In the latest Democratic primary debate Thursday night, Hillary Clinton went after the core of Bernie Sanders’ appeal to the progressive base. The Wall Street-hating Senator’s hands aren’t as clean on financial policy as he claims, Clinton said, citing his support 16 years ago for a key favor to the banking business.
“While we’re talking about votes, you’re the one who voted to deregulate swaps and derivatives in 2000, which contributed to the overleveraging of Lehman Brothers, which was one of the culprits that brought down the economy,” Clinton said. “I’m not impugning your motive because you voted to deregulate swaps and derivatives. People make mistakes.”
Unlike stocks and business debts, derivatives are a category of investments that provide no tangible value to the real economy where workers sell their time to bosses so they can feed their families. They are contracts between investors that function almost exactly like betting tickets at a race track: People who have contributed nothing to the business of raising and training horses get a chance to win or lose money based on how those horses perform in the near future.
Efforts to make derivatives trading more transparent and less risky were central to the Dodd-Frank Wall Street reform effort during President Obama’s first term. Opposing that same idea, even 16 years ago, runs counter to Sanders’ crusader image on regulating the billionaires.
But the story of Sanders’ votes for the Commodity Futures Modernization Act (CFMA) isn’t quite as straightforward as Clinton depicted Thursday. And it implicates Bill Clinton’s trusted financial policy advisors far more deeply than it does Sanders.
Getting the story of the CFMA right goes beyond Clinton and Sanders’ squabble over whose Wall Street credentials are shinier. Exempting derivatives from regulation all but ensured that Wall Street’s crisis in 2008 would spill over to Main Street. And even after the crisis, the derivatives market was 23 times larger than the GDP of the entire planet.
A Dress Rehearsal For The Financial Crisis
1998 saw both the opening salvo in a public battle within the Clinton administration over derivatives regulation, and a mini-crisis on Wall Street that now looks like a dress rehearsal for the 2008 panic.
Brooksley Born, the woman Clinton chose to head the Commodity Futures Trading Commission (CFTC), began arguing in 1998 that derivatives like credit default swaps were becoming so popular on Wall Street that the government needed to start overseeing the market for the then-new investment products. Federal Reserve chair Alan Greenspan, Treasury Secretaries Robert Rubin and Larry Summers, and Securities Exchange Commission chair Art Levitt all opposed Born’s proposal to put the derivatives markets under the CFTC’s jurisdiction. Born lost the fight and later resigned.
But in September of 1998, a prominent hedge fund with a massive derivatives portfolio called Long Term Capital Management fell apart. Fearing the damage that would be caused across the financial sector as LTCM’s failure untangled itself, the head of the Federal Reserve Bank of New York convinced 14 large banks to scrape together almost $4 billion to bail the firm out.
The LTCM debacle set off alarms in part because the firm had been so successful at modeling the markets in prior years that both the financial world and public policymakers were convinced its derivatives-heavy strategies were safe. When those models broke down in ’98, that faith was revealed as fiction. LTCM’s models had said that the most it could ever lose in a day of trading was $35 million, Roger Lowenstein noted in his book about the episode, but it dropped $550 million in a single day in late August. It was like a dress rehearsal for the 2008 collapse, when the dollar figures involved in unwinding the derivatives casino would have to be measured in billions and even trillions.
The firm’s collapse and bailout changed the political dynamics surrounding Born’s idea enough that Congress began deliberating over legislation to resolve the questions Born had raised — and assure the industry it needn’t fear new rules on derivatives.
A Legislative Sleight Of Hand
The present-day tussle between Clinton and Sanders centers on the bill that came out of Born’s fight and LTCM’s collapse, crafted by anti-regulation lawmakers and administration officials.
But in its first incarnation – the measure Sanders voted for in the House, and which only four members of that body opposed – the CFMA was milder. Introduced by then-Rep. Richard Ewing (R-IL) in May of 2000, the bill prevented the CFTC from creating rules for the derivative market but left room for regulators to go after fraudulent uses of derivatives. That was too much wiggle room for potential future regulation of the derivatives market for Sen. Phil Gramm (R-TX), who blocked Ewing’s measure from moving through the Senate. Gramm introduced his own more aggressive measure.
Before the two could be reconciled, Congress adjourned for the election season. The infamous recount battle between then-Gov. George W. Bush and then-Vice President Al Gore captured the media’s attention for weeks. With the nation distracted, Gramm, Ewing, and a group of White House advisers hammered out a compromise that favored Gramm’s absolutist prohibitions on regulating Wall Street gambling. He also inserted a provision later known as the “Enron loophole” that prevented regulators from scrutinizing the energy futures contracts that fraudulent Texas investment house relied upon for its swindles.
Then, Gramm attached the new CFMA – unread by almost all of his colleagues, and significantly changed since they had last considered a measure with that title – to an appropriations bill to keep the government funded. Congress approved the spending bill a few days after Gramm slid the new language into it.
Sanders voted in favor of passing Ewing’s original CFMA in October of 2000 and for the appropriations package that included Gramm’s end-around rewrite of it in December of that year. It’s that second vote that helped slam the door on regulations for derivatives. Again, such regulation wouldn’t have prevented the housing bubble, but it could at very least have put a canary in the mine on the elaborate system of interlocking wagers that investors placed on and around that bubble.
But the legislative sleight of hand perpetrated between Sanders’ two votes makes it harder to accuse the Vermont socialist of betraying his core ideals on financial regulation here. Gramm, Ewing, and several Clinton advisers worked together to alter the deal significantly and quietly.
After the 2008 crisis exposed just how wrongheaded the Gramm-Clinton posse of deregulators had been about derivatives, a few key participants in that process have changed their minds. Gary Gensler, a veteran of both Goldman Sachs and the Clinton and Obama administrations, now says that Brooksley Born was right about derivatives all along. Both Greenspan and Levitt – two key Clinton advisers who were vehement about trusting the derivatives market to regulate itself at the time – have each conceded the decision was a mistake.
None of that necessarily makes this an unfair attack from Clinton, however. Sanders, after all, has criticized the former Secretary of State, Senator, and First Lady for a variety of decisions throughout her career in which she went along with a broad consensus among Democrats that later proved disastrously incorrect. The argument is that Clinton’s present-day positions are invalidated by past episodes of poor judgment.
Such criticisms mean Sanders can be held to a similar standard here. Four of his colleagues said “no” to the original bill. Sanders declined to be a fifth such vote.