All the Devils Are Here [42]
But the derivatives dealers also wanted something even more important from the government: they wanted regulators to keep their paws off their shiny new product. For J.P. Morgan, which had been one of the leading derivatives dealers long before it came up with credit default swaps, this was its top Washington priority.
The person who led the lobbying effort for the bank, Mark Brickell, could not have been better suited to this task. A tall, thin, mildly disheveled man, Brickell wasn’t like most Washington lobbyists. He wasn’t a hired gun. Rather, he was a true believer, both in the virtues of derivatives and in the need for government to leave them alone. Handed this role in 1986, Brickell embraced it with a gusto that would never abate; even in the wake of the financial crisis, Brickell insisted—against all observable evidence—that derivatives had not been a leading cause.
Brickell graduated from the University of Chicago in the early 1970s, where he had studied economics and become a convert to the fierce free-market ideology that dominated its faculty—an experience he would later describe as one of the formative experiences of his life. After attending Harvard Business School, he toyed with a career in politics before joining J.P. Morgan in 1976, where he stayed for the next quarter century.
It was the growing popularity of interest rate and currency swaps in the mid-1980s that first caused regulators to begin asking questions about them. In response, the big banks, which dominated the business, formed a lobbying group in 1985, called the Independent Swaps and Derivatives Association, or ISDA. Brickell, representing J.P. Morgan, joined the following year. In 1988, he became its chairman.
Not long after Brickell joined ISDA, the Commodity Futures Trading Commission, a relatively new agency, published a notice saying that it planned to examine whether derivatives qualified as futures. If the answer was yes, then the CFTC would have regulatory authority over the swaps business. This was the first time anyone in government had raised such an idea—though it would hardly be the last. Over the course of the next decade, the question of whether derivatives should be regulated would arise regularly in Washington. Brickell’s job essentially was to beat it back.
Brickell made at least four central arguments. The first was that because the major derivatives dealers were banks, they were already regulated by federal bank supervisors. His second argument was that the derivatives business was a hothouse of innovation, making the financial world less risky, and regulation would stifle further innovations. A third was that derivative transactions took place only among the most sophisticated investors, who didn’t need the government looking over their shoulders. His final argument was that the market itself would impose the discipline needed to keep the growing business on the straight and narrow. Mistakes would lead to losses. Bad practices would cause other participants in the derivatives market to shun the offender. In making this argument, Brickell had a powerful ally in Alan Greenspan, who was also a believer in the power of market discipline—and a skeptic of regulation. It also didn’t hurt that he had been on the J.P. Morgan board before becoming Fed chairman.
What Brickell did not talk about—or, rather, what he consistently poohpoohed—was the fear that, in dispersing risk so widely, derivatives were transferring risk from a single institution to the entire financial system. All that hedging of derivatives—the reflecting mirror syndrome—was creating an interconnectedness among financial institutions that hadn’t existed before. If one counterparty failed, what would happen to all the institutions holding its swap contracts? What would happen if the risks weren’t properly hedged? Who kept track of the exposures major financial institutions held in their derivatives books?
In addition, derivatives also created an enormous amount of unseen—and unaccounted for—potential debt. A credit default swap is