Tomorrow's Washington Post contains a big profile of former CFTC chair Brooksley Born. The Post dubs her "the Cassandra of the credit crisis" because of her infamous showdown with Alan Greenspan and Bob Rubin over the OTC derivatives markets in 1998. So was she, in fact, the Cassandra of the credit crisis? Yes and no. My answer is partly "no" for the same reason I thought back in 1998 that the reaction of the industry and (especially) the other regulators was appalling: there was, and still is, a widespread misunderstanding of Born's actions. The conventional wisdom is that Born proposed regulations for OTC derivatives, and was quickly smacked down by the market-worshipping Greenspan and Rubin. That's only half right. It's true that Greenspan and Rubin quickly and publicly smacked Born down, but she never proposed any regulations on OTC derivatives. Born issued a "concept release," which merely asked questions about the OTC derivatives markets. The concept release didn't propose even one regulation, and actually went to great lengths to emphasize that it wasn't proposing any regulations. Despite this, Robert Kuttner recently wrote that "Born distributed for comment a proposed regulation that would have required greater supervision of these so called over-the-counter derivatives." Alan Blinder even went so far as to suggest that he disagreed with Born's non-existent regulatory proposal, writing in his NYT column that "while [Born's] specific plan may not have been ideal, does anyone doubt that the financial turmoil would have been less severe if derivatives trading had acquired a zookeeper a decade ago?" The concept release essentially asked the financial industry for its analysis of the costs/benefits of a broad range of regulatory approaches to OTC derivatives. For some reason, the entire financial industry flipped out. Just look at how much the concept release bent over backwards to emphasize that it was purely informational, and should not be interpreted as a regulatory proposal:
The Commission urges commenters to analyze the benefits and burdens of any potential regulatory modifications in light of current market realities. The Commission has no preconceived result in mind. The Commission is open both to evidence in support of easing current restrictions and evidence indicating a need for additional safeguards. The Commission also welcomes comment on the extent to which certain matters are being or can be adequately addressed through self-regulation, either alone or in conjunction with some level of government oversight, or through the regulatory efforts of other government agencies.Sound the alarms! Seriously though, we had clients calling the firm all week long flipping out about the concept release—which they usually referred to as "the new OTC derivatives regulations." They were allegedly concerned about the legal status of existing OTC derivatives, even though the concept release clearly stated that any new regulations would be "applied prospectively only," and that:
This release in no way alters the current status of any instrument or transaction under the Commodity Exchange Act. All currently applicable exemptions, interpretations, and policy statements issued by the Commission regarding OTC derivatives products remain in effect, and market participants may continue to rely upon them.The way that Greenspan, Rubin, Arthur Levitt, and Larry Summers treated Born was particularly appalling. As regulators, they should have immediately realized how benign and non-threatening Born's concept release was. And even if they had substantive disagreements with her, they should never have aired those disagreements in public. The whole thing reeked of sexism. The reason Born was partly the "Cassandra of the credit crisis" is that she warned about exactly the situation the Fed and Treasury found themselves in with AIG. Born's major concern was that regulators had no information about the enormous OTC derivatives markets, and so it was possible that regulators wouldn't be able to see a financial crisis coming. (As chairman of the Fed, which is charged with protecting the "safety and soundness" of the system, Greenspan should have been thanking Born for doing his job for him.) The Fed was caught completely off-guard by AIG's collapse, and, consequently, they literally had less than 24 hours to decide whether to bail AIG out. So it's indisputable that Born was right. I don't think it's completely accurate to say, "if we had listened to Born in 1998, we wouldn't be in this mess," because—and I think Born would agree about this—she never actually proposed any regulations that would have prevented any of the actions that contributed to the crisis. Her whole point was that regulators didn't know anything about the OTC derivatives markets. If Born had been given full access to information on the OTC derivatives markets, there's no guarantee that she, or any other regulator who had access to the information, would have made the right regulatory decisions. On the other hand, she clearly demonstrated an ability to think about systemic risks and possible preventative steps, so it's not totally crazy to think that she would have seen the crisis coming and taken appropriate action. Whatever one thinks about Born's actions in 1998, her refusal to say "I told you so," or to even comment on the record about the 1998 episode, demonstrates a grace rarely seen in modern politics.