In 2006, Arthur Levitt Jr., former head of the Securities and Exchange Commission, came under intense criticism in San Diego. At the time, Levitt was raking in $900 an hour as titular head of an outside group probing the City’s financial-disclosure practices. His firm, Kroll Inc., and its law firm, New York’s Willkie Farr & Gallagher, found the monetary joys of a cut-and-paste job. They took a year and a half to slap together a $20.3 million report that was greatly borrowed from previous studies. That is, it was a “derivative” report — copied or adapted from the work of others.
Now that word “derivative” is hanging over Levitt’s head again. Financial derivatives — or monetary instruments whose value is linked to, or derived from, some other security, such as a stock — have dragged the global financial system to the brink. There are a quadrillion dollars’ worth of these extremely complex derivatives sloshing around the world, and half are not regulated — something that is now recognized as a horrible mistake. When he was head of the securities agency, Levitt played a major role in this colossal misjudgment. He had some high-powered company: Alan Greenspan, then head of the Federal Reserve; Robert Rubin, then secretary of the treasury; and Larry Summers, then Rubin’s top assistant and now President Obama’s chief economic guru.
Some of the people that Levitt battled in San Diego three years ago are on his trail once again — this time, over the financial derivatives issue. Frank Partnoy, law professor at the University of San Diego, has been a longtime Levitt critic. When the professor learned that Levitt was charging $900 an hour to investigate San Diego, Partnoy cracked that Levitt wasn’t worth $9 an hour. In his 2003 book Infectious Greed, Partnoy came down hard on Levitt. In one passage, he recalled that in 1994, Levitt declared that top derivatives dealers should regulate themselves. “Levitt urged the dealers to form a self-regulatory ‘Derivatives Policy Group,’ and said legislation should wait until that group had decided on a plan,” wrote Partnoy. In 1994 and 1995, “Levitt gave speeches saying the financial industry should police itself.”
I have dug up a Levitt speech from 1995. Although he admitted there had been some abuses, he told a group of derivatives dealers, “We must avoid the temptation to demonize derivatives, which are a vital tool in modern financial markets.… We must resist the siren call for stringent regulation.”
The way to regulate derivatives was through the computerized risk models of the dealers themselves, continued Levitt. Displaying a prescience he surely never perceived at the time, he said it was critical that “the models are not built on a house of cards.” Of course, it turned out that they were.
And Levitt, Greenspan, Rubin, and Summers should have known it, says Mike Aguirre, who as city attorney battled the $20.3 million bill Levitt and his cronies foisted on the City. (The City sued Willkie Farr for unauthorized practice of law; the firm tried unsuccessfully to get the suit thrown out on the grounds that the City was suing for intimidation purposes. It is now at the appellate level.) “Had Arthur Levitt done his job, the derivatives debacle would never have happened,” says Aguirre, who has prepared a voluminous report on how derivatives escaped regulation. He is preparing to file a suit against American International Group (AIG), the notorious insurance company that drowned in derivatives and could have taken the world’s financial system with it if it weren’t for billions of bailout dollars from the U.S. government.
The unsung heroine in this slimy mess was Brooksley Born, who got her law degree from Stanford in 1964 and was named chairman of the federal Commodity Futures Trading Commission in 1996. Once in office, she quickly saw that the billowing market for financial derivatives had to be restrained — and regulated. But that went against the so-called free market religion of Levitt, Greenspan, Rubin, and Summers. They tried to get her to change her mind. She wouldn’t budge. Summers told her that lobbyists for derivatives dealers were putting pressure on him, according to an article in the March/April Stanford magazine. At a heated meeting, Rubin told her that her commodity agency had no jurisdiction over derivatives. Greenspan told her that the action she proposed would drive creative financial business offshore.
In May of 1998, Rubin, Greenspan, and Levitt issued a joint statement expressing “grave concerns” about Born’s regulation proposal, once again warning that interfering with the derivatives marketplace might drive the dealers offshore. In June of 1998, Greenspan, Rubin, and Levitt called on Congress to prevent Born from going forward. That fall, Long-Term Capital Management nearly collapsed because of foolish gambles on financial instruments, including derivatives. Nonetheless, Congress froze the Commodity Futures Trading Commission’s regulatory authority for six months. The next year, Born resigned.
“History already has shown that Greenspan was wrong about virtually everything, and Brooksley was right,” Partnoy told the Stanford publication. “I think she has been entirely vindicated.… If there is one person we should have listened to, it was Brooksley.”
Partnoy has now come out with a new edition of his 1997 book, F.I.A.S.C.O.: Blood in the Water on Wall Street, the first major probe of the derivatives scam. Late last month, he discussed the derivatives calamity on National Public Radio. He noted that Greenspan “admitted to some mistakes.… Arthur Levitt, the former SEC chair, admitted his errors and called for reform. No one mentioned Brooksley Born.” (Actually, three weeks earlier, Newsweek had quoted Levitt saying, “We had a warning. It was from Brooksley Born. We didn’t listen.”)
That same Newsweek article told how Born had turned ashen after Summers shouted at her over the phone. In 2006, Summers was forced to resign as president of Harvard when faculty members complained of his arrogance. He also got into trouble suggesting that there are few women in the top ranks of mathematicians because of innate gender differences. Now he is being criticized for accepting $2.7 million in speaking fees from financial institutions that have accepted government bailout money.
“She did a fabulous job,” agrees Aguirre.
However, the alpha male contingent still gets in its digs. Rubin complains that Born did not act “in a constructive way. My recollection was…this was done in a more strident way.”
And Levitt? He says that Born was “characterized as being abrasive.”
The macho males who resented Born for being “abrasive” (and for being right) went on to engineer other tragic errors. The Depression-era Glass-Steagall Act had barred a bank from offering investment, commercial banking, and insurance services. It had to go, declared the musclemen. So in November of 1999, Congress overwhelmingly passed the Gramm-Leach-Bliley Act, which overturned part of Glass-Steagall, permitting banks, insurers, and securities companies to poach on each other’s terrain and also consolidate. There followed a wave of acquisitions: banks, brokerages, and insurance companies joined forces under one corporate umbrella. The result? Ill-conceived and ill-managed hodgepodges, addicted to derivatives, that the government feels it must pump taxpayers’ money into.
Arthur Levitt is contrite about helping to create the derivatives disaster, but he is not contrite about fleecing San Diego. Certainly, he did far more damage to the world. Sums up Partnoy, “Derivatives are the most recent example of a basic theme in the history of finance: Wall Street bilks Main Street.”