Derivatives and the Deregulation Gamble

The highly misunderstood derivatives market has offered a perfect real-life economic experiment, and should offer a vital lesson to future policymakers. The mystique of “self-regulation” championed by men like Alan Greenspan was pushed for years from the Halls of Congress to the Treasury and Federal Reserve. The idea that the free-market knew better than the government, and would act more promptly and efficiently than the government, has largely been squashed by our recent financial fallout, according to The Washington Post.

With the gift of hindsight always being 20/20, it is now clear that when given the opportunity to operate unbridled – as was the case on Wall Street during Greenspan's tenure – corporations will not necessarily act in their own best interests, let alone the interests of the nation as a whole. By dabbling in the unregulated derivatives market, companies were able to hedge huge bets on stock futures and rake in short-term profits by the bushel. The profit margins of derivative futures have dried up, and companies who had hedged their bets – like American International Group, Lehman Brothers Holdings, and Bear Stearns – have come up empty.

The deregulation of the derivatives markets, and the economy in general, began in the 1980s under Reagan. The popular conception of George W. Bush is that of a “deregulator,” but in actuality he has merely been following the precedent set by the previous three presidents. The one man constantly at the center of the U.S. economy during the last thirty years has been Alan Greenspan. During his nineteen years at the helm of the U.S. economy, we have seen more deregulation than at any other point in history.

In 1998 Brooksley Born, the head of the Commodity Futures Trading Commission, brought the President's Working Group on Financial Markets attention to the lack of oversight, instability, and potential hazards associated with the burgeoning “derivatives industry.” Greenspan and his like-minded associates, Treasury Secretary Robert Rubin and SEC Chairman Arthur Levitt Jr., shunned any suggestions made by Born, encouraging regulation of this industry.

To them, oversight might push the industry to more accommodating regulatory practices overseas. Even though the industry represented a clear hazard to the American economy and built instability into the structure of our financial system, they believed that the free-market could do no wrong. These men are the same ones who champion “free-trade” without flinching. They believe that more trade equates to a better life, ignoring the very real fact that trade often brings with it both inequality and exploitation. Likewise, the derivatives market – which in its infancy in 1998 already represented tens of billions in nearly untraceable transactions – would somehow “trickle down” to the benefit of the great economy.

Born focused her entire career at the CFTC on regulating the derivatives market and somehow getting a hold of an industry, which in her eyes, was spiraling out of control. It threatened the greater economy and carried the potential to quickly exacerbate any economic problem into crisis proportions. Fast-forward to 2008, and we are reaping the benefits of the deregulation that Born fought against. From members of Congress, like Phil Gramm, to Wall Street executives, everyone seemed to ignore the danger of unfettered free-market action.

Having witnessed the calamity that unregulated capitalism has wrought, the only member of the old-school triumvirate not accepting the truth is the still-influential Greenspan. Levitt, upon reflection, has stated that a strong regulatory framework could have staved off the worst of our current downfall.

After being hounded in Washington before being pushed aside and replaced as CFTC chairman by a more compliant individual (William Rainer), Brooksley Born can now tell the world “I told you so.” If only that were enough to make up for an opportunity lost.

Source Washington Post: