy process increases democratic accountability, promotes constructive dialogue between policymakers and informed outsiders, reduces uncertainty in financial markets, and helps to anchor the public’s expectations of long-run inflation–which, as I have argued already, promotes economic growth and stability.

February 1, 2006 – Ben Bernanke was sworn in as Chairman of the Federal Reserve. For those who like gallows humor, an amusing story from naked capitalism:

The story goes that shortly after Ben Bernanke was confirmed as Fed Chairman, he attended a dinner in New York attended by the heads of the major banks. All the big banksters were there. After dinner, Chairman Bernanke gave a speech and he at one point reportedly commented that the financial markets were "not very leveraged," causing audible laughter from the audience.

According to one attendee, Lehman Brothers CEO Dick Fuld eventually spoke up and, while declaiming any intention to disagree with Chairman Bernanke publicly, told the newly minted Fed chief that his comments about the degree of leverage in the financial markets were mistaken. JPM CEO Jamie Dimon, who also attended the dinner, was reported to second Fuld’s comments.

Who would have thought that only several months later, Fuld and Dimon, both of whom are directors of the Federal Reserve Bank of New York BTW, would be calling upon Chairman Bernanke to rescue them from leveraged OTC swamp? Guess they’re not laughing now – or are they?

July 10, 2006 – Henry Paulson became United States Secretary of the Treasury. Prior to his nomination, Paulson was CEO of Goldman Sachs.

In 2004, at the request of the major Wall Street investment houses, including Goldman Sachs, then headed by Paulson, the U.S. Securities and Exchange Commission agreed unanimously to release the major investment houses from the net capital rule, the requirement that their brokerages hold reserve capital that limited their leverage and risk exposure. The complaint that was put forth by the investment banks was of increasingly onerous regulatory requirements — in this case, not U.S. regulator oversight, but European Union regulation of the foreign operations of US investment groups. In the immediate lead-up to the decision, EU regulators also acceded to US pressure, and agreed not to scrutinize foreign firms’ reserve holdings if the SEC agreed to do so instead. The 1999 Gramm-Leach-Bliley Act, however, put the parent holding company of each of the big American brokerages beyond SEC oversight. In order for the agreement to go ahead, the investment banks lobbied for a decision that would allow "voluntary" inspection of their parent and subsidiary holdings by the SEC.

During this repeal of the net capital rule, SEC Chairman William H. Donaldson agreed to the establishment of a risk management office that would monitor signs of future problems. This office was eventually dismantled by Chairman Christopher Cox, after discussions with Paulson. According to the New York Times, "While other financial regulatory agencies criticized a blueprint by Mr. Paulson, the [new] Treasury secretary, that proposed to reduce their stature — and that of the S.E.C. — Mr. Cox did not challenge the plan, leaving it to three former Democratic and Republican commission chairmen to complain that the blueprint would neuter the agency."[11]

In late September 2008, Chairman Cox and the other Commissioners agreed to end the 2004 program of voluntary regulation.

June 27, 2007 – Walter Lukken was appointed Acting Chairman of the US Commodity Futures Trading Commission and nominated to be Chairman by President Bush in September 2007. From the CFTC website:

Prior to joining the CFTC, Acting Chairman Lukken served for five years as counsel on the professional staff of the U.S. Senate Agriculture Committee under Chairman Richard Lugar (R-IN), specializing in futures and derivatives markets. In this capacity, he was prominently involved in the development, drafting and passage of the Commodity Futures Modernization Act of 2000 (H.R. 5660).

Previous Chairs of the CFTC were:

  • Wendy L. Gramm (Chairman 2/22/88-1/22/93)
  • William P. Albrecht (Acting Chairman 1/22/93-8/20/93)
  • Sheila C. Bair (Acting Chairman 8/21/93-12/21/93)
  • Barbara P. Holum (Acting Chairman 12/22/93-10/7/94)
  • Mary L. Schapiro (Chairman 10/13/94-1/26/96)
  • John E. Tull, Jr. (Acting Chairman 1/27/96-8/25/96)
  • Brooksley E. Born (Chairperson 8/26/96-6/1/99)
  • David D. Spears (Acting Chairman 6/2/99-8/10/99)
  • William J. Rainer(Chairman 8/11/99 – 1/19/01)
  • James E. Newsome (Acting Chairman 1/20/01 – 12/27/01) (Chairman 12/27/01 – 7/23/04)
  • Sharon Brown-Hruska (Acting Chairman 7/24/04 – 7/10/05)
  • Reuben Jeffery III (Chairman 7/11/05 – 6/27/07)

October 15, 2007 – Treasury’s SIV rescue plan, the Master Liquidity Enhancement Conduit (MLEC), is announced:

The Master Liquidity Enhancement Conduit (MLEC), also known as the Super SIV (structured investment vehicle), was a plan announced by three major banks based in the United States on October 15, 2007, to help alleviate the subprime mortage financial crisis. Citigroup, JPMorgan Chase, and Bank of America created the plan in an effort stave off financial damage.[1] Due to a tightening of the credit markets linked to the crisis, a number of structured investment vehicles (SIVs), backed by major banking institutions, found themselves less able to obtain short-term financing on the open market, which they need in order to ensure their continued operations. Complicating the problem was the fact that many of the investment securities held by SIVs are valued by a computer model[2] developed by the securities holder. The mark to model process is similar to certain tactics used to support the Enron accounting fraud, where assets were assigned values that benefited the company’s bottom line.

The United States Department of the Treasury played a significant role in the idea of the formation of the fund. Treasury Secretary Henry Paulson championed the idea, with Under-Secretary for Domestic Finance Robert K. Steel taking the initiative in bringing the banks together for the plan.[4] Others questioned the legality of fund participants’ ability to work in concert, supporting price discovery in certain illiquid positions held by the SIVs, in light of United States antitrust law.[5]

December 21, 2007 – SIV bailout plan abandoned:

Citigroup, JPMorgan and BofA cancel plans for a mortgage backed securities rescue fund, but leave the door open in case of more credit woes.

January 30, 2008 – As reported by CNN Money, Robert Rubin: What Meltdown:

In a talk on Wednesday, the Citigroup director said the current financial upheaval is just cyclical. And none of the blame that there was to assign went to Wall Street.

A lending catastrophe has consumed homeowners, mortgage companies, and the financial system, but Robert Rubin, Citigroup’s director and executive committee chair, doesn’t seem particularly alarmed.

He told a small crowd at Manhattan’s Cooper Union for the Advancement of Science and Art Wednesday that the problems now roiling the markets and forcing the Federal Reserve into a defensive posture are "all part of a cycle of periodic excess leading to periodic disruption," and that we are not in fact on the verge of a financial meltdown.

And the economic problems that he did acknowledge were blamed on just about everyone but the major U.S. financial players.

Rubin said part of the problem is that we need a "more educated electorate" to hold politicians accountable. Without that, the U.S. won’t be able to overcome long-term economic challenges, like the troubles surrounding social security and budget deficits, or the new problems created by globalization.

"The key to our future is how well or badly politicians address the economic issues we face," he said. He added that politicians must face the "brutal politics around entitlement programs," cut spending and be willing to shrink the deficit using unpopular tools like higher corporate taxes.

While he did not endorse a candidate Wednesday, he has already thrown his support behind Hillary Clinton.

Citi’s credit hangover

Rubin may be correct in his assessment of issues like entitlement programs, but this was hardly the speech one would expect from a man whose bank has written down more than billion in losses due in large part to greed, cynicism, and bad judgment.

Rubin has been a director and chair of Citigroup’s (C, Fortune 500) executive committee since 1999, overseeing a period during which the bank took on huge risks that it is paying dearly for now. He didn’t talk about Citi, but when asked he defended both former chief executive Charles Prince and the decision to replace him with Vikram Pandit.

Also at the root of the country’s larger economic problems and one of the most serious deterrents to growth, Rubin said, is the wealth gap. He added that this is a global problem.

"It’s a paramount task for policy makers to understand why market economy and globalization are associated with severe income distribution issues in almost every country; and then they must create policy to address the problem."

March 11, 2008 – Christopher Cox, chairman of the Securities and Exchange Commission, says, “We have a good deal of comfort about the capital cushions at these firms at the moment.”

As rumors swirled that Bear Stearns faced imminent collapse in early March, Christopher Cox was told by his staff that Bear Stearns had billion in cash and other assets — more than enough to weather the storm.

Drained of most of its cash three days later, Bear Stearns was forced into a hastily arranged marriage with JPMorgan Chase — backed by a billion taxpayer dowry.

April 2, 2008 – FASB votes to change accounting rules that have allowed mortgage lenders sell packaged loans to off-balance-sheet SIVs and then record the profit even while being liable for losses.

FASB voted to remove the Qualified Special Purpose Entity (QSPE) concept (used for some securitizations) from FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and to remove the related scope exception from FIN 46R, Consolidation of Variable Interest Entities (VIEs).

The QSPE concept specified in FAS 140 had been criticized, particularly in light of recent market turmoil tied largely to origination (and related issues involving securitization) of subprime mortgages. To obtain ‘sale treatment’ or off-balance sheet treatment for assets transferred or sold to a QSPE, (and for asset transfers generally) the transferor (e.g. a bank or other originator of mortgages) must give up control over the assets, otherwise the assets would have to remain on the transferors balance sheet (and gain on sale would be limited). The QSPE concept as defined in FAS 140 provided a means to demonstrate control was given up by the transferor, however, the restrictions specified in FAS 140 prohibiting a QSPE from managing the underlying assets, unless pre-specified in the original documents of the securitization trust, or agreed to subsequently by a majority of the investors in the trust, was viewed by some as threatening the ability of lenders and servicers to modify the terms of mortgages to help borrowers avoid foreclosure in the recent credit crunch.

FASB has had a longer term project to amend FAS 140, dating back to its 2005 Exposure Draft. The expedited nature of dealing with the QSPE issue as a short-term project was in response to a request from the SEC that FASB address this issue by year-end

Barry Ritholtz explains:

To grossly oversimplify, Banks have been using QSPEs to effectively boost their leverage and hence, their return on capital. Without the balance sheet constraints of the old days, banks were encouraged to create assets — by making lots of loans they shouldn’t have — that could, in theory, be sold off later. It hasn’t quite worked out that way.

QSPEs can have legitimate purposes — but they also can obfuscate the true financial condition of a bank or broker. The purpose is not to simply hide losses off balance sheet, but to get those assets off balance sheet so leverage/Tier 1 capital ratios look better. Essentially you can be much more leveraged than you appear, so that ratios like ROA and ROE look stronger than they would if they weren’t employed.

June 2008 – At a conference in Cannes on asset-backed securities, accounting rule changes are discussed:

Accounting changes could force US banks to take thousands of billions of dollars back on to their balance sheets in the coming months in a move that is likely to curb further their lending and could push them into new capital raisings, analysts have warned.

Analysts at Citigroup said a planned tightening of the rules regarding off-balance sheet vehicles would force banks to reconsider arrangements and could result in up to,000bn of assets coming back on to the books.

The off-balance sheet vehicles have been used by financial institutions to keep some assets off their balance sheets, thereby avoiding the need to hold regulatory capital against them.

Birgit Specht, head of securitisation analysis at Citigroup, said: "We think it is very likely that these vehicles will come back on balance sheet.

"This will not affect liquidity because [they] are funded, but it will affect debt-to-equity ratios [at banks] and so significantly impact banks’ ability to lend."

July 30, 2008 – Implementation date for FASB rule change to eliminate QSPEs was delayed:

On Wednesday, the Financial Accounting Standards Board said its upcoming exposure drafts on revisions to two securitization-related rules — FAS 140 and FIN 46(R) — will likely propose an effective date of November 15, 2009. FAS 140 is the accounting rule that specifies the conditions for keeping securitized assets off the balance sheet, while FAS 46(R) focuses on when a company should consolidate variable interest entities (known as either VIEs or SPEs

The new disclosure rules, which will be included in the upcoming exposure drafts, will likely go into effect in January 2009. The draft rules call for information about the nature, purpose, and activities of VIEs — including how the entity is financed, as well as the terms of arrangement that could require the company to provide financial support to the VIE — such as liquidity commitments and obligations to purchase assets. The comment period for the disclosure rules will be 30 day

October 1, 2008 – Representative Markey sent a sternly worded letter to SEC chair Cox:

I am writing you as the principle House author of H.R.3657, the Market Reform Act of 1990, a bill which President George H.W. Bush signed into law on October 16, 1990 (se Public Law 101-432).

This legislation was enacted by Congress to address many of the concerns that had been raised regarding the stability of our nation’s securities markets in the aftermath of the October 1987 Crash, the October 1989 "mini Crash," and the failure of Drexel Burnham following the collapse of the junk bond market. At the time this bill was signed into law, the-SEC Chairman Richard Breeden noted that the risk assessment language "creates a system of information and oversight over the parents and other affiliates of broker-dealers, therby giving the Commission ‘early warning’ of potential danger signs."

I am writing you to express my strong concern that the Commission’s appalling failure to implement this provision of hte Market Reform Act. I am also dismayed to learn that instead of vigorously administering and enforcing this law, the SEC instead created a largely toothless and ineffectual voluntary "Consolidated Supervised Entity Program." This program turned out to be completely inadequate and inconsistent with the intent of Congress in passing the Market Reform Act.

I believe the SEC’S inexcusable regulatory failure in this entire area has contributed to the current problems roiling our nation’s financial markets. The Commission’s failure has now necessitated a massive federal government intervention into the financial services industry. I request that the Commission explain, in specific terms, what actions it now intends to take in response to this situation.

October 2, 2008 – In his keynote address at Georgetown University’s conference on the State of the Judiciary- Our Courts and Corporate Citizenship, Alan Greenspan attributes the current crisis in credit markets, not to a lack of regulation or oversight, but to a lack of trust. From his address:

It is remarkable that large numbers of contracts, especially in financial markets, until recent advances in information technology, were initially oral, confirmed by a written document only at a later time, even after much price movement. It is remarkable how much trust we have in the pharmacist who fills the prescription ordered by our physician. Or the trust we grant to automakers that their motor vehicles will run as certified. We are not fools. We bank on the self-interest of our counterparties with whom we trade to foster and protect their reputation for producing quality goods and services. Just contemplate how little division of labor and wealth creation would be engendered if that were not the prevailing culture in which we lived.

Wealth creation requires people to take risks, and thus we cannot be sure our actions to enhance our material wellbeing will succeed. But the greater our ability to trust in the people with whom we trade, that is, the more enhanced their reputation, the greater the accumulation of wealth. 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.

Reputation and the trust it fosters have always appeared to me to be the core attributes required of competitive markets. Laws at best can prescribe only a small fraction of the day-by-day activities in the marketplace. When trust is lost, a nation’s ability to transact business is palpably undermined. In the marketplace, uncertainties created by not always truthful counterparties raise credit risk and thereby increase real interest rates and weaker economies.

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.

As I noted in my opening remarks, trust will eventually reemerge as investors dip hesitantly back into the marketplace. From that point, history tells us, financial and economic revival sets in. I suspect it will be sooner rather than later.

October 3, 2008 – A conference held at the University of Maryland School of Law in Baltimore and moderated by Michael Greenberger included sessions on: The Housing Crisis and Early Solutions, The Financial Infrastructure, Meltdown and Impact on the Economy and The Role of Credit Agencies and Insurance:

The failure of Bear Stearns and Lehman Brothers; the recent Congressional bailout of AIG, Fannie Mae, and Freddie Mac; the incessant search for new capital to offset mortgage-related losses by once-thriving financial institutions; the seizing up of credit markets; and the increasing stockpiles of vacant and abandoned housing have collectively caused one of the worst financial crisis since the end of World War II.

How did these events happen? What does it mean for the future of the world economy? What corrective policies have been put in place? Does more need to be done by Congress and federal and state regulators? This symposium will gather experts from academia, the financial services sector, consumer groups, Capitol Hill, journalism, unions, and regulatory institutions to provide answers to each of these questions.

November 23, 2008 – in the NYT: Citigroup Saw No Red Flags Even as It Made Bolder Bets

While much of the damage inflicted on Citigroup and the broader economy was caused by errant, high-octane trading and lax oversight, critics say, blame also reaches into the highest levels at the bank. Earlier this year, the Federal Reserve took the bank to task for poor oversight and risk controls in a report it sent to Citigroup.

The bank’s downfall was years in the making and involved many in its hierarchy, particularly Mr. Prince and Robert E. Rubin, an influential director and senior adviser.

Citigroup insiders and analysts say that Mr. Prince and Mr. Rubin played pivotal roles in the bank’s current woes, by drafting and blessing a strategy that involved taking greater trading risks to expand its business and reap higher profits. Mr. Prince and Mr. Rubin both declined to comment for this article.

When he was Treasury secretary during the Clinton administration, Mr. Rubin helped loosen Depression-era banking regulations that made the creation of Citigroup possible by allowing banks to expand far beyond their traditional role as lenders and permitting them to profit from a variety of financial activities. During the same period he helped beat back tighter oversight of exotic financial products, a development he had previously said he was helpless to prevent.

And since joining Citigroup in 1999 as a trusted adviser to the bank’s senior executives, Mr. Rubin, who is an economic adviser on the transition team of President-elect Barack Obama, has sat atop a bank that has been roiled by one financial miscue after another.

November 25, 2008 – On Charlie Rose Vikram Pandit, the CEO of Citigroup, said:

The banks and financial institutions around the world have found themselves with more securities than they’d like to hold today. That’s called deleveraging.

……………….. ……………….. ………………..

Apendix I- some additional random and potentially useful links:

  • Another Frightening Show About the Economy, October 3, 2008 – This American Life, episode 365. see especially: Act Three, Swap Cops, at about 40 minutes in.
  • Was ‘Adult Supervision’ Needed On Wall Street?, September 17, 2008 – Fresh Air, WHYY (NPR) with Michael Greenberger
  • Our Confusing Economy, Explained, April 3, 2008 – Fresh Air, WHYY (NPR): with Michael Greenberger
  • CBS’s timeline of a financial meltdown beginning September 2, 2008
  • Where Was The Wise Man [Rubin]?, April 27, 2008 NYT
  • Muzzling the Watchdog, April 29, 2008 NYT oped by William Donaldson, Arthur Levitt Jr. and David Ruder.
  • Taking Hard New Look at a Greenspan Legacy, October 9, 2008, NYT
  • What Went Wrong, October 15, 2008 WaPo
  • Greenspan Slept as Off-Books Debt Escaped Scrutiny, Oct 30, 2008 Bloomberg article
  • Rubinomics Recalculated, November 24, 2008 NYT

……………….. ……………….. ………………..

Please add corrections, comments and/or additional details and references in the comments.


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