The Warning, producer Michael Kirk's documentary on the failure of senior level economic officials to listen to prescient warnings about the dangers to the U.S. economy from an unregulated derivatives market, reaffirms the vital necessity of properly regulating complex financial arrangements and ensuring that government agencies responsible for regulating industries are performing their missions as required.
Having spent six years as a senior staffer on the U.S. Senate Committee on Banking, Housing, and Urban Affairs, I had an interesting perspective on the issue of regulation of business and industry. From that perspective, as well as from the vantage of other positions I held in the United States Congress, there was no question that Executive Branch agencies were frequently delinquent in their responsibilities for policing businesses. Their failure to do so can adversely affect the entire economy and/ or the nation's security. The Executive Branch of the federal government is responsible for regulating business when it is determined that such oversight is warranted. The financial services industry certainly qualifies for such scrutiny. As important, however, is the role of Congress in overseeing those federal agencies--a responsibility that also too often falls to the wayside. As depicted in The Warning, the derivatives market qualifies on both counts.
The U.S. economy, as in most countries, reflects the interactions of a myriad of variables, including the private sector, government, international developments, and more. One of the federal government's primary responsibilities, needless to say, is protecting the public it serves from criminal or potentially dangerous influences. The financial services industry is vital to the welfare of the entire country, and it is supposed to be regulated and, for the most part, it is. Financial experts are smart, though, and tend to be clever in their conceptualization of complex financial instruments that fall outside the boundaries of regulatory structures intended to protect the economy and the public from catastrophic failures. As the documentary illuminates, derivatives provided a classic example of such instruments that were little-understood and insufficiently regulated. Derivatives were not an unknown instrument; on the contrary, everybody who dealt with finances knew they existed, and many understood how they functioned. To most of the public, however, they were arcane business models that eluded easy comprehension. Still, their importance to the national and global economy cannot be overstated. According the Bank for International Settlements in Basel, Switzerland, the global value of over-the-counter derivatives at the end of 2007--the time frame in which the global economy melted-down--was around $15 trillion. That was, coincidentally, the size of the United States' gross domestic product that year. In short, the little-understood and little-regulated derivatives industry was a dagger pointing at the heart of the U.S. economy.
The Warning uses Brooksley Born as its principle protagonist. At the time, Born was the chairperson of the Commodity Futures Trading Commission, the federal regulatory agency responsible for the trade in commodities such as oil and gas--a pretty important responsibility for a relatively obscure agency. Born's warnings about the fragility of the derivatives market, went unheeded by the Federal Reserve, White House, Congress, and virtually every agency and department tasked with protecting the public from precisely the type of catastrophic development that occurred. This is where the regulatory role of Executive Branch agencies comes into play. Had those agencies responsible for regulating the financial services industry fully understood their responsibilities, there is a very good chance the crisis could have been averted, at least in part (the housing market played a large role in the crisis as well). Additionally, if Congressional committees, like the Senate Banking and Finance Committees and their counterparts in the House of Representatives (mainly the Financial Services Committee), had been doing their jobs and overseeing the Executive Branch regulatory agencies, then sufficient attention might have been focused on the derivatives market, and necessary laws and regulations could have been passed and implemented. Derivatives, however, were allowed to slip through the regulatory net.
A key problem, as Kirk's documentary further highlights, is the power of the financial services industry to lobby against regulations it believes will hinder its ability to function. Sometimes, those lobbying efforts are warranted; sometimes, they are not. Industry, especially financial services, want the minimum level of regulatory structure they can get, and it is, as noted, a powerful sector of the national economy. Not for nothing, in fact, have the chairmanships of key congressional committees been held by senators and congressmen from areas like New England. Connecticut in particular is home to a vast financial services sector. Industry should have a say when it comes to the regulatory environment in which it must operate, but it is incumbent upon its government overseers to ensure the regulatory structure is sufficiently robust to prevent major disruptions to the economy caused by malfeasance on the part of business. This is why relationships between business and government, in both the Executive and Legislative Branch, is so difficult to regulate.
The Warning provides the unique perspective of a key figure, Brooksley Born, who was able to analyze the derivatives market and assess its dangers to the national economy. That her warnings were ignored is not surprising, as intelligence failures have invariably resulted in nasty surprises for the nation. The failure of key officials to accept and act upon important information is the underlying cause of most man-made catastrophic developments. The case of the derivatives market was one such example, but it won't be the last.