All the Devils Are Here [68]
Over the next few months, Born testified more than fifteen times in a series of highly charged congressional hearings about the concept release. It was an extraordinary spectacle: in one hearing after another, an array of Clinton regulators lined up to publicly denounce the action of another Clinton regulator. Congressional Republicans were only too happy to pile on.
In a hearing before the Senate banking committee in July, for instance, Greenspan made the specious claim that derivatives were already adequately supervised: “I would say that the comptroller and ourselves for the banks and the SEC for other organizations create a degree of supervision and regulation which, in my judgment, is properly balanced and appropriate.”
Jim Leach, the committee chairman, then addressed John Hawke, repeating Born’s complaint in her testimony that the proposed legislation “would delegate review of federal law governing derivatives markets from the jurisdiction of the CFTC and SEC to a body dominated by banking regulators with no expertise in derivatives and market regulation.” Leach continued, “I would like to ask Mr. Hawke—The name of the Treasury secretary of the United States at this time is Robert Rubin. Does he have a background in financial supervision and financial market participation?”
“If he were here, he would say he spent twenty-seven years in that,” replied Hawke.
Leach: “I would continue to ask Mr. Hawke—The name of the chairman of the Federal Reserve Board of the United States is Alan Greenspan. Does he have a background in financial market participation?”
Hawke: “I believe he does.”
More than a decade later, you can still hear them chuckling at that exchange.
The concept release got nowhere. Persuaded by Greenspan et al., Congress slipped a provision into an agriculture bill that prevented the CFTC from acting on derivatives for six months—which just happened to be the amount of time left in Born’s term as chairman.
Three months later, Long-Term Capital Management blew up.
It would be hard to overstate the feeling of terror the LTCM collapse inflicted on Wall Street. The Russian crisis was taking place at virtually the same time; indeed, it was the precipitating event that had led to LTCM’s problems. The markets were incredibly volatile. The Dow Jones Industrial Average dropped 512 points one day in late August—the fourth largest drop in history—only to gain nearly 400 points one day in early September. The fear that the financial crisis, having swept through Asia and Russia, was about to hit the United States was palpable.
The main reason it didn’t was that the New York Fed ordered all the big Wall Street firms into a room and insisted that they hammer out a rescue plan. In the end, fourteen firms injected equity into LTCM, effectively taking it over. (Only Bear Stearns refused to participate.) In other words, it was government action—not market discipline—that prevented disaster.
Washington was every bit as terrified as Wall Street—as it should have been. The potentially destructive power of derivatives had been exposed. For that matter, all the tools of modern finance—excessive leverage, probabilistic risk models, unseen counterparty exposure—had been shown to be flawed. When Wall Street finally got a look at Long-Term Capital’s books, for example, it was astounded by the size of the firm’s total counterparty exposure: $129 billion. Up until that moment, LTCM’s lenders had only known about their own small piece of it.
During a hearing on October 1, 1998, even the Republicans on the Senate banking committee fretted about whether the LTCM disaster signaled the beginning of another S&L-style crisis. If ever there was a moment when Bob Rubin could have used his immense stature to do something about the derivatives problem he