Interview: Michael Greenberger

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• HIGHLIGHTS
• Brooksley Born's infamous lunch with Alan Greenspan
• The early warning signs about derivatives
• The "shootout" at the President's Working Group meeting
• Why Democrats didn't rally behind Born

... How high is [then-Federal Reserve Board Chair] Alan Greenspan riding in the mid-90s?

... In October, I think it was Oct. 22, '97, the stock market crashed again, went down I think 522 points, something like that. And boom, the President's Working Group is called together. ... So I attend the first meeting … and it's clear at that point that Greenspan is a very, very powerful person. He has got the attention of everybody in the room. He's held in great esteem. ...

And of course that problem, the failure and break in the stock market, wasn't a direct impact on the CFTC [Commodity Futures Tradition Commission], although when you have a crash of that kind it affects all markets. And what you're especially worried about is the ability of investors to make margin calls. The equities market, you can buy a stock on 50 percent margin. In other words, you can borrow 50 percent of the money. The futures market is you only have to put down 4 percent to 7 percent; the rest is all borrowed money. And the reason for that, in its best and most important phase, it's a risk-shifting market where people in the commercial businesses are hedging their risk. And it's more of an insurance policy than it is an investment. ...

So when this crash took place, somebody who's taking a beating in the stock market may not be able to make their margin calls in the futures market. And simply put, the burden that I had was checking with all the futures exchanges, "Are you going to make your margin calls? Are people reporting?," because if they don't, the exchangers are exposed. They're the ones who are effectively lending the money. And if they don't get paid the margin, they could go busto [sic], and that would cause systemic risk for the economy. And that's what everybody's worried about. Just as we know from the present credit crisis -- one big institution fails; it can't pay its obligations; it forces somebody else into a dangerous territory who can't pay their obligations; and pretty soon it's a falling domino effect through the economy. ...

... When you start, even knowing [then-CFTC Chair] Ms. [Brooksley] Born just a little bit, what could you tell fairly early on ... she was up against?

First of all, I knew she was very bright, but now I'm getting to see it firsthand. She's very bright; she knows everything. She's got a phenomenal memory. She manages people well. And you really feel like you're in the presence of somebody who's a very special person personality-wise, intelligence-wise and management-wise. And I can't emphasize enough, when the market goes down like it did then, which is a very substantial drop, there's panic in the streets. She is calm, cool and collected through the entire process. And it's not that she's delegating out responsibility. She is really managing the ship. ...

Did she know anything about the business? ...

Brooksley, who is a very well-established, broad-agenda lawyer at a very prominent firm, knows about commodities. She's been involved in the Hunt brothers' investigation, which is the famous cornering of the silver market. She's represented I think the London Stock Exchange or the London Futures Market, so she knows this statute, the Commodity Exchange Act, which is terribly written, very, very complicated. You can't just pick it up and read it. She knows it. She knows the players; she knows the people. So she comes into this job fully armed with the knowledge to be able to deal with it effectively.

But [the CFTC is] not a big agency. Is it overwhelmed in terms of what's out there that it needs to do, if it can do it?

That's an interesting thing. I never viewed us as being overwhelmed. ... What I did feel was, ... too often the agency was in a situation of being captured where instead of regulating the industry, the industry was regulating the commission. And ... there were exceptions to that, but that's the overall history.

It doesn't sound like Brooksley Born is somebody who wants to take a job and just kind of work for the industry. She wants to regulate?

Brooksley comes in; she wants to be an effective regulator. Part of her job was to bring in top-flight lawyers and other professionals, and she built an infrastructure that was very effective and smooth-working. So the only change here is not a sense that we're overwhelmed. The change is that the industry is saying: "Whoa, wait a minute. We can't tell these people to jump and then when they ask how high to tell them how high. Now they're telling us what needs to be done. They're enforcing the law."

In this vein, I don't want to take you too far off track, but in my division there was a policy that lawyers could come in and say, "Look, we have a question that we view as being ambiguous under the law, and we want to get a staff letter from you that tells us we can go ahead and do this, and we won't be subject to enforcement." And these are called no-action letters, "no-action" meaning the enforcement division will take no action if you commit to do what you tell us you're going to do.

One of the first things Brooksley tells me when I walk in the door, "You be very careful of this no-action process, because this is not a question of what the letter says; it's a question of who signs the letter." And there are a group of highly favored lawyers who whatever they say they want to do, arguably ambiguous, in many instances clearly in conflict with the law, they're going to get a letter back saying, "It's fine." ... So there's all this low-level favoritism going on.

Now, Brooksley and I look at this, and we say: "This is not the way the system is going to work. If you need these kinds of exemptions" -- we established a rule -- "here's the way it needs to be filed. Here are the set of facts you have to set out. Here's the law you have to cite. And this has to be a regularized, objective, neutral process." Before we got there, it was a matter of who signed the letter. ...

I read that she was one of the finalists for attorney general. True?

She had developed a very close relationship with Hillary Clinton when Hillary Clinton was a very prominent lawyer in Little Rock, Ark. ... When [President Bill] Clinton got elected, I remembered hearing the story that [Mrs. Clinton] and Clinton and a group were bandying about who would be the attorney general, and somebody said, "Well, Brooksley Born would be a good attorney general." ... And Brooksley went in for an interview with Clinton. The story comes back was that Clinton found her boring and that it never went anywhere. ...

I think to some extent you could view this [position as head of the CFTC] as a consolation prize. ... To the general world, people who knew Brooksley, the circles she traveled, the American Bar Association, the D.C. Bar, all the prestigious boards she served on, people were probably scratching their heads. ...

... [Former Treasury Secretaries Robert] Rubin, [Larry] Summers, [former Securities and Exchange Commission Chair Arthur] Levitt and Greenspan, I wonder what they thought of this woman who comes in and takes this job. ...

I don't think that either Rubin, Greenspan or Levitt or Summers knew who Brooksley Born was. And one of the messages of this story is that although they're 200-and-some miles apart, Wall Street and the D.C. Bar, the prominent lawyers in Washington, D.C., could be on opposite sides of the world. They just didn't know who she was. And moreover, they didn't really care. ...

Secondly, they don't have a real good understanding, from where I'm sitting, of what the CFTC does. They think it's backwater; they think it's pork bellies. ... And I think throughout the entire crisis we went through, they had no idea who they were dealing with. They never took the time to figure out that this was a very accomplished, smart, highly ethical and charming woman.

You mentioned, and we've read some about, this lunch that she has early on in her tenure with [Greenspan]. Tell me what you know about it.

When I went to work with her and she was telling me, "This is what you're up against," she told me that she had had this lunch with Alan Greenspan, and he had said to her probably that she and he were going to have a disagreement about something, and the subject was fraud. And he didn't believe that fraud was something that needed to be enforced or was something that regulators should worry about, and he assumed she probably did. And of course she did. I've never met a financial regulator who didn't feel that fraud was part of their mission, but that was her introduction to Alan Greenspan.

What does it tell you -- what did it tell her -- that he didn't believe fraud was a problem?

From what it told her and from what I could see in my observations of Alan Greenspan was that this was a man who was living almost in another era; that he was a total believer that the markets were self-correcting. For example, the reason he thought that fraud shouldn't be the worry of regulators is, well, if somebody committed fraud in the business community, the rational workings of the market would be that people wouldn't do business with that person, and therefore they would die on the vine. And so the free market self-corrects and takes care of fraudulent actors. ...

... Is [Greenspan] admired, elevated, unquestioned? Is there something about him by then -- is [he] just untouchable?

Yes. Look, the economy, by and large in this period, is booming. There are hiccups. You have the Asian financial crisis, the default on the Russian ruble. Later on, you have the Long-Term Capital Management [LTCM] fiasco. But basically it's an upward move. We're in the middle of the dot-com bubble. ... He is a force to contend with. He's very, very highly regarded, although there's an understanding that he's coming at issues from a very orthodox free-market view, and he's not happy with the regulatory structure. He's tolerating it. He's not happy about it. ...

Rubin spent a lot of time catering to Alan Greenspan's whims. ... But as much as he was inclined to cater to Greenspan, for one reason or another, he only dealt with Brooksley as a sort of foreign power, and maybe a banana republic foreign power, rather than somebody he needed to spend the same amount of time catering to.

Do you have any explanation for that?

A lot of people have guessed about it. Some people have said, "Oh, she was a woman," whatever. I don't put a lot of stock in the fact that she was a woman. I put a lot of stock in the fact he never took the time to understand who she was and that she was a person in her own right who should have been listened to, even if on first blush you didn't agree with the direction she was going in. I feel very confident Bob Rubin didn't agree with everything Alan Greenspan told him, but he made it a high priority to deal with and embrace and work with Alan Greenspan. Had he done the same thing with Brooksley Born, I think there's a good chance we would today be sitting here on a very healthy, thriving economy. ...

[What were the early warning signs about derivatives?]

In 1994, you have the failure of Orange County, [Calif.]; goes bankrupt dealing in these unregulated, over-the-counter derivatives. The financial officer of Orange County doesn't understand the products he's dealing with, gets taken to the cleaners by the banks he's dealing with. And if you go to the popular media, everybody knows Orange County has failed. Everybody knows they failed because they were dealing with these highly toxic, complex, unregulated instruments. And it's a source, almost, of common parlance: a county, at that point, a county had actually gone bankrupt. It was rather remarkable.

At the same time within the financial services industry, there's this major scandal at Bankers Trust, where they have taken two of their customers, Procter & Gamble and Gibson Greeting Cards, to the cleaners with these complex over-the-counter derivative products. And unfortunately for Bankers Trust, it's all caught on tape in the exchanges not only between Bankers Trust and their customers, but the laughing up the sleeves of the salespeople about how they've taken these Fortune 500 companies to the cleaners. ...

And in fact, legislation is introduced. They wanted to set up a derivatives regulatory commission that would focus expressly on this subject. But at the time, the urban legend is that Lloyd Bentsen, who was then-secretary of the Treasury, went up to the Hill and said: "Look, we have this thing called the President's Working Group on Financial Markets. This is really a problem of a lack of coordination between the Fed, the Treasury, the SEC and the CFTC. We will make this our highest priority. We can deal with this within the existing structure, and don't you worry your pretty little heads about this."

So '94 goes by; '95 goes by; '96 goes by; '97 goes by. By '98, nobody's done anything about it. And while there aren't the kinds of dramatic scenarios that Orange County and Bankers Trust revealed in '94, there's a series of school boards being taken to the cleaners, cities being taken to the cleaners, and Brooksley just finally said: "These guys are operating outside of the legal structure. Somebody has got to do something about it, because if they don't, there's going to be a calamity." ...

And when you guys take over, how big is [the over-the-counter derivatives] market?

When I first walk in the door, Brooksley said to me, "This is a $13 trillion market." ... By the time in May 1998 that we actually try to do something about it, it is a $27 trillion market. By the time Congress in December of 2000 deregulates it, it's an $80 trillion market. As we sit here today, the market has dropped from above $600 trillion to $592 trillion notional value. It's dropped because of the meltdown. ...

And obviously, it went from $13 to $27 to $80 to $600 trillion because nobody's watching the market. And in fact, as we went through the economic collapse, these products are exploding all over the place, coming to us in the form of, most prominently, credit default swaps. And the panic in the market and the tightness of credit is a direct reflection that these products are spread all over the place, and somebody who today looks highly profitable has got these products' off-balance sheets on things called structured investment vehicles, so they're hidden like land mines in a battlefield. Nobody wants to give money to anybody else because they don't know, are you sitting on top of products like AIG [American International Group] was sitting on top of that takes you from the biggest insurance company in the world to bust to 80 percent owned by the United States government?

... Here's a contagion that literally metastasizes exponentially across the '90s and the early part of the 2000s.

Absolutely. ... The template is clear. Crisis caused '94 Orange County-Bankers Trust. Panic in the streets, we're going to fix it. Time passes; it cures itself. Lobbying takes over by the financial [services industry]. All is forgotten.

It happens again in late '98 when Long-Term Capital Management fails. ... You have a crisis that now looks like a picnic. But at the time, everybody, including Alan Greenspan, was sobered by that episode. Even the conservative House Financial Services Committee: "What can we do to make sure this doesn't happen again?" Opportunity for regulation, time passes, problem solved, it solves itself, all is forgotten. ...

By [Jan. 1, 1998], there was stuff in The Wall Street Journal, school boards taken to the cleaners over these things, and I don't remember exactly how it developed within the agency, but Brooksley and I talked about it. Something needs to be done. I said, "Let me think about it." And I assembled a small team of people within the Division of Trading and Markets, and we sort of gave it the name the Manhattan Project.

And we put people to work on -- in the financial services regulatory system, there is a regulatory vehicle called a concept release, and essentially what it is, it's a very preliminary white paper delivered by the regulatory agency, most often used by the CFTC and the SEC. ...

Our two goals were, one, to present the problem, and two, to propose a broad range of possible solutions to the problem without reaching any conclusions. So we began working on this. Brooksley had the conception that she wasn't worried about the rest of the administration. She was worried about the financial services industry, that we were effectively now going to say swaps are futures, the dirty words, and that this would meet a lot of resistance.

Because?

Because it meant that this multitrillion-dollar market would now have to be traded transparently with capital reserves, with fraud and manipulation requirements, with the regulation of intermediaries, and on organized exchanges rather than this private little gamesmanship where it was. ...

We aren't going to take it over. It's not going to be government-run, but it's got to be done transparently. Everybody needs to know what's happening. It's got to be overseen by a regulator who ensures that fraud and manipulation are not conducted within those markets. We've got to make sure that when people make commitments, they have the capital to back those commitments up. ...

Now, we're not saying [in the concept release] we're going to put the full regulatory template in place. We have the authority to exempt it from the full regulatory template, but something's got to be done, and here's a list of questions and a list of proposals about what might be done. Should it be a transparent market? Should we ensure adequate capital reserves? Should it be subject to fraud? Should it be subject to manipulation? Should the intermediaries be regulated? Should there be adequate capital protections? That's what the concept release was. ...

One thing I think must be made very clear is we didn't do this in secret. Brooksley called in every representative of every leading financial trade association, institution. I sat in some of those meetings. She brought them into her personal office and said: "This market has caused problems. It's subject to the Commodity Exchange Act. It's supposed to be a transparent, protected market. It's not. We think the time has come to address it." And they were then called the International [Swap] Dealers Association -- it's now the International Swaps and Derivatives Association, a branding issue there -- they all came in, they all were explained this, and nobody said, "Oh, my God, you're going to cause the worst financial crisis." I mean, they either sat there and said nothing, or some people said, "You know, it's about time somebody's going to do this."

The second transparent thing we did is sometime in March, we had a draft of the concept release. We sent it far and wide. Whoever wanted it, we sent it to all the other regulators, all the financial institutions; we sent it to Congress. ...

There were two first shots across the bow, a double shot. One was I walk into Brooksley's office one day; the blood has drained from her face. She's hanging up the telephone; she says to me: "That was Larry Summers. He says, 'You're going to cause the worst financial crisis since the end of World War II'"; that he has, my memory is, 13 bankers in his office who informed him of this. "Stop, right away. No more." ... It was not done in a tactful way, I'm quite confident of that.

Why is he acting that way? What power do the 13 in his office have? What's that all about?

... A lot of this has to do with finance contributions, political contributions.

I mean, 1998 is an election year, right, a midterm election year?

Look, every two years is an election year, and what is a lot of campaign contributions to members of Congress is chump change to the financial services industry. There was a recent report in the House Ag[riculture] Committee, which is the committee of jurisdiction [for the CFTC], I think the figure was $27 million from financial services, $9 million from the agriculture community. Now, to them, $27 million is a lot of money. Do you think $27 million is a lot of money to Goldman Sachs or Morgan Stanley?

But these people speak with tremendous power, and we see the template -- crisis, worry, threatened reform, pull back from the crisis, 24/7 lobbying, all is forgotten. And as we sit here today, we're experiencing that, a feeling that the crisis of the fall of 2008/winter of 2009, [we've] now survived. Goldman Sachs just reported record profits, and the pushback is coming to the reforms that have been proposed.

But at that time, why do the banks have such clout inside the Clinton administration?

It's a very interesting question. But I think one of the driving forces, politically at that time, was that the financial services industry was essentially a Republican-captured institution and that these were the New Democrats that were going to prove to the financial services industry that they could do better. The economy is booming. You've never made so much money. Don't look to the Republicans as your saving grace. Look to the Bob Rubins of this world, who are melding Democratic politics with a growth economy. ...

When Born gets the call from Summers, what's her aspect and counsel to you and others? ...

Look, we're all grown people; we're all heavily experienced. We've all been around the block before. Each of us has gone through various crucibles in our lives. I was a litigator for 25 years; I appeared in courts across the country. I argued cases in the United States Supreme Court. My colleagues that she had brought in were the same way.

There was just a feeling -- it was an unspoken assumption -- we're going forward. We'll deal with whoever we need to deal with. We'll be open and candid, we'll make our best arguments, but this is the right thing to do.

Did you worry about how vociferous it could be?

I think the first thing that caused me to worry about it was the April 21 meeting [of the President's Working Group], which was a very, very, very tense meeting. But up until that point, I think we felt, look, this wasn't a matter of discretion. We were given the responsibility to regulate futures markets, to make sure they were transparent, that there were capital reserves, there was no fraud, no manipulation. Here's a market that's a futures market, it's got nothing, and it's up to $27 trillion notional value. You can tell us, "Don't do this," ... but this is our constitutional job. Brooksley took an oath to uphold the laws of the United States. These are the laws of the United States. And we didn't bat an eyelash about it. And frankly, she has the support of the other commissioners on the CFTC up to that point as well.

Republican and Democrat?

Republican and Democrat.

OK, so the meeting is called for the 21st. … Is it a walk? Where is the meeting?

The meeting is at the Treasury in this ornate conference room off the secretary's office where these meetings are held. The meetings are usually well attended. This was standing room only.

Why?

Because it was known this was going to be a major showdown, that Rubin, Greenspan and Levitt were going to try and stop Brooksley from doing this.

Shootout at the O. K. Corral?

... You would think that if this issue has reached the level it's reached that Bob Rubin would pick up the phone and say, "Brooksley, let's sit down and talk about this. I want to understand what you're doing. Let's see." No, it is the shootout at the O.K. Corral. No diplomacy, no picking up the phone. And by the way, during this period, Rubin would not take Brooksley's phone calls. He would not take Brooksley's phone calls. ...

So it's April 21, 1998. The players are arrayed.

... It was Brooksley, [then-CFTC General Counsel] Dan [Waldman], [then-Chief of Staff] Susan Lee and me go to this meeting. We're driven there. We get out at the entrance of the Treasury, go up to the room, everybody assembles. The secretary walks in; the meeting is called to order. And the subject of the meeting was to discuss the concept release, and the clear mission of it was to convince Brooksley that it shouldn't be issued.

What's she like at that moment? Is she tense? Was she nervous? How do you read her?

She's extremely professional. She has a capability of being a very charming and funny person, but I think quite appropriately in that setting, she's dealing with it as she would in litigation, or I would in litigation, as a very serious matter. So she is professional, organized, orderly and matter-of-fact about what she's doing. It was a very, very tense meeting. Nobody lost their temper; nobody shouted. But short of that, it was made absolutely clear that virtually everyone in that room wanted her to stop that concept release and used very strong terms in making those arguments, including that this would cause a financial calamity.

So you've told us before of an exchange you witnessed where Greenspan turns to her. Tell me about that.

Each of the principals in turn -- that is to say, Rubin, Greenspan and Levitt -- take their shot at telling Brooksley that she shouldn't do what she's doing.

I happen to be sitting behind Brooksley and behind Greenspan. They're sitting next to each other. Greenspan turns to her, she turns to him; his face is red, and he's clearly quite upset. He certainly did not in any way raise his voice or do anything that would be unprofessional, but he was very adamant that this was a serious, serious mistake, that it would cause untold damages to the financial services market and that she should stop and not do this; that it was unwise and would cause tremendous damage. ...

Did she fight back?

Oh, yeah. Well, fight -- I want to be careful. She, in a very professional, orderly fashion, met each argument head on and gave her response to it. ... But people were coming at her from all sides.

The point has been made by some of these gentlemen that she's strident or difficult to deal with. Many of them wouldn't talk to her on the phone. But in that meeting, she was not a charming, motherly person. She was a professional, and they may have been looking for something softer in their images. But she acted as anybody would act under those circumstances. And it was not a comfortable setting, because she had no allies at the table.

How long did it last?

My memory is that it was about an hour, hour and 15 minutes. The interesting exchange came at the very end. Rubin said to her, "I am told that you do not have the jurisdiction to do this." And Brooksley said: "Well, that's interesting. That's the first time I've ever heard that. All my lawyers at the CFTC have assured me that we have the exclusive jurisdiction to do this." And Rubin said: "Oh, you're listening to government lawyers. You shouldn't be listening to government lawyers; you should be listening to private lawyers. All the private lawyers representing the banks say you don't have the jurisdiction." ...

As someone who has spent five years in the federal government, I will tell you that you could give me a list of 500 lawyers from the Department of Justice, people I do not know, and I would take any of those 500 over the "private lawyers" he was referring to in terms of competence in understanding the law. It was a tremendous insult to the professional government-lawyer staff in the United States government at that point in time. ...

At the end of this lecture on listening to private lawyers rather than government lawyers, Rubin says to Brooksley, "Will you assure me that before you do anything with this concept release, you will discuss this with the Treasury Department lawyers?" And my remembrance is Brooksley said, "Of course." I was very comfortable with that, because I felt -- all four of us felt -- there was no doubt that there was nobody at the Treasury Department who was going to convince us that we didn't have jurisdiction.

Rubin physically relaxed at that point. It was as if he had won the major purpose of the meeting. And all I could intuit from that was he was convinced that when these hicks from the CFTC talked to the powerful lawyers at the Department of Treasury, we would see the light of day, and the concept release was done. ...

We go back to the CFTC and wait for the call from the Treasury Department. This is April 21. One week goes by, no call. Two weeks go by, no call. So Dan Waldman, who was the general counsel, my memory is, starts calling over there and saying, "Where's the meeting?" No response. May 6, 7 comes along, and I go to see Brooksley, and she says: "Look, we can't be slow-rolled into inaction by their refusal to talk to us. We're going to issue the concept release." I agreed completely. We had acted in the best of faith. They didn't call us; we tried to call them; they didn't call us back. We're an independent regulatory agency. This is our statutory mission.

So we issued the concept release. The release, my best memory is, is publicly released on May 8, doesn't appear at the Federal Register until May 12, the Federal Register being the government publication. It was released in the morning. By the afternoon, Rubin, Greenspan, Levitt put out a statement saying this is a very bad thing, and Congress should act with all deliberate speed to block it. ...

… This is really playing the next heavy card by them, I take it. Is that what that's about?

It was a serious card. Again, going back to that point in time, you're dealing with a group of people who were deemed to be the, as Time magazine said, "The Committee to Save the World." And they wanted Congress to stop us, and I think it was almost a foregone conclusion that that was going to happen.

Legislation was introduced to block us for one year from doing anything in the concept release. Hearings were held on it; Brooksley testified. She had no support anywhere. The people who had previously said, "This makes sense," or, "Let's look at it," or, "These are only questions," were now of the view that we were causing serious problems that would lead to a systemic break in the economy. And she started receiving hostile communications from every direction. ...

Bear in mind through all this, too, the Democratic Party is basically not a party highly skilled in the financial services sector. That was what Bob Rubin brought to the table, a Democrat who understood the sector and was going to deal with it. And so Brooksley is a person who fights for the homeless, women's rights, civil liberties, all sorts of issues that if she had been attacked on those grounds for doing any of those things, any number of Democrats would have said: "Hands off. She's doing the right thing." But here we're talking about a time when the Democratic Party, save these Rubinistas, don't know the first thing about these markets. This is like off everybody's radar screen, so there's no natural constituency anywhere to come to her defense. And the people who are being lobbied about it are angry as they could be, not returning phone calls, being mean to her, hostile. It's a very, very unfriendly environment. ...

And Brooksley's oft-repeated mantra [was] that: "If you're troubled by us doing this, fine. Someone's got to do it. You want the SEC to do it? Fine. You want the Treasury to do it? Fine. But this is a world-class problem." And she used to say she would lay awake at night turning in her bed because she could see coming down the road [that] the crisis kept building and building, and now we've seen [that] historically. ...

Were you amazed by the vehemence of the reaction? ...

What amazed me more than anything else when I became adjusted to it was the ... refusal to sort of sit down, get everybody in a room and sit down and say, "Let's work this thing out," the refusal to sort of let us explain ourselves. ...

How do you know about LTCM melting down? What are you thinking? How are you hearing about it?

You start seeing articles in The Wall Street Journal. LTCM, this market is private, opaque; nobody in the federal government knows what's going on. ... LTCM was like, wow. They had had 46 percent, 40 percent, 20 percent returns in the prior three years before the collapse. In January 1998, they're giving money back to their investors because they don't know how to invest it all. Those investors are suing LTCM for turning back money that they want them to invest.

So LTCM is a black box. But the Journal in September '98 starts reporting they're experiencing losses. I think they started in 1998 with $4.4 billion. I know by the time of the collapse they're down to $400,000. So somebody's lost $4.4 billion. What does that mean? Nobody knows that $4.4 billion, they're leveraged 125:1. It's not 4.4. It's 4.4 times 125. ...

If you want to invest in Long-Term Capital Management, you've got to walk into a conference room, abandon computers, abandon pencils, abandon yellow pads, no notes, and you're told there's a black box. Look at these returns: 46 percent, 40 percent, 20 percent. People are fighting to get in to invest. People are fighting to lend money to Long-Term. They know they're leveraged, but nobody knows they're leveraged like this. People are fighting to be their counterparties because they're transacting all these things in these swaps transactions. They need to have a counterparty to take the other end of the transaction. And banks will do that for a very nice price. There's a great commission that goes with that. ... But every bank thinks it's the sole lender to Long-Term; it's the sole counterparty. ...

It's Friday afternoon when ... the president of the New York Fed [receives a call]. ... What we know historically [is] that Monday, Tuesday and Wednesday, the banks are informed. They're sitting around, again, another ornate conference table in the New York Fed, which is like a fortress on Wall Street. And look to your left, look to your right. Each of you has loaned enormous sums of money to Long-Term Capital Management. For every dollar they have now, they've borrowed $125. That is yours. If they collapse and go bankrupt, it's going to be a house of cards, and it is our belief that your financial stability is in jeopardy. And the way to solve this problem is for you each to pony up $400 million and buy the fund, prevent it from collapsing, and try and work the thing out.

And the fact that this happens between Monday morning and Wednesday morning is remarkable and only evidences the fact of how serious the problem was. The banks are shocked. They don't know that all these other banks are involved; they don't know all the other banks are lending, all the other banks are counterparties. But they agree, unhappily, because in those days, $400 million was a lot of money. They unhappily agree to buy the fund. ...

There is a conference call that is set up for the steering committee of the President's Working Group, and I believe we took the call in Brooksley's conference room off her office. And I believe she listened into the call. And the chief operating officer of the New York Fed made the call, and he articulated to the rest of the federal financial regulatory system what had happened. This was all unknown that [LTCM] had called [then-New York Fed Chair Bill] McDonough on Friday. They'd gone out, the world was going to come to an end, and they've saved the day by getting all the banks to agree to buy the fund out.

You mean you're all sitting there, and you had no idea this had happened?

No, nobody told anybody about it.

So stunning.

Very stunning. Very stunning. And of course it's clear that the transactions that Long-Term is involved in are the over-the-counter derivative transactions, which we say should not be hidden from the federal government, should not be leveraged 125:1; that there should be capital reserves to make sure payments are made; that this should not come as a surprise and require a -- thank God -- call from Long-Term that they're in trouble, because if they hadn't, it would have collapsed with nobody knowing about it. ...

This is a big earthshaking event, and they have dodged not a bullet but a nuclear weapon by getting the banks to buy this, propping it up. And they are very sobered and very worried about this.

… It's a Cassandra-like moment, yes?

... We all looked at each other. I mean, it was like, you know, vindication. Vindication. Yeah, it was a big event. …

Oct. 1, 1998, [then-House Banking Committee Chair Jim] Leach [R-Iowa] calls the mother of all oversight hearings, and Greenspan, McDonough, Levitt, Rubin and Brooksley are individually called to opine on what happened. And this is a Republican-controlled House Financial Services Committee.

The moment is ripe. They are angry as they can be. If you go back to the transcript, these Republicans are saying: "This is the savings and loan crisis all over again. How could this happen? This is a moral hazard. This is too big to fail." Do those words sound familiar? ...

The message that goes forth from that hearing is, to Rubin: "You are the chair of the President's Working Group on Financial Markets. We want right away a report from you on what happened and how we can prevent this from ever happening again. Fast." ...

Rubin now is trying to form a consensus within the four big players, and he's getting Greenspan to make a lot of compromises toward a regulatory posture. Not quite far enough, though, that he's not got to worry about Brooksley coming from the other side. ...

The bank financial services community is in a state of high panic at this point, and they get the idea, "We're going to be facing legislation; the game is going to be up." So the idea is that the financial services industry will start its own self-regulatory study of the problem. And they create a group called the Counterparty Risk Management [Policy] Group, and every big name on Wall Street is either on the board of overseers or the staff of this group, and they are going to mimic the President's Working Group on Financial Markets, and they are going to come up with their own report. It is clearly designed to head off any kind of mandatory regulation.

So the President's Working Group comes out in April '99 with a decent report (PDF) -- not a great report, but a decent report. That's probably Bob Rubin's last act as secretary of the Treasury. He steps down; Summers takes over.

In June '99, the Counterparty Risk Management Group -- that is, the banks -- issue their report, and it is a scathing discussion of how this market operates. There's a wonderful passage in it, which I have my students read, that says, "While oral contracts are enforceable, the better practice is to write these transactions down and execute them." And the tenor of the report is: "This market is the Wild West, and the problem is there's no adult supervision." And the industry commits itself to bringing this market under control and to put all these risk management controls to make sure that these 28-year-old salesmen who are selling these products are supervised by people who understand what's going on. No regulation is needed; we will take care of this ourselves, thank you very much.

Two things then happen. The bets that Long-Term Management placed that got them into trouble suddenly start paying off. So the banks who think they're losing all this money get all their money back, close the shop down, all is forgotten. ...

In November '99, the President's Working Group on Financial Markets issues a report (PDF). Brooksley is gone; I'm gone; Dan's gone. "These markets should be unregulated because there has been so much uncertainty about them. Because of the CFTC saying that they should be, this has been troubling to these markets. It hasn't allowed them to grow. The market will be limited henceforth to 'sophisticated investors,' not the widow and orphan. [They] won't be able to invest in it. But companies with names like Lehman Brothers, Bear Stearns, AIG, Merrill Lynch -- they're savvy -- will take control of these markets." And actually the thresholds are companies with over $5 million in assets are entitled to trade these unregulated.

They push the recommendation forward to Congress: Deregulate it. ...

On the very last day of the lame-duck Congress, Dec. 15, 2000, suddenly out of the conference committee report on the 11,000-page omnibus appropriation bill is a 262-page deregulatory bill for the over-the-counter derivative market. ... I doubt very much that there is one member of Congress or one staff member in Congress who read from end to end that legislation. I firmly believe it was written on Wall Street. When they suddenly saw that they had a chance to pass it, they just threw everything under the kitchen sink into this bill. There are little exceptions to regulation that are next to bigger exceptions to regulations that make the little ones irrelevant. It's a dog's breakfast. But that is the law that, as we sit here today, we operate under.

There's no doubt the CFTC cannot do anything about this. The SEC can do virtually nothing about it. This is an unregulated market -- no transparency, no capital reserve requirements, no prohibition on fraud, no prohibition on manipulation, no regulation of intermediaries. All the fundamental templates that we learned from the Great Depression are needed to have markets function smoothly are gone. ...

Back in the Oct. 1, 1998, House hearings that you talked about that Leach says Born has some reason to be vindicated --

To feel vindicated, I think he said.

Greenspan also testifies. And I think it's just an interesting point how stubbornly insistent Greenspan is at that point. He sees Long-Term Capital as proof that his philosophy is appropriate.

Yes. ... He had this utopian vision of markets working rationally the way gentlemen function in the best clubs in London. And the market blew up in his face. It's not self-regulating. ...

The big thing for me is the quandary that the Obama people now face. ... In a world where the banks contribute this much money, can anything ever be done?

Well, those are very good questions, and it's ironic, because Obama has essentiality brought back many of the actors who were unsympathetic to our point of view in 1998, 1999, 2000.

However, from my perspective, and I believe from Brooksley's perspective as well, the lessons have been learned. Recently, the Treasury proposed a white paper. It's confused and not as clear as one would like, but embedded within it is a program that comes in the direction of where Brooksley and I were 10, 11 years ago. And many progressives have now reached the point where after the bailout of the banks and the banks now profiting while everybody else is unemployed, they've become disenchanted with the Department of Treasury and Secretary [Timothy] Geithner and are not willing to give any credit to efforts that are being made. My view is, I believe Brooksley's view is right now, that they have put forward proposals that are meaningful and strong. ...

The benefit now, and the difference now, for Obama and the Treasury is, a, the understanding of what just happened; b, people like [CFTC Chair] Gary Gensler, who was a Goldman Sachs partner and a protégé of Bob Rubin, have come back into power, and they have given every evidence of the fact that they have learned their lesson. They are advocating the kinds of things that we advocated 10 or 11 years ago.

Right now, all I can tell you is that the battle is evenly matched. You would think after everything we've been through there shouldn't be a battle; it should be understood. No, no, the financial services industry has organized itself and will pitch very, very hard for continuing to have these markets be unobserved by anybody outside of the banking system or their customers. No capital requirements, no fraud controls, no manipulation controls and no regulation of the intermediaries. It's going to be a close-fought battle.