The events surrounding the financial difficulties of Long-Term Capital Management L.P. ("LTCM") raise a number of important issues relating to hedge funds and to the increasing use of OTC derivatives by those funds and other institutions in the world financial markets. The issues most directly posed by LTCM include lack of transparency, excessive leverage, insufficient prudential controls, and the need for coordination and cooperation among international regulators. I welcome the heightened awareness of these issues that the LTCM matter has engendered and believe it is critically important for all financial regulators to work together closely and cooperatively on them. Therefore, I applaud Secretary of the Treasury Robert Rubin's call for meaningful studies by the President's Working Group on Financial Markets on hedge funds and on OTC derivatives and look forward to working with him and the other members of the Working Group.
--Brooksley Born, Chairperson, Commodity Futures Trading Commission, November 13, 1998
Kudos to Nelson Schwartz and Eric Dash of The New York Times for the Sunday business section cover story on Robert Rubin. Their article puts into place another piece of the subprime puzzle. In addition to reporting on Rubin's seemingly conflicted behavior as a director of Citigroup (C), the overview of Rubin's policy role in blocking federal oversight of the Over-the-Counter derivatives markets is a great contribution.
Schwartz & Dash describe how former Fed Chairman Alan Greenspan, former Treasury Secretary Larry Summers and Rubin coordinated to undermine efforts by CFTC Chairperson Brooksley Born to impose greater federal oversight of OTC derivatives markets. They report: "On at least one occasion, Mr. Rubin lined up with Mr. Summers as well as Mr. Greenspan to block a 1998 proposal by the Commodity Futures Trading Commission under Ms Born that would have effectively moved many derivatives out of the shadows and made them subject to regulation."
Click here to read the entire April 27, 2008 Times profile: "Where Was the Wise Man?"
Note that Born's comments of a decade ago regarding the LTCM collapse highlights those very same issues which led to the collapse of Bear, Stearns (BSC) earlier this year, namely the systemically unstable nature of an OTC market structure. Note too that over the intervening decade nothing happened in Washington to effectively address these issues.
Greenspan, Summers and Rubin all acted -- or failed to act -- to enable Wall Street's quest for higher profits via the opaque OTC market structure model and did so at the expense of the public interest. Instead of a truly free and transparent securitization market where occasionally a player does fail, today's OTC jungle ensures the destruction of a significant portion of capital deployed by dealers and investors both. How does this serve the interest of investors or the marketplace?
The US Congress, the major regulators and industry groups such as the President's Working Group on Financial Markets, and two presidential administrations from different political parties, all collaborated to bring the financial crisis involving subprime debt and OTC securities to fruition. While talking about "innovation" and "competitiveness," the US political elite and their clients on Wall Street authored the subprime crisis from beginning to end, specifically by allowing the OTC marketplace to grow the point where it threatens the safety and soundness of large banks.
And the real irony of the past year or more is that the OTC market structure has been a catastrophe for many dealers, some of which laid out millions of dollars in lobbying fees to make the OTC markets a reality.
Perhaps even scarier than the Times account of the pro-Wall Street policies openly pursued by the Subprime Three is the peculiar position taken by Rubin regarding his role at C, namely that he was somehow not responsible for the financial performance and chaotic corporate governance of this bank over the past decade -- when he served as director and, in our view, shadow CEO. Read our previous comments, ("Should Alan Schwartz Be Citigroup's Next CEO?") for background on the House that Sandy Weill built.
Regardless of what his employment agreement with C may say, the fact is that Rubin is a director and chair's the firm's executive committee. Rubin's confession to the Times that he was not aware of the details of C's deteriorating financial situation seems incredible and entirely at odds with his duties as a director. The revelation that the management committee rarely met before last year is another eye-opener, an admission that will doubtless delight members of the trial bar -- but may concern federal bank regulators.
Keep in mind too that Rubin does have some type of management role at C beyond his statutory role as a director, thus the references to negotiations regarding a new job description. The Times report that Rubin represented the bank earlier this year in negotiations with foreign investors seemingly shatters his protestations of not having a material operating role in the management of C. To us, shadow CEO seems more accurate to describe Rubin's role - at least to date.
In view of the normative standards of care required of directors under Delaware law, not to mention the duties of directors spelled out in the Sarbanes-Oxley legislation and the particular duties of a director of a bank, how can Rubin continue to sit as a C director given his statements to the Times? He finds time to call Ben Bernanke to congratulate the Fed Chairman on monetary policy, but Rubin does not seem to have time to review C's financial disclosure with the SEC and consider prospective risks, as required by state and federal law? Keep in mind too that the duties of care applicable to the director of a bank are more stringent than under the Sarbanes-Oxley rules.
The apparent lack of care shown by Rubin with respect to C, and the blatant pandering to Wall Street's interest by the Subprime Three, begs the question about how we govern the actions of our public officials. Why did Rubin, Summers and Greenspan work so diligently to block regulation of OTC instruments a decade ago? They may claim that the ill-effects of their policy decision so visible today were not apparent, but their actions and public statements say otherwise.
We renew the call by Dr. Anna Schwartz to compel Greenspan - now joined by Rubin and Summers - to publicly account for their actions, for what they have done and what they failed to do, with respect to the direction of federal policy regarding financial market structure. Is there a US congressional committee with the cojones to hold such an inquiry?
Until a majority of elected officials in Washington decide to push back against Wall Street on the issue of market structure, and insist that all securities sold by or to commercial banks, pension and mutual funds be registered with the SEC, there will be no solution of the crisis regarding OTC structured assets, only about one third of which contained subprime loans at the end of 2007.