All the Devils Are Here [43]
To deflect Washington’s concerns, in the early 1990s Weatherstone chaired an international committee on derivatives that came up with a four-volume tome of best practices for derivatives. Brickell was his aide-de-camp on the project. The report, entitled “Derivatives: Practices and Principles,” impressed the bank regulators so much that some of them tried to codify the report into regulatory language. Brickell, of course, pushed back.
Brickell took care of the Commodity Futures Trading Commission, meanwhile, by simply claiming that derivatives were not futures and were therefore outside the agency’s jurisdiction. If derivatives were ruled to be futures contracts, he said, the derivatives business would immediately be destroyed. Why? Because under the law, futures had to be traded on exchanges, and derivatives didn’t trade on an exchange. What’s more, the law said that any futures contracts that did not trade on an exchange were unenforceable. So if derivatives were declared futures, every derivative contract in the world would suddenly be worthless. Therefore they couldn’t be futures.
It was a circular argument, but it worked. Shortly after the CFTC first expressed its interest in derivatives, President George H. W. Bush appointed Wendy Gramm as the agency’s chairwoman. The wife of Senator Phil Gramm, the conservative Texas Republican, she had a PhD in economics and had been a high-level appointee at the Office of Management and Budget. After talking to Greenspan, the CFTC staff—and Brickell—Gramm ruled, in 1989, that derivatives were not futures. The Wall Street Journal ran an editorial with the headline “Swaps Saved.”
Gramm’s ruling did not put the issue to rest, however. On the contrary, prior to 1989 there were almost no congressional hearings about derivatives; over the next five years, there was a blizzard of them. Legislation to reauthorize the CFTC reopened the question of whether derivatives should be regulated like futures, leading to battles that went on for years. Court decisions that ruled that derivatives were, in fact, futures contracts had to be preempted by legislation. In 1992, the president of the New York Federal Reserve, Gerald Corrigan, made a widely noticed speech about the risks posed by derivatives. “High-tech banking and finance has its place, but it’s not all that it is cracked up to be,” he said in the speech. “I hope this sounds like a warning, because it is.” The following year, a derivatives scandal broke out when two big companies, Procter & Gamble and Gibson Greetings, lost tens of millions of dollars on swap deals. Both later sued the issuing bank, Bankers Trust, claiming they had been misled about the risks those deals posed. In Orange County, a county treasurer had boosted the county’s returns by using derivatives that Merrill Lynch had sold to him. When interest rates rose in 1994, the county lost so much money it had to file for bankruptcy.
Yet despite all the concern, the government never even came close to regulating derivatives. Brickell was relentless in his advocacy, but he had help. Shortly after making his speech in 1992, Corrigan left the New York Fed and joined Goldman Sachs; he was soon testifying in favor of derivatives. And Greenspan, who had a godlike status in Washington, was adamant that derivatives should be left alone. “Remedial legislation relating to derivatives is neither necessary nor desirable,” he said at one congressional hearing. “We must not lose sight of the fact that risks in the financial markets are regulated by private parties.” In other words, market discipline would take care of everything.
In the spring of 1994, James Bothwell of the General Accounting Office—the same man who had been threatened with the loss of his job after he wrote a tough report about Fannie and Freddie—released a report