Paul Krugman: Reagan Did It. I always said Reagan was the 2nd worst president

I believe it was David Stockman himself who later recanted all the phoney economics of the Reagan years (and Stockman was an architect)

June 1, 2009
Even in Crisis, Banks Dig In for Fight Against Rules
By GRETCHEN MORGENSON and DON VAN NATTA Jr.
New York Times

As the financial crisis entered one of its darkest phases in October, a handful of the nation’s largest banks began holding daily telephone sessions. Murmurs were already emanating from Washington about the need for a wide-ranging regulatory overhaul, and Wall Street executives girded for a fight.

Atop the agenda during their calls: how to counter an expected attempt to rein in credit-default swaps and other derivatives " the sophisticated and profitable financial instruments that were intended to limit risk but instead had helped take the economy to the brink of disaster.

The nine biggest participants in the derivatives market " including JPMorgan Chase, Goldman Sachs, Citigroup and Bank of America " created a lobbying organization, the CDS Dealers Consortium, on Nov. 13, a month after five of its members accepted federal bailout money.

To oversee the consortium’s push, lobbying records show, the banks hired a longtime Washington power broker who previously helped fend off derivatives regulation: Edward J. Rosen, a partner at the law firm Cleary Gottlieb Steen & Hamilton. A confidential memo Mr. Rosen drafted and shared with the Treasury Department and leaders on Capitol Hill has, politicians and market participants say, played a pivotal role in shaping the debate over derivatives regulation.

Today, just as the bankers anticipated, a battle over derivatives has been joined, in what promises to be a replay of a confrontation in Washington that Wall Street won a decade ago. Since then, derivatives trading has become one of the most profitable businesses for the nation’s big banks.

The looming fight over regulation is the beginning of a broader debate over the future of the financial industry. At the center of the argument: What is the right amount of regulation?

Those who favor more regulation say it would offer early warning signals when companies take on too much risk and would help avert catastrophic surprises like the huge derivatives losses at the giant insurer the American International Group, which has so far received more than $170 billion in taxpayer commitments. The banks say too much regulation will stifle financial innovation and economic growth.

The debate about where derivatives will trade speaks to core concerns about the products: transparency and disclosure.

There are two distinct camps in this argument. One camp, which includes legislative leaders, is pushing for trading on an open exchange " much like stocks " where value and structure are visible and easily determined. Another camp, led by the banks, prefers that some of the products be traded in privately managed clearinghouses, with less disclosure.

The Obama administration agrees that more regulation is needed. A proposal unveiled recently by Treasury Secretary Timothy F. Geithner won plaudits for trying to make derivatives trading less freewheeling and more accountable " a plan that hinges in part on using clearinghouses for the trades.

Critics in both the financial world and Congress say relying on clearinghouses would be problematic. They also say Mr. Geithner’s plan contains a major loophole, because little disclosure would be required for more complicated derivatives, like the type of customized, credit-default swaps that helped bring down A.I.G. A.I.G. sold insurance related to mortgage securities, essentially making a big bet that those mortgages would not default.

Mr. Rosen and other bank lobbyists have pushed on Capitol Hill to keep so-called customized swaps from being traded more openly. These are contracts written for the specific needs of a customer, whose one-of-a-kind nature makes them very hard to value or trade. Mr. Rosen has also argued that dealers should be able to trade through venues closely affiliated with banks rather than through more independent platforms like exchanges.

Mr. Rosen’s confidential memo, dated Feb. 10 and obtained by The New York Times, recommended that the biggest participants in the derivatives market should continue to be overseen by the Federal Reserve Board. Critics say the Fed has been an overly friendly regulator, which is why big banks favor it.

Mr. Rosen’s proposal for change was similar to the Treasury Department’s recently announced plan to increase oversight. Treasury officials say that their proposal was arrived at independently and that they sought input from dozens of sources.

Even so, market participants, analysts and members of Congress who have proposed stricter reforms worry that the Treasury proposal does not go far enough to close several important regulatory gaps that allowed derivatives to play such a destructive role in the current financial crisis.

But increased transparency of derivatives trades would cut into banks’ profits " hence the banks’ opposition. Customers who trade derivatives would pay less if they knew what the prevailing market prices were.

“The banks want to go back to business as usual " and then some. And they have a lot of audacity now that everyone has bailed them out,” said Yra Harris, an independent commodities trader who was involved in an effort to regulate derivatives nine years ago. “But we have to begin with the premise that Wall Street doesn’t want transparency, because more transparency means less immediate profits.”

Legislators in the Senate and the House of Representatives have introduced bills offering stricter controls than those pushed a decade ago. The pending legislation goes even further than Mr. Geithner’s proposals.

“These mathematical geniuses who create these things can find a way to turn anything into a customized swap,” said Senator Tom Harkin, an Iowa Democrat, who has introduced legislation that would require all derivatives to be traded on an exchange. “You’d get a loophole big enough to drive a truck through. It could be worth trillions and trillions of swaps.”

Lessons From History

Hotly contested legislative wars are traditional fare in Washington, of course, and bills are often shaped by the push and pull of lobbyists " representing a cornucopia of special interests " working with politicians and government agencies.

What makes this fight different, say Wall Street critics and legislative leaders, is that financiers are aggressively seeking to fend off regulation of the very products and practices that directly contributed to the worst economic crisis since the Great Depression. In contrast, after the savings-and-loan debacle of the 1980s, the clout of the financial lobby diminished significantly.

The current battle mirrors a tug-of-war a decade ago. Arguing that regulation would hamper financial innovation and send American jobs overseas, Congress passed legislation in December 2000 exempting derivatives from most oversight. It was signed by President Bill Clinton.

The law passed despite the strenuous objections of Brooksley Born, a former head of the Commodity Futures Trading Commission, who left the government after her unsuccessful effort to impose more regulation. In a recent speech, Ms. Born said big banks are again trying to water down oversight efforts.

“Special interests in the financial-services industry are beginning to advocate a return to business as usual and to argue against any need for serious reform,” Ms. Born, now a lawyer in private practice, said at the John F. Kennedy Library in Boston, where she received a Profile in Courage Award.

After the 2000 legislation was passed, derivatives trading exploded, helping the biggest traders earn immense profits.

The market now represents transactions with a face value of $600 trillion, up from $88 trillion a decade ago. JPMorgan, the largest dealer of over-the-counter derivatives, earned $5 billion trading them in 2008, according to Reuters, making them one of its most profitable businesses.

Among the companies that expanded rapidly was A.I.G. Straying from its main business of providing property and life insurance, A.I.G. wrote a type of contract known as credit-default swaps that protected holders of mortgage securities against defaults. When millions of subprime borrowers stopped paying their mortgages, A.I.G. had to provide cash collateral that it did not have to clients that had bought its insurance.

Before the crisis, few market participants knew the size of A.I.G.’s exposure. Some derivatives transactions occur on exchanges, where the value and nature of the contracts are disclosed, but many do not. Credit-default swaps trade privately. This kept risk in these trades under wraps, leaving regulators unaware of how dangerously stretched and poorly managed the market was.

Where to Trade

On Capitol Hill, banking lobbyists have argued that derivatives should be traded on clearinghouses rather than exchanges, legislative leaders and their staffs say. The Geithner plan favors clearinghouses, where an intermediary would guarantee trades between participants, instead of participants dealing directly with one another as in an exchange.

A major New York clearinghouse is ICE U.S. Trust, an entity closely affiliated with banks that are also members of Mr. Rosen’s group, the CDS Consortium.

Although the Chicago Mercantile Exchange is a more established place for derivatives trading and is independent from the big New York banks, ICE seems to be the clearinghouse of choice, especially among policy makers in Washington, said Brad Hintz, a brokerage firm analyst at Bernstein Research. That is because under the Treasury proposal, the Federal Reserve Bank of New York would oversee ICE, while the Commodity Futures Trading Commission would oversee the Chicago Mercantile Exchange. Critics say the Fed has been too easy on those it oversees.

Theo Lubke, a senior New York Fed official, countered Mr. Hintz’s view, saying the Fed wants a market where a variety of clearinghouses can succeed.

Analysts say that because major banks that deal derivatives are so closely affiliated with ICE, they could seek to have many of the products classified as “customized” " the only category that would keep them off regulators’ radar screens under Mr. Geithner’s proposal.

This worries Mr. Harkin, the Iowa Democrat, whose constituents include agricultural concerns that want better oversight of trading.

This is needed, he said, to “add openness, transparency and integrity in futures trading to rebuild the financial system.”

Letting “customized” derivatives " like many credit-default swaps " trade without detailed disclosure is a way to keep regulators in the dark, he said.

Mr. Harkin said Mr. Geithner visited the Democratic caucus on Capitol Hill three weeks ago. At that meeting, Mr. Harkin said, he challenged Mr. Geithner to “define customized swaps.” Mr. Harkin said the Treasury secretary told him he would have to get back to him.

The big dealers, including major banks, say exchange trading would impose overly strict rules. But requiring exchange trading would have another effect: it would reduce the profits dealers make on derivatives.

Members of Congress say the lobbying efforts by big banks promise to produce one of the most intense political face-offs in Washington in years.

“The swaps and derivatives people are all over the place up here,” Mr. Harkin said. “They sure are trying hard to win. A lot of money is on the line.”

Lobbyists for the banks plan to make a renewed push on Capitol Hill this week.

The Financial Lobby

Through political action committees and their own employees, securities and investment firms gave $152 million in political contributions from 2007 to 2008, according to the most recent Federal Election Commission data.

The top five companies " Goldman Sachs, Citigroup, JP Morgan Chase, Bank of America and Credit Suisse " gave $22.7 million and spent more than $25 million combined on lobbying activities in that period, according to election data compiled by the Center for Responsive Politics.

All five companies are members of the CDS Dealers Consortium, the lobbying group formed in November. Lobbying records show that the group has paid Mr. Rosen, the Cleary Gottlieb partner, $430,000 for four months’ work. Mr. Rosen declined to comment, a spokeswoman said, citing “client sensitivities.”

Mr. Rosen, co-author of a treatise on derivatives regulation, frequently counsels the industry on these complex contracts. In late January, according to e-mail messages, he asked the members of the CDS dealer group if they would support his testifying before Congress on behalf of the Securities Industry and Financial Markets Association, a trade group. The CDS dealers are a much smaller group with a far larger interest in derivatives than Sifma as a whole.

Mr. Rosen received an e-mail response from Mary Whalen, managing director for public policy at Credit Suisse, the Swiss bank, which is active in the derivatives market:. “It is a good idea for Ed to write the testimony and if necessary testify. That way we can be sure that the banks’ point of view is expressed, rather than taking a chance on testimony that Sifma might craft.”

Sifma’s members include 650 firms of varying size and interests, many of which do not trade complex derivatives. By taking the lead, Mr. Rosen was able to position himself as the main advocate on derivatives for the securities industry and to make sure that the group of nine banks in the CDS Dealers Consortium had a loud voice within Sifma.

A spokeswoman for Ms. Whalen declined to comment.

Testimony to Congress

At a House Agriculture Committee hearing on derivatives in February, Mr. Rosen testified on behalf of Sifma. He did not mention that he was also a paid lobbyist for the CDS Dealers Consortium, whose interests might be different from Sifma’s.

Those testifying at such hearings are not required to disclose all of their affiliations. But when asked, Representative Collin C. Peterson, a Minnesota Democrat and the chairman of the House Agriculture Committee, said he had not known of Mr. Rosen’s relationship to the consortium. He said he would have liked to have known because it would have guided his questioning and interpretation of Mr. Rosen’s testimony, given that his clients in the smaller CDS group represented a narrower interest group with a more specific agenda.

Mr. Peterson, whose constituents include farmers, who are historically suspicious of Wall Street and whose livelihoods depend on efficient markets, is a longstanding critic of loose regulation. And since his committee oversees the Commodity Futures Trading Commission, he would retain more of his prerogatives overseeing the market if the C.F.T.C. were the main regulator.

Mr. Peterson’s bill specifically bars derivatives trading in a clearinghouse regulated by the New York Federal Reserve, which he said in an interview “is a tool of the big banks” that “wouldn’t do much” to regulate the contracts.

Because the banks’ lobbyists persuaded some of his Republican colleagues to resist more sweeping changes, Mr. Peterson said, he has had to modify a bill he introduced that is similar to Mr. Harkin’s in calling for wide-ranging limits on derivatives.

“The banks run the place,” Mr. Peterson said. “I will tell you what the problem is " they give three times more money than the next biggest group. It’s huge the amount of money they put into politics.”

As a result of the lobbying efforts, champions of broad-based regulation are concerned that proposals will be significantly limited by banking interests.

“The outrage among the public means that things have a chance to change, if things move quickly,” said Michael Greenberger, a professor at the University of Maryland Law School and a former director of trading and markets at the C.F.T.C. “We’re in this brief moment of time when the average citizen is on a level playing field with the lobbyist.”

In Cox Years at the SEC, Policies Undercut Action
Red Tape Halted Cases, Drove Down Penalties
By Zachary A. Goldfarb
Washington Post Staff Writer
Monday, June 1, 2009

The five enforcement officials caught a morning Acela train bound for Washington. Based at the New York office of the Securities and Exchange Commission, the team was seeking agency approval to impose tens of millions of dollars in fines on a drug company, Biovail, which had allegedly used the crash of a truck hauling depression medicine to cover up financial losses.

But when the group arrived at SEC headquarters on that winter day early last year, it was barred from the room where the commission was meeting, according to a person familiar with the case. Chairman Christopher Cox and his colleagues reviewed the case inside. When the doors opened, the enforcement officials learned the commission had knocked down the penalty to a small fraction of what they had sought.

The outcome, though discouraging to the team, was not a complete surprise, sources said. After Cox became SEC chairman in mid-2005, he adopted practices that undermined the enforcement division's efforts to investigate cases of corporate wrongdoing and punish those involved, according to interviews with 19 current and former SEC officials.

During Cox's tenure, investigators who wanted to subpoena documents or compel interviews faced an increasingly cumbersome process to win the commission's approval for each case, according to current and former agency officials.

Cox also required enforcement officials to see the commissioners before approaching a company about a civil settlement. In several high-profile cases, when SEC lawyers were ready to ask the commission to authorize lawsuits or approve settlements, Cox postponed the decisions at the last minute, leaving cases unresolved for months, the sources said. At times, as in the Biovail case, the commission eventually weakened the sanctions sought by the enforcement division.

This is the legacy Mary Schapiro inherited when she replaced Cox as chairman this year. Among her first acts, Schapiro freed enforcement officials from getting commission approval before negotiating settlements with companies and established an accelerated process for authorizing subpoenas and depositions. She speaks frequently of taking the "handcuffs" off of the enforcement division.

This effort is central to Schapiro's strategy for rebuilding the SEC and ensuring it has a dominant voice in the emerging debate on overhauling the nation's regulatory system. Since the 1930s, the agency has been the top cop on Wall Street and the primary regulator of financial markets, requiring that firms play fair and give investors honest, timely information.

But a backlog of financial crime cases continues to slow the enforcement division as Schapiro tries to turn more of the agency's attention to abuses linked to the financial crisis, SEC officials said. The agency is still working to reinvigorate its dispirited enforcement ranks.

As grounds for the policies he adopted, Cox cited efficiency and ensuring that commissioners had the chance to review cases. Cox said in a recent interview that he had taken steps that made clear that "corporate penalties are an important part of the agency's enforcement arsenal."

But former enforcement lawyers said the practices had a chilling effect. Several cases, they said, were scaled back or dropped because of anticipated resistance from the commission.

"The presentation of cases is the culmination of the investigative process. When that process is interrupted, delayed or denied, it can't help but have a negative impact on the people who conduct those investigations," said James T. Coffman, a former assistant director of the enforcement division. "Clearly some people wonder, 'If they don't want these kinds of cases, why should I bother doing them even though they're very important?' "

Most former and current SEC officials spoke on condition of anonymity because they were discussing confidential legal matters or were not authorized by the agency to comment. But in a report last month, the Government Accountability Office, after interviewing many enforcement lawyers, concluded that the SEC penalty policies in 2006 and 2007 "led to less vigorous pursuit of corporate penalties, may have made penalties less punitive in nature and could have compromised the quality of settlements."

During Cox's tenure, penalties imposed on companies fell 84 percent, from $1.59 billion in 2005 to $256 million in 2008.

Before and After Cox

Cox's predecessor as chairman, William Donaldson, had pursued hefty penalties against companies accused of wrongdoing, often despite dissent from other commissioners. But when Cox took office, there was a growing concern within government and the financial industry that the United States was losing business to less-regulated markets overseas, and Cox wanted to achieve consensus among the commissioners.

One commissioner, Paul Atkins, was particularly skeptical about corporate penalties. He argued that these ultimately were shouldered by shareholders -- the very people most frequently hurt by fraud -- and he often asked for more time to review cases.

"It's important that commissioners have a fair opportunity to fully understand the cases before they vote on them," Cox said in the interview.

Cox defended his enforcement credentials and pointed to the agency's aggressive pursuit last year of financial firms that misled investors into buying the exotic bonds called auction rate securities. Billions of dollars were returned to investors.

Cox also said he took an important step to modernize the enforcement division and speed cases by introducing a new case-management system. He said staff turnover during his tenure decreased, and he noted that the number of cases brought by the commission has stayed level.

But within months of Cox's appointment, tensions surfaced between the chairman and the enforcement division. Lawyers said in interviews they sometimes waited weeks to appear before the commission to request "formal orders," which enabled them to subpoena documents and conduct depositions. During Cox's tenure, the annual number of these orders fell 14 percent.

"Some investigative attorneys came to see the commission as less of an ally in bringing enforcement actions and more of a barrier," the GAO reported.

But enforcement lawyers faced even greater frustrations once investigations were finished and cases were finalized. In early 2006, Cox outlined nine conditions for investigators to consider when proposing penalties.

On many occasions, former enforcement lawyers said, Cox removed cases from the agenda because of Atkins's concerns. Often, the enforcement team had already reached a settlement with a company. The practice made it more difficult for enforcement lawyers to negotiate credibly, the attorneys said.

"Cases would sit and linger for months while you waited to get a response. . . . There was often a question as to what authority the staff had," said Thomas O. Gorman, a defense lawyer at Porter Wright Morris & Arthur in Washington who specializes in SEC cases.

Cases began disappearing from the agenda shortly after Cox became chairman. Two similar cases against financial firms -- MBIA and RenaissanceRe Holdings -- were plucked from the calendar after the companies agreed to pay penalties. The commission removed the items because of its concerns about the size of the proposed penalties, $50 million for MBIA and $15 million for RenaissanceRe, according to sources familiar with the cases. It took more than a year to close the cases, with penalties the parties had agreed to earlier.

In 2007, the SEC prepared to charge Ingram Micro, a California technology company accused of abetting a "massive financial fraud" in exchange for business at the software company McAfee from 1998 to 2000. But the case was repeatedly pulled from the commission's agenda. In mid-May, the SEC approved the settlement. Ingram, which agreed to pay $15 million, did not admit or deny wrongdoing.

Smaller Settlements

In 2006, an SEC enforcement team forged an agreement with Brocade Communications Systems for the company to pay $7 million to settle allegations it illegally backdated hundreds of millions of dollars worth of stock options. Afterward, Brocade wrote the commission directly, saying the penalty was unreasonable because the company had cooperated with the investigation.

The SEC enforcement team flew to Washington from California to present its case against the company and its executives. On the eve of the meeting, while the lawyers were at dinner, a message from the chairman's office appeared on their BlackBerrys: The commission would hear the case against the executives but postpone the one against the company, a source said.

Ten months later, to the surprise of the enforcement team, the commission met in executive session and approved a penalty against Brocade. The company did not admit or deny wrongdoing.

When subsequent cases were brought against firms for alleged backdating of stock options, penalties often were not sought, several former and current agency officials said. "People openly discussed that if you wanted to get your case done quickly, you didn't put in a civil penalty," a former enforcement lawyer said.

In two cases involving large banks, the commission eased the penalties sought by the staff. Last year, the commission slashed the penalty proposed in a case against J.P. Morgan Chase. The bank was accused of ignoring improper transactions at one of its clients that had cost investors $2.6 billion. J.P. Morgan agreed to pay a $2 million penalty to settle the case.

In late 2006, the SEC enforcement staff sought a penalty of $122 million against Deutsche Bank, which was charged with granting a hedge fund exclusive information about trading by mutual funds in exchange for business. The commission proposed reducing the fine to $17 million.

In paying penalties, neither company admitted or denied wrongdoing.

In the Biovail case, the company had projected earnings that proved too rosy. The company blamed its poor performance on the crash of a truck in Illinois carrying depression medication. But SEC investigators determined the accident "had no impact on Biovail's financial results." Rather, the SEC said Biovail was engaged in a broader effort to defraud investors. The enforcement team sought penalties in the tens of millions of dollars, a source said.

Instead, the commission set a range of $2 million to $10 million. Biovail settled for $10 million, without admitting or denying guilt.

fascinating I'm sure but could you please explain what it all means (for those of us too stupid to understand derivatives marketing?)

To make it easier for you, the Financial Services industries are members of the Criminal Classes along with the politicians who help them for money and allow them to control the Congress. Damn them all!

BBB

Well, one day a mommy derivative and a daddy derivative meet and fall in love...

Yeah, I got that part