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How the Clinton Team Thwarted Effort to Regulate Derivatives

In April 1998, a decade before a historic crisis wreaked havoc on global financial markets, an obscure regulator saw a potential gap in the government’s oversight of Wall Street and tried to do something about it.

Now, newly released records show just how ardently some of the Clinton administration’s most prominent figures shot her down. The documents add to the story of how President Bill Clinton’s team took a stance, on derivatives and other issues, that shielded Wall Street from more aggressive oversight in the years leading up to the 2008 financial crisis.

At the time, Brooksley Born was head of the Commodity Futures Trading Commission (CFTC), a small agency responsible for overseeing lesser-known corners of the markets. At the April meeting, she asked other regulatory leaders if the government was doing enough to monitor trading in over-the-counter (OTC) derivatives—a type of financial tool, often used to hedge risk and place speculative bets, that would later feature prominently in the 2008 crisis.

Born’s question was not well received.

Treasury Secretary Robert Rubin, who had spent most of his career at Goldman Sachs and joined Citigroup shortly after his stint in government, said the “financial community” was “petrified” by the notion that OTC derivatives previously exempt from CFTC regulation would now fall under the agency’s purview, according to newly released notes from the April meeting.

The possibility of CFTC oversight would create “uncertainty over trillions of dollars of transactions,” Rubin warned, adding that if Born tried to solicit the public’s input on potential derivatives regulation, “Treasury will put out [a] statement that CFTC has no jurisdiction,” according to the notes.

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The Project On Government Oversight found the handwritten notes, taken during a meeting of President Bill Clinton’s Financial Markets Working Group, in a trove of documents posted online this month by the Clinton Presidential Library. The notes were contained in files of the Clinton White House’s Council of Economic Advisers, according to the library’s release, but it’s unclear who took the notes or if the notes reflect the exact words spoken by the meeting participants.

Born thought that “Rubin [was] asking CFTC not to uphold the law,” the meeting notes say. Rubin claimed he didn’t “disagree w/ substance of CFTC’s actions” but thought there was a “better way to proceed,” the notes say.

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His views were echoed by Larry Summers, then a deputy Treasury secretary, who likewise wondered if there was a “better way to proceed” given that regulators and the financial industry viewed the CFTC’s posture “as being disastrous for markets.”

Arthur Levitt, then the head of the Securities and Exchange Commission, said it would be “problematic” for the CFTC to publicly discuss changes to the regulation of OTC derivatives without the support of other agencies.

And Alan Greenspan, then the Chairman of the Federal Reserve, warned that increased regulation could “suppress OTC derivatives business.” Once regulators began tinkering with the rules, he said, they wouldn’t be able to “put [the] cork back in [the] bottle,” the notes say.

Greenspan was also concerned that derivatives trading would move overseas. “Worry, then, that OTC derivatives market could flee to London (or Europe) if this isn’t handled well,” the notes say. “That would be a failure on CFTC’s part.”

The notes also attribute this assessment to Greenspan: “There are contradictions in the CEA [Commodity Exchange Act] – but that shouldn’t induce us to do things that will undercut the system that we are beholden to serve…”

Born’s clash with other Clinton officials has been widely covered, including in reports by Frontline, The Washington Post, and The New York Times. The newly released documents add to the historical record, offering a fly-on-the-wall account of a pivotal meeting on derivatives and taking the public inside Clinton administration discussions from that period.

Shortly after the April 1998 meeting, the derivatives dispute boiled over.

On May 7, 1998, the CFTC issued a concept release—a sort of regulatory trial balloon—raising a series of broad questions about the regulation of OTC derivatives. That same day, Rubin, Greenspan, and Levitt issued a joint statement saying they had “grave concerns” about the concept release “and its possible consequences.” They questioned the “CFTC’s jurisdiction in this area” and said they were worried about “reports that the CFTC’s action may increase the legal uncertainty.”

Behind the scenes, Clinton officials lobbied to keep the CFTC on the sidelines of derivatives oversight, according to other records newly released by the Clinton Library.

In a June 1998 email, a program analyst in the White House’s Office of Management Budget wrote that “Treasury, the FED, and the SEC all object to the CFTC’s concept release, and have drafted legislation that would prohibit the CFTC from any rulemaking until after FY 2000, while the President’s Working Group on Financial Markets studies the issue.” He added that “Treasury Secretary Rubin has talked with Gene Sperling”—director of the National Economic Council under Presidents Clinton and Obama—“concerning the legislative proposal.”

In an email commenting on testimony Treasury had prepared about the CFTC, Sarah Rosen, then a senior advisor on Clinton’s National Economic Council, identified weak spots in Treasury’s argument.

“Without better justification, sounds like Treasury wants to protect the traders from regulation,” she wrote.

In addition, she expressed concern about ongoing risks in the derivatives markets. “God forbid a major pension plan looses [sic] its shirt in OTC derivatives while we are performing this study and workers are at risk of loosing [sic] retirement benefits,” she wrote. “Wouldn’t we be better off if we had at least acknowledged the concerns now.”

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“Treasury makes only the most cursory nod at the concerns in the OTC derivatives markets,” she added. “Even Greenspan noted recently that these transactions have never been tested in a down market.”

Rosen also took aim at the concern that a CFTC regulatory concept release could be so harmful. “By this argument, we could never discuss possible regulation of any market because it might chill the market in anticipation of what the regulator ‘might’ do,” she wrote.

Rosen, now president of the Urban Institute, did not respond to POGO’s request for comment.

In September 1998, Long-Term Capital Management, a large and opaque hedge fund that made highly leveraged bets using OTC derivatives and other tools, found itself on the brink of collapse. It was saved only when the Federal Reserve orchestrated a $3.6 billion private-sector bailout of the firm.

Rather than taking the opportunity to tighten the rules for derivatives trading, Congress and the President enacted an appropriations bill in October 1998 that included a six-month moratorium prohibiting the CFTC from taking any action. Congress explained in an accompanying report that it wanted to give the Financial Markets Working Group more time to study derivatives and hedge funds.

The following year, the Working Group issued a report on the Long-Term Capital Management episode. The report offered a few modest reforms but stopped short of calling for increased oversight of derivatives or direct regulation of hedge funds.

As the report was being drafted, Douglas Elmendorf—who was serving on the Council of Economic Advisers and is now the head of the Congressional Budget Office—recommended wording it in a way that avoided opening the administration’s regulatory record to criticism, according to a memo released by the Clinton Library.

“As I suggested before, I think it’s useful to emphasize the idea that financial-market innovation has made the existing disclosure rules and regulatory approaches inadequate,” he wrote. “I’m not sure how much of the story this really is, but it’s a convenient argument because it absolves us of regulating badly in the past and neatly justifies the range of actions we’re now proposing.”

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Elmendorf declined POGO’s request for comment.

Born left the government in June 1999. In November of that year, the Financial Markets Working Group—with Summers, Greenspan, and Levitt serving as members—issued a highly anticipated report on OTC derivatives.

The report concluded that, “under many circumstances, the trading of financial derivatives…should be excluded” from the CFTC’s oversight. “To do otherwise would perpetuate legal uncertainty or impose unnecessary regulatory burdens and constraints upon the development of these markets in the United States,” the report said.

The following year, Congress passed and President Clinton signed the Commodity Futures Modernization Act, which “effectively shielded OTC derivatives from virtually all regulation or oversight” and marked a “key turning point in the march toward the financial crisis,” according to a 2011 report by the Financial Crisis Inquiry Commission. (Born served as a Commission member.)

The OTC derivatives market expanded greatly after the bill was enacted, as detailed in the Financial Crisis Inquiry Commission report. “At year-end 2000, when the [Commodity Futures Modernization Act] was passed, the notional amount of OTC derivatives outstanding globally was $95.2 trillion,” the report said. “In the seven and a half years from then until June 2008, when the market peaked, outstanding OTC derivatives increased more than sevenfold to a notional amount of $672.6 trillion.”

At the height of the financial crisis, the government approved a massive taxpayer bailout of insurance giant AIG, which had a $79 billion derivatives exposure to mortgage-related financial products that were tanking in value.

In the wake of the crisis, President Clinton and his economic team—some of whom had been featured as “The Committee to Save the World” in an infamous 1999 Time magazine cover story—were often asked to explain the positions they took on derivatives regulation in the 1990s.

Rubin told the Financial Crisis Inquiry Commission he was “‘not opposed to the regulation of derivatives’” but explained that “‘very strongly held views in the financial services industry in opposition to regulation’ were insurmountable” during his tenure as Treasury secretary.

Summers told the commission that “while risks could not necessarily have been foreseen years ago, ‘by 2008 our regulatory framework with respect to derivatives was manifestly inadequate.’”

Clinton told ABC News in 2010 he shouldn’t have listened to officials who advised him against taking a tougher stance on derivatives. “On derivatives, yeah I think they were wrong and I think I was wrong to take [their advice],” he said. “[S]ometimes people with a lot of money make stupid decisions and make it without transparency.”

Born told Frontline she expected pushback from industry players when the CFTC issued its 1998 concept release, but said she was surprised to encounter resistance from her follow regulators. “I had hoped that they would work with us to learn more about the [derivatives] market, decide whether there was an appropriate regulatory regime for it,” she said.

When asked why other regulators resisted the CFTC’s action, Born had a few ideas. “[S]ome of the people involved really were purists in terms of belief in free markets and were absolutely, from a doctrinal point of view, opposed to regulation,” she told Frontline. “I think others were concerned with keeping the big banks and the investment banks happy and making sure that they were responsive to the demands of those entities.”

Other records released by the Clinton Library this month show how officials lobbied to undo the Glass-Steagall Act, a Depression-era law that separated commercial banking, which is protected by a government safety net, from investment banking and insurance underwriting. The idea was to limit banks’ ability to put federally insured deposits at risk.

Those records were first highlighted in a story by The Guardian.

In a 1995 memo, Clinton’s then-deputy assistant for economic policy, Bo Cutter, told the President that Rubin was scheduled to testify on a proposed Glass-Steagall repeal, and it was “therefore necessary to have an agreed-upon Administration position” within a matter of days. Cutter did not respond to POGO’s request for comment.

Two years later, Rubin and other officials tried again to push through a repeal of Glass-Steagall. In a 1997 memo to the President, Rubin explained that advancing the proposal “would be a Treasury initiative, and would not require a significant time commitment from the White House.”

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As described in the Financial Crisis Inquiry Commission report, “Citicorp forced the issue” the following year “by seeking a merger with the insurance giant Travelers to form Citigroup.” Congress soon passed and President Clinton enacted a Glass-Steagall repeal that “adopted many of the measures Treasury had previously advocated.”

(According to The New York Times, Citigroup’s then-CEO Sandy Weill installed in his office a “hunk of wood – at least 4 feet wide – etched with his portrait and the words ‘The Shatterer of Glass-Steagall.’” He later changed his tune, telling CNBC in 2012: “What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that’s not going to risk the taxpayer dollars, that’s not too big to fail.” )

Rubin joined Citigroup after stepping down as Treasury Secretary, going to work for a firm that benefited directly from the Glass-Steagall repeal.

While serving as chairman of the Executive Committee on Citigroup’s board, Rubin “recommended that Citigroup increase its risk taking,” according to the FCIC report. “Citigroup’s investment bank subsidiary was a natural area for growth after the Fed and then Congress had done away with restrictions on activities that could be pursued by investment banks affiliated with commercial banks,” the report said.

By the middle of the 2000s, “Citigroup was a market leader in selling CDOs”—a product that was at the heart of the 2008 financial crisis—“often using its depositor-based commercial bank to provide liquidity support.”

After the crisis struck, taxpayers bailed out Citigroup to the tune of $45 billion, and the government promised to limit Citi’s losses on a $300 billion pool of toxic assets. The bank has since paid back the bailout money at a financial profit to taxpayers.

Rubin stayed with Citigroup until January 2009, and was paid more than $115 million for his work at the bank, the Financial Crisis Inquiry Commission reported.