RS: Regulators Mount Up, Part II

This blog post is in response to “The Warning”, published by PBS.

Let’s set the stage. Someone congress doesn’t know very well, Brooksly Born, top of her class at Stanford, the first woman president of the Stanford Law Review, top notch lawyer, and chairperson of the Commodities Futures Trading Commission, comes and tells them that the over the counter derivatives they’re letting go unlegislated will cause a horrible financial crisis in the United States that will affect everyone unless something is done about it. And what happens? She is dismissed.

Firstly, let me explain what derivatives are. An over the counter derivative is a bet or swap between companies and banks as insurance to protect them unforeseen economic calamities. It’s a safety net for companies invested in the market. But what people did not know was about the fraud that was going on behind the scenes. Since derivatives aren’t regulated by the government, all known records of these swaps are strictly private, allowing banks like the Bankers Trust be basically presented with money from a contract with Proctor and Gamble. It wasn’t until it was too late that people were learning that banks were giving derivatives on derivatives on derivatives.

 I’m not surprised at all that when Brooksly Born came to congress and told them about her research about over the counter derivatives and its association with fraud would cause an economic upheaval, she was denied..  She went up against Alan Greenspan, Chairman of the Federal Reserve at that time, who was completely against regulation of derivatives because it would cause more harm than good. He thought it was okay for fraud to happen, either at basic levels or higher levels. When a no body like Born goes up against a prominent member of Washington, paired with 90% of congress not understanding what Born was talking about when it came to the derivatives, of course they would side with “their guy”.

But no more than six weeks after Born was dismissed in front of congress does it come out that one of the major companies, LTCM, a long term capital management company hedge fund based in the affluent Greenwich, CT, was going down because of the same thing that Born was lobbying for.  But LTCM gets saved by 14 banks who pledge enough money to keep it afloat in order to save the market. And finally, the people of congress start to ask questions about Born’s idea, and start to wonder about whether she really had something going or she just got lucky. Still, nothing productive was done. And to this day, something that has proven to be instrumental in the most recent fall of the stock market is still not taken care of. But President Barack Obama is weighing its pros and con’s. So hopefully, he’ll prove worthy of my vote.