As part of the Sunlight Foundation's Read the Bill campaign, we've been writing a series of case studies highlighting bills that slipped through Congress with little time for public input or for lawmakers to review. After reading the following, please go to ReadTheBill.org and sign the petition to tell Congress that bills should be made publicly available for at least 72 hours prior to consideration. And now, your case study: the Commodity Futures Modernization Act of 2000.
In the waning days of the 106th Congress and the Clinton administration, Congress met in a lame-duck session to complete work on a variety of appropriations bills that were not passed prior to the 2000 election. There were other, unmet pet priorities of some lawmakers that were under consideration as well. One of those pet priorities was a 262-page deregulatory bill, the Commodity Futures Modernization Act. Tucked into a bloated 11,000 page conference report as a rider, with little consideration and no time for review, this bill would be viewed only eight years later as part of the failure of our political system abetting a financial storm that brought the world to its knees.
The saga of the Commodity Futures Modernization Act begins in 1998. At the time, the economy was booming, stocks soared, and new instruments of trading were found to make more money while evading the oversight of regulatory bodies. Two of those growing instruments were financial derivatives and credit-default swaps. As these new financial instruments emerged a debate began over whether or not to regulate them.The chairman of the Commodity Futures Trade Commission (CFTC) Brooksley Born issued a first call for her regulatory commission to have power to oversee financial derivatives. While previous legislative attempts had been made earlier, Born's efforts were the most direct and threatening to the financial industry. During an April 1998 meeting of the President's Working Group on Financial Markets, Federal Reserve chairman Alan Greenspan, Clinton Treasury Secretary Robert Rubin (and later Secretary Larry Summers), and Securities and Exchange Commission (SEC) chairman Arthur Levitt opposed Born's efforts and attempted to derail her.
[A]n unregulated derivatives market ... could "pose grave dangers to our economy."
Soon afterwards, Born released a "concept" paper with ideas of what regulation of derivatives and swaps could look like under the CFTC's oversight authority. The response to Born's paper was swift. The financial industry and government officials responded fiercely in opposition to Born's ideas. Greenspan, Summers, and Senate committee chairmen all criticized her and her proposals.
In the midst of this debate Long Term Capital Management (LTCM), a major hedge fund employing some of the top economists, collapsed. LTCM was highly over-leveraged and held a big portfolio of swaps. In the end, during the government organized bailout of the company, LTCM recorded a loss of $1.6 billion on swaps alone.
Born felt that an unregulated derivatives market that spawned the LTCM bailout could "pose grave dangers to our economy." In the end, Born lost her battle and, in May 1999, asked to be replaced as CFTC chairman. The new chairman, William Rainer, was more amenable to the positions of industry leaders and the major government officials Summers, Greenspan, and Levitt. Later that year, the President's Working Group on Financial Markets released a report calling for "no regulations" of derivatives and swaps and began crafting a program to make that possible. Meanwhile in Congress, lawmakers were still up-in-arms over Born's attempts to regulate the financial derivatives market and began working to pass their own set of deregulatory language.
Leading the charge in Congress were Sens. Phil Gramm (R-TX) and Richard Lugar (R-IN) and Rep. Thomas Ewing (R-IL). In May of 2000, Rep. Ewing introduced his Commodity Futures Modernization Act. While Ewing's bill sailed quickly through the House, it stalled in the Senate, as Sen. Gramm desired stricter deregulatory language be inserted into the bill. Gramm opposed any language that could provide the SEC or the CFTC with any hope of authority in regulating or oversight of financial derivatives and swaps. Gramm's opposition held the bill in limbo until Congress went into recess for the 2000 election.Throughout the better part of the year Gramm, Lugar and Ewing worked with the President's Working Group on Financial Markets--most specifically, Treasury Secretary Summers, CFTC Chairman Rainer and SEC Chairman Levitt--to strike a deal on the bill.
"Details of the final language are not immediately available."
Little attention followed Congress as the contentious 2000 presidential election was stuck in a stalemate as lawyers and khaki-clad protesters fought over the Florida recount to decide whether Gov. George W. Bush or Vice President Al Gore would be the next president.
During a lame-duck December session, while the media was focused on the recounts and court cases, Gramm and Ewing sought to strike a compromise on the Commodity Futures Modernization Act. The day after the Supreme Court ruled in favor of Gov. Bush, December 14, Ewing introduced a new version of the Commodity Futures Modernization Act. On December 15, with little warning or fanfare--aside from the overshadowed discussions on the floors of Congress--the new, compromise version was included as a rider to the Consolidated Appropriations Act for FY 2001, an 11,000 page omnibus appropriations conference report.
HedgeWorld Daily News, a trade publication for hedge funds and one of the few news outlets following the bill, stated, "Details of the final language are not immediately available. Congressional aides said Sen. Gramm did succeed in getting additional language protecting the legal certainty of swap, especially those traded by banks, which are the main users of the products."
The final language, which the public was hardly aware of, contained some new sections not in the original Ewing bill that, for all intents and purposes, exempted swaps and derivatives from regulation by both the CFTC, which had already implemented rules that it would not regulate swaps and derivatives, and the SEC. Also, hidden within the bill was an exemption for energy derivative trading, which would later become known as the "Enron loophole" - this loophole would provide the impetus for Enron's nose dive into full blown corporate corruption.
Ultimately, while the unregulated market in derivatives and swaps did not cause the economic downturn itself, it was a propellant of the crisis, accelerating the collapses of major financial companies across the globe. As of June 30, 2008, the global derivatives market had exploded to $530 trillion, while credit default swaps had grown from mere insignificance to $55 billion. When the credit crisis and the mortgage meltdown began to take hold, major firms found out the swaps made their investments far riskier than they could handle.Bear Stearns, Lehman Brothers, and American International Group (AIG) all collapsed due to problems with the unregulated market of credit default swaps. The major banks were also heavily involved with credit default swaps. A report from the Comptroller of the Currency recorded in the third quarter of 2007 that the top banks in the credit default market were JP Morgan Chase, Citibank, Bank of America and Wachovia. Wells Fargo purchased Wachovia after it collapsed. Bank of America has received approximately $45 billion in TARP funds from the Treasury Department, mostly to offset losses from its acquisitions of Countrywide Financial in 2007 and Morgan Stanley in 2008. Citibank's parent company Citigroup faced a complete meltdown during the end of 2008, received $50 billion in TARP funds from Treasury, and is breaking apart into smaller companies. JP Morgan Chase, while weathering the crisis far better than the other banks, still received $25 billion in TARP funds.
If ever there was a case where Congress should have given more time and listened closer, this was it.
Consensus is nearly universal that the failure to regulate financial derivatives trading and the subsequent explosion of credit default swaps, by passing the Commodity Futures Modernization Act, was a mistake. Deregulation supporter Chris Cox, a former SEC chairman under President George W. Bush and congressman from California, called the swaps "the fuel for what has become a global credit crisis." According to Bloomberg, Alan Greenspan "acknowledges he'd been 'partially' wrong to oppose regulation of such instruments." Former SEC chairman Levitt stated that if given the chance for a do-over he "would have pushed for some way to give greater transparency to products which turned out to be injurious to our markets."
In the end, the country would have been better served had Congress not taken the 262-page Commodity Futures Modernization Act, which had trouble passing Congress on its own accord, and inserted it into a bloated 11,000 page conference report when no one was looking. If ever there was a case where Congress should have given more time and listened closer, this was it. Now, we're all paying for it.