ABA Journal - May 2009

Alan Greenspan

Robert Rubin

Lawrence Summers

rivatives that involved just two parties. The thinking was that sophisticated entities negotiating individually tailored derivatives could look out for themselves. More generic derivatives still had to be traded on exchanges, which were subject to regulation.

By 1997, the over-the-counter derivatives market had more than doubled in size—by one measure reaching an estimated $28 trillion, based on the value of the instruments underlying the contracts. (It has now reached an estimated $600 trillion.)

And some cracks were already surfacing in the landscape. Several customers of Bankers Trust, including Procter & Gamble, sued for fraud and racketeering in connection with several OTC derivatives deals. Orange County, Calif., had gone bankrupt in part because of an OTC derivatives-trading scheme gone awry.

What’s more, all the growth had taken place at a time of economic prosperity. Some people were beginning to ask what would happen if the market suffered a major reversal.

“The exposures were very, very big and if it
was your job to worry about things that could go wrong,
and I think it was, this is one of the things you couldn’t
help but notice,” says Daniel Waldman, a partner at
Arnold & Porter who was the CFTC general counsel
under Born. “It was only your blind faith in the partic-
ipants that could give you much comfort because you
really did not know much about the real risks.”

“There was no transparency of these markets at all. No market oversight. No regulator knew what was happening,” Born says. “There was no reporting to anybody.”

She chose what she thought was a middle ground, circulating a draft “concept release” to regulators and trade associations, which was intended to gather information about how the markets operated. She and her staff suspected the industry was trying to exploit the earlier regulatory exemption.

But even the modest proposal got a vituperative response. The dozen or so large banks that wrote most of the OTC derivatives contracts saw the move as a threat to a major profit center. Greenspan and his deregula-tion-minded brain trust saw no need to upset the status quo. The sheer act of contemplating regulation, they maintained, would cause widespread chaos in markets around the world.

“We would go to conferences and it would be viciously attacked,” Waldman says. “They would just be stomping their feet and pounding the tables.” With Born unlikely to change her mind, the industry focused on working through the other regulators.

Born recalls taking a phone call from Lawrence
Summers, then Rubin’s top deputy at the Treasury

Arthur Levitt

Born’s warnings about potential havoc from unregulated financial derivatives were met with skepticism by key Clinton economic advisers.

tive or the perspective of an insider. She looks at the perspective of outsiders and how people without power are going to be affected,” says Esther Lardent, president and CEO of the Pro Bono Institute at Georgetown University, who worked with Born on various ABA matters. “That is a theme constantly running through her life and career.”

“She is a very polite and low-key person, but she is never somebody who steps back from a disagreement or a fight if it is a matter of importance to her,” Lardent adds. “Did that make people uncomfortable? Did that make the men who dominated the leadership fail to take her seriously enough? I am sure that was the case.”

THE COMMISH

CLINTON NAMED HER TO HEAD THE CFTC IN 1996. SHE was not without experience: At Arnold & Porter she had represented the London futures exchange in rule-mak-ing and other matters before the commodities agency.

Born also knew how markets could be manipulated, having represented a major Swiss bank in litigation stemming from an attempt by the Hunt family of Dallas to corner the silver market in the 1980s.

“Brooksley had the advantage of knowing the law and understanding the fragility of the system if it weren’t regulated,” says Greenberger, her former adviser at the CFTC. “She could see that the data points, by lack of regulation, were heading the country into a serious set of calamities—each calamity worse than the one before.”