Introduction
Failure to regulate the derivatives market during President Bill Clinton’s and President Bush eras contributed to the economic crisis that hit the U.S in the year 2008. “The Warning” is a documentary that was aired on PBS Frontline in 2009.In the documentary, a former Chairperson of the Commodity Futures Trading Commission (CFTC), Mr. Brooksley Born talks of her attempts to control the derivatives market while she was at the helm of the CFTC. She says that these attempts failed and legislation was passed to prevent her and the CFTC from regulating the derivatives markets. The passing of this legislation prompted her to resign as the chairperson of the agency. Arthur Levitt, a former Securities and Exchange Commission (SEC) chairman says that Born’s efforts to regulate the derivatives market were vehemently opposed by two powerful people in the Clinton’s administration. The two were Alan Greenspan, former Fed Chairman and Robert Rubin, former treasury secretary.The two believed that if the CFTC regulated the $27 trillion derivatives market, the results would have been a financial turmoil in the country. Levitt, Greenspan, and Rubin were principals of Working Group on Financial Markets, which President Clinton trusted a lot (video.pbs.org).
Discussion
The documentary provides a clear illustration of what caused the 2008 financial crisis. From the documentary, it has been revealed that the derivatives market was dark and was short of transparency. The derivatives market was one that even the government was not aware of. Some government officials only came to here of the derivatives market after Gibson Greetings Card and Proctor & Gamble sued the Bankers Trust for being sold products that they could hardly understand (video.pbs.org).
Brooksley Born
Born was appointed as the chairperson of the CFTC in 1996. By then, CFTC was a small agency whose responsibility was to oversee lesser markets. She noticed that firms at the Wall Street were not being monitored for the over-the-counter derivatives and raised the issue to the other government officials. However, her concerns did not go well with Levitt, Greenspan, and Rubin. As mentioned earlier, the three were principals in the Working Group on Financial Markets. They tried all they could to stop her from making any effort to regulate the derivatives market. The topic in the book “Economics USA” that fits this case is “The Problem of Discrimination” (Behravesh, 297). This is because one lady in the movie is quoted saying that these men were used to dealing with men. In her efforts to ensure that there was regulation in the derivatives market, BrooksleyBorn and her agency issued a document called “Concept Release” on May 7, 1998.In response, the Working Group drafted a bill that was aimed at prohibiting CFTC from regulating the derivatives market until after the 2000 financial year. The law was later passed by the congress. After suffering frustrations from the Working Group, Born resigned as the chairperson of CFTC in June 1999 (video.pbs.org).
“Black Box”
In the Wall Street, the derivatives market was referred to as the “black box”. The reason why the market was referred to as the “black box” is because the owners of the derivatives were unknown, and it was only these unknown owners who understood what was going on in this market. The players in this market were also few and aggressive making the market to grow at a very fast rate. The topic The “black box” still exists in the businesses until today. This is evident from failure of companies to disclose all the information that regards the income and expense items. Wall Street companies tend to hind information about their performance in the market and how they make their money. A case in point is when an intervention of the congressional inquiry that was there in 2010 forcing Goldman Sachs to disclose the amount of money it acquired from the mortgage market in the year 2007. As the documentary revealed, lack of transparency in business can have devastating effects because it was a huge contributor of the 2008 financial crisis (video.pbs.org).
Long-Term Capital Management (LTCM)
LTCM or Long-Term Capital Management was a hedge fund that leveraged bets on high scale using over-the-counter derivatives and other things. LTCM was under the operation of two economist Nobel Prize winners. The two were Myron Scholes and Bob Merton. Scholes was an advocate of the free-market. LTCM was thinly capitalized, but a very huge player in the over-the-counter derivatives that were not collateralized or secured. LTCM nearly collapsed in September 1998. However, the intervention of the Federal Government that planned its bail out from the private sector saved the firm from collapse.
LTCMneared its collapse because it had no enough resources to support the investments, leading to the market overwhelming it. According to Born, LTCM had a capital value of only$4 billion to support $1.25 trillion investment value from over-the-counter derivatives. The first thing that happened after the near collapse of LTCM was President Clinton and the Congress enacting the bill that the Working Group published. Instead of learning from the case of LTCM, the congress and the President ensured that CFTC was prevented from regulating the derivatives market by passing and signing this Act. The other thing that happened isthat the Federal Reserve Bank discovered that a lot of derivative trading and also credit default swaps were conducted in an informal manner and there were no sound paperwork. This discovery happened in the 2000s. The topic, “Unemployment” in the book “Economics US” can be related to the near collapse of LTCM because its collapse could have led to massive job losses (Behravesh 393). Another topic in the same book that can be related to the case of near collapse of LTCM is “business fluctuation” (Behravesh, 383). The last topic in Economics USA that can be related to the case of near collapse of the LTCM is in a case study in chapter twenty-five. This case study is namely “How much attention should the Fed pay to the stock market and housing prices” (Behravesh 609). The Fed should pay much attention to the stock market to avoid a similar case to that of LTCM. If Fed had paid good attention on what LTCM was doing, the firm would not have neared its collapse.
Clinton’s Role in the Derivatives market Issue
President Clinton did not take any action to punish the people were involved in opposing regulation of the derivatives market. Instead, he signed the Commodity Futures Modernization Act that had been passed by the congress in 2000. This law shielded the derivatives market from regulation even further. One topic from the book Economics USA that emerges in this case is “divergent political belief,” in chapter twenty-six. Larry Summers, Greenspan, and Rubin had divergent beliefs from Born and that is why they lobbied the Congress to pass the bill so as regulation of the derivative market could be prevented (Behravesh 636). Though the concern was economical, the three politicized it.
In regard to the people involved, Robert Rubin joined the Citigroup. Larry Summers joined President Obama’s administration as the director of the United States National Economic Council.Timothy Geithner also joined Obama’s administration as Treasury Secretary in 2009. Finally, Gary Genslerbecame the chairman of the Commodity Futures Trading Commission also in the Obama’s administration. The reason why the four were not imprisoned is that they lobbied for the undoing of the Glass-Steagall Act that could have seen them take responsibility for their actions as public officers (video.pbs.org). The three people were heavily involved in frustrating Born from regulating the derivatives market. However, they all went unpunished. Even now, they have not faced any action for their responsibility in the economic crisis. There is still a huge debate on how they all went scot-free. This debate can be associated with chapter twenty- six’s topic called “debate over post-crisis fiscal austerity,” in the Economics USA (Behravesh 640).
Current Situation
President Obama has established some plans to regulate derivatives. One such plan is in the credit default swap. The rules say that standardized derivatives should be traded on a regulated central counterparty (CPP). This is a kind of middleman. Another thing is that Obama’s administration wants to make the trading of these standardized markets electronic. By making the trade electronic means that regulation will be made more transparent. Making the derivatives market electronic-based is embracing technology which can be related to the topic “The Role of Technology Change” in the book “Economics USA” (Behravesh 318). Making this market electronic-based could be one role technology.
Conclusion and Policy Recommendation
One policy recommendation that is required in regards the derivatives market is to trade them in the exchanges where transparency can be observed. Another policy is that their routing should be through clearinghouses which will ensure that companies are able to use them as post collateral. The final policy recommendation is that there should be a stronger oversight when establishing hedge fund firms. This can avoid situations like the one that happened to LTCM. In the Book “Economics USA,” the three policy recommendations can be related to the topic “role of government, financial re-regulation after financial crisis 2008-2009” (Behravesh, 331). This is because it is the role of the government to establish policies that protect public interest. Forming of policies to regulate markets is one function of the government. So the topic “What Functions Should the Government Perform?” in the same book fits this situation (Behravesh, 281).
Works Cited
Behravesh, Nariman. Economics Usa. W. W. Norton & Company; 8 edition, 2014. Print.
"Watch Full Episodes Online of FRONTLINE on PBS | The Warning." PBS.Web. 13 Apr. 2016. <http://video.pbs.org/video/1302794657/>.
