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Derivatives are complex financial instruments that many investors and businesses use to both hedge against disruptions to the markets for specific goods or to predict the growth or contraction of the value of specific goods. Commodities futures are agreements to buy or sell specified goods at a specified date for a specified price. If the market value of the individual category of goods rises, than the investor makes money, sometimes a lot of money. As with a properly-functioning stock market, commodities markets, mainly the Chicago Mercantile Exchange, exist in a netherworld of uncertainty and risk, with the integrity of the process vital to the welfare not just of most investors but of the public at large. Unlike stocks traded in formal markets, however, derivatives, which began to play a larger and larger role in commodities futures, are traded “over-the-counter,” or outside of the formal structure of the stock exchanges. As such, they eluded the level of oversight common to the stock market, despite their complexity.
In August 1996, Brooksley Born was appointed by then-President Bill Clinton to chair the Commodity Futures Trading Commission (CFTC), the commodities futures equivalent of the U.S. Securities and Exchange Commission. She held that position until resigning in protest in June 1999. The reason for her resignation was the rest of the federal government’s refusal to heed her warnings about the tenuous nature of the derivatives market and the effect the obliqueness of that market could eventually have on the economy as a whole. Lest anyone underestimate the gravity of the situation that Born was attempting to address, “commodities” are not inconsequential goods or services. They include oil and minerals vital to the high-technology industries that represent a considerable proportion of American manufacturing. In other words, commodities are really important, and really valuable, and oil in particular is prone to massive fluctuations depending upon events around the world. Consequently, a derivatives market centered on commodities futures would seem a likely candidate for strict regulation. As Born pointed out, however, that was not the case. Derivatives, in fact, had largely succeeded in eluding the kind of regulatory structure common to other, less complicated financial instruments.
Derivatives markets were gaining in value at astronomical rates during the 1990s, yet very few in Congress understood them. A 2010 article, the link to which is below, described the situation well (note that date: 2010. Well after Brooksley Born first issued her warnings about the need to regulative derivatives):
“One of the biggest risks to the world's financial health is the $1.2 quadrillion derivatives market. It's complex, it's unregulated, and it ought to be of concern to world leaders that its notional value is 20 times the size of the world economy. But traders rule the roost -- and as much as risk managers and regulators might want to limit that risk, they lack the power or knowledge to do so.” ["Big Risk: $1.2 Quadrillion Derivatives Market Dwarfs GDP," Daily Finance, June 9, 2010]
So, it is reasonable to suggest that Born, who resigned her position as chair of the CFTC because of concern about the failure of the federal government to address the dangers of derivatives, may have been right in her concerns. Which brings us to the matter of the individuals who opposed her, a veritable “who’s who” of brilliant economic minds all of whom were wrong: Chairman of the Federal Reserve Alan Greenspan; Secretary of the Treasury Robert Rubin; Arthur Levitt, chairman of the Securities and Exchange Commission; and Lawrence Summers, Rubin’s successor as secretary of the Treasury and future director of President Barack Obama’s National Economic Council. None of these individuals suffered politically or professionally on account of their opposition to Born’s proposal to regulate the derivatives market. Greenspan and Rubin were, until the bottom fell out of the economy due in no small part to their decisions, considered the geniuses behind President Clinton’s economic successes and both retired gracefully to the private sector. Similarly, Summers has remained a prominent figure in the worlds of economics and finances, and currently retains his prestigious position at Harvard University. The 83-year-old Levitt is presumably also living out his retirement in comfort.
The decisions to oppose Born’s proposals regarding the regulation of derivatives, proposals that included efforts at bringing derivatives out of the dark and making them more transparent, were grounded in a very common malady affecting government and the financial services industry: the reluctance to interfere in a line of business that is proving highly profitable to many people. In short, “if it ain’t broke, don’t fix it.” The tensions between private industry, especially those industries the welfare of which have direct implications for society as a whole, and those who advocate for greater regulation of industry is a feature of the U.S. political system. Industry almost always opposes regulation; those less confident that the public’s welfare is protected against unethical or unwise practices argue for greater regulation. Those who opposed Born were concerned that greater regulation of derivatives would undermine their effectiveness and weaken the market.
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