As featured on p. 218 of "Bloggers on the Bus," under the name "a MyDD blogger."

Friday, May 29, 2009

Bill Clinton And Derivatives

Bill Clinton, whose Administration set the ball rolling on a lot of the structures that ultimately led to ruin in the financial markets, gives a pretty honest take of where he feels he went right and wrong:

Mr. CLINTON: Now, there basically have been three charges, if you will, laid at our doorstep, because everybody recognizes that I vetoed the securities reform bill and that we had a very different economic philosophy. But they — the three charges are one, because I enforced the Community Reinvestment Act for the first time and over 90 percent of all lending done under that law was done when I was president, $300 billion, that part of that was a lot of little banks made loans to people they had no business making loans to to buy houses so they could check the box for the Community Reinvestment Act. That’s the right-wing argument.

Then there’s the argument from the left that I shouldn’t have signed the bill that got rid of the Glass-Steagall law because that enabled banks and investment banks in effect to merge their functions.

And then there’s the argument that I make, which is that I should have raised more hell about derivatives being unregulated. I believe the last one is by far the most valid, although I don’t think that the Congress would have permitted anything to be done because Alan Greenspan was against it [...]

But I do believe on the derivatives they made the argument, the people who were against regulating it, that people like you weren’t buying derivatives. It wasn’t like you were investing your 401(k) in derivatives. You were investing your 401(k) in mutual funds, which were subject at least under normal times to the jurisdiction of the S.E.C., which was supposed to be minding the store. And so because we had a hostile Republican Congress which threatened not to fund — I don’t know if you remember this but we had a huge knock-down fight when they threatened not to fund the S.E.C. because of what Arthur Levitt was doing to try to protect the American economy from meltdowns. They said, “Oh, he’s interfering with a free market” and all that. This is what he’s supposed to do.

They argued that nobody’s going to buy these derivatives, we’ll do it without transparency, they’ll get the information they need. And it turned out to be just wrong; it just wasn’t true. And once you got that massive amount of money invested in derivatives that people thought — it’s like these credit default swaps, where people thought, the Lehman people talk about it, they thought, or the A.I.G. people, they thought it was 100 percent safe investment, they thought there would never be defaults on these mortgage securities. So of course you wanted insurance there because you got the insurance premium, you make the profit and you couldn’t possibly lose money, right? Well, it turned out to be all wrong. That rested on a lot of assumptions, including the fact that the ratings agencies would do a good job, which didn’t happen, in evaluating risk. So I very much wish now that I had demanded that we put derivatives under the jurisdiction of the Securities and Exchange Commission and that transparency rules had been observed and that we had done that. That I think is a legitimate criticism of what we didn’t do.

Clinton doesn't buy the arguments about Glass-Steagall or the Community Reinvestment Act. And much of his argument rests on the fact that the Bush Administration just gutted the regulatory apparatus, particularly the SEC, and so he was operating under a different environment. And David Leonhardt makes another very good point - the Clinton Administration allowed the run-up of the dot-com stock bubble, so thinking they would have charged in and stopped the housing bubble doesn't really hold water. They were lucky to get out of office when they did.

But this is pretty honest, and points to Clinton's instincts on this, which were always more finely attuned than his advisors. The derivatives market took off after Clinton left office, when the stock bubble popped and the relationship between housing and mortgage-backed securities started to realize itself. At the same time, Long-Term Capital Management, which invested heavily in derivatives, failed during Clinton's tenure (he couldn't come up with the name in the interview), and apparently this led Clinton to approach Alan Greenspan on the subject, who predictably said that derivatives were a niche market. In other words, Clinton deferred to Greenspan. So how would he have stopped the bubble from inflating, then? I can't see Clinton having bungled the issue as much as Bush, but while his instincts were solid, the follow-through, not so much.

Meanwhile, we have the benefit of hindsight now, and certainly a desire to regulate derivatives. Which makes the banksters unhappy:

For credit-default swaps, information about intraday trades and prices has long been controlled by a handful of large banks that handle most trades and earn bigger profits from every transaction they facilitate if prices aren't easily accessible.

For example, credit-default swaps tied to bonds of companies such as General Electric Capital and Goldman Sachs typically have a pricing gap of 0.1 percentage point between the bid and offer price. That translates into a $40,000 margin for every $10 million in debt insured for five years. Greater price transparency could narrow that gap, lowering costs for buyers and sellers but reducing fees for banks.

Just so you know who's looking out for you. Now, if the banksters still run the place, as Dick Durbin said, then everyone can be right about the dangers of the financial markets and it wouldn't amoung to a hill of beans.

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