Prophet and Loss

from Stanford Alumni Magazine

Brooksley Born warned that unchecked trading in the credit market could lead to disaster, but power brokers in Washington ignored her. Now we're all paying the price.

Shortly after she was named to head the Commodity Futures Trading Commission in 1996, Brooksley E. Born was invited to lunch by Federal Reserve chairman Alan Greenspan.

The influential Greenspan was an ardent proponent of unfettered markets. Born was a powerful Washington lawyer with a track record for activist causes. Over lunch, in his private dining room at the stately headquarters of the Fed in Washington, Greenspan probed their differences.

“Well, Brooksley, I guess you and I will never agree about fraud,” Born, in a recent interview, remembers Greenspan saying.

“What is there not to agree on?” Born says she replied.

“Well, you probably will always believe there should be laws against fraud, and I don’t think there is any need for a law against fraud,” she recalls. Greenspan, Born says, believed the market would take care of itself.

For the incoming regulator, the meeting was a wake-up call. “That underscored to me how absolutist Alan was in his opposition to any regulation,” she said in the interview.

Over the next three years, Born, ’61, JD ’64, would learn first-hand the potency of those absolutist views, confronting Greenspan and other powerful figures in the capital over how to regulate Wall Street.

More recently, as analysts sort out the origins of what has become the worst financial crisis since the Great Depression, Born has emerged as a sort of modern-day Cassandra. Some people believe the debacle could have been averted or muted had Greenspan and others followed her advice.

As chairperson of the CFTC, Born advocated reining in the huge and growing market for financial derivatives. Derivatives get their name because the value is derived from fluctuations in, for example, interest rates or foreign exchange. They started out as ways for big corporations and banks to manage their risk across a range of investments. One type of derivative—known as a credit-default swap—has been a key contributor to the economy’s recent unraveling.


FRONT AND CENTER: Born became the first woman at Stanford Law School to be president of the Law Review. In this 1964 photo, she is pictured with senior editors and classmates (back row, from left) Bruce Gitelson, Robert Johnson and Paul Ulrich, and (front row) Richard Roth and James Gaither.
The swaps were sold as a kind of insurance—the insured paid a “premium” as protection in case the creditor defaulted on the loan, and the insurer agreed to cover the losses in exchange for that premium. The credit-default swap market—estimated at more than $45 trillion—helped fuel the mortgage boom, allowing lenders to spread their risk further and further, thus generating more and more loans. But because the swaps are not regulated, no one ensured that the parties were able to pay what they promised. When housing prices crashed, the loans also went south, and the massive debt obligations in the derivatives contracts wiped out banks unable to cover them.

Back in the 1990s, however, Born’s proposal stirred an almost visceral response from other regulators in the Clinton administration, as well as members of Congress and lobbyists. The economy was sailing along, and the growth of derivatives was considered a sign of American innovation and a symbol of the virtues of deregulation. The instruments were also a growing cash cow for the Wall Street firms that peddled them to eager takers.

Ultimately, Greenspan and the other regulators foiled Born’s efforts, and Congress took the extraordinary step of enacting legislation that prohibited her agency from taking any action. Born left government and returned to her private law practice in Washington.

‘History already has shown that Greenspan was wrong about virtually everything, and Brooksley was right. If there is one person we should have listened to, it was Brooksley.’
“History already has shown that Greenspan was wrong about virtually everything, and Brooksley was right,” says Frank Partnoy, a former Wall Street investment banker who is now a professor at the University of San Diego law school. “I think she has been entirely vindicated. . . . If there is one person we should have listened to, it was Brooksley.”

Speaking out for the first time, Born says she takes no pleasure from the turn of events. She says she was just doing her job based on the evidence in front of her. Looking back, she laments what she says was the outsized influence of Wall Street lobbyists on the process, and the refusal of her fellow regulators, especially Greenspan, to discuss even modest reforms. “Recognizing the dangers . . . was not rocket science, but it was contrary to the conventional wisdom and certainly contrary to the economic interests of Wall Street at the moment,” she says.

“I certainly am not pleased with the results,” she adds. “I think the market grew so enormously, with so little oversight and regulation, that it made the financial crisis much deeper and more pervasive than it otherwise would have been.”

Greenspan, who retired from the Fed in 2006, acknowledged in congressional testimony last October that the financial crisis, which he described as a “once in-a-century credit tsunami,” had exposed a “flaw” in his market-based ideology.

He says Born’s characterization of the lunch conversation she recounted does not accurately describe his position on addressing fraud. “This alleged conversation is wholly at variance with my decades-long held view,” he said in an e-mail, citing an excerpt from his 2007 book The Age of Turbulence, in which he wrote that more government involvement was needed to root out fraud. Born stands by her story.

Robert Rubin, who was treasury secretary when Born headed the CFTC, has said that he supported closer scrutiny of financial derivatives but did not believe it politically feasible at the time.

A third regulator opposing Born, Arthur Levitt, who was chairman of the Securities Exchange Commission, says he also now wishes more had been done. “I think it is fair to say that regulators should have considered the implications . . . of the exploding derivatives market,” Levitt told STANFORD.

In a way, the battle had the look and feel of a classic Washington turf war.

The CFTC was created in the ’70s to regulate agricultural commodities markets. By the ’90s, its main business had become overseeing financial products such as stock index futures and currency options, but some in Washington thought it should stick to pork bellies and soybeans. Born’s push for regulation posed a threat to the authority of more established cops on the beat.

“She certainly was not in their league in terms of prominence and stature,” says a lawyer who has known Born for years and requested anonymity to avoid appearing critical of her. “They probably thought, ‘Here is a little person from one of these agencies trying to assertively expand her jurisdiction.’”

Some of the other regulators have said they had problems with Born’s personal style and found her hard to work with. “I thought it was counterproductive. If you want to move forward . . . you engage with parties in a constructive way,” Rubin told the Washington Post. “My recollection was . . . this was done in a more strident way.” Levitt says Born was “characterized as being abrasive.”

Her supporters, while acknowledging that Born can be uncompromising when she believes she is right, say those are excuses of people who simply did not want to hear what she had to say.

“She was serious, professional, and she held her ground against those who were not sympathetic to her position,” says Michael Greenberger, a Washington lawyer who was a top aide to Born at the CFTC. “I don’t think that the failure to be ‘charming’ should be translated into a depiction of stridency.”

Others find a whiff of sexism in the pushback. “The messenger wore a skirt,” says Marna Tucker, a Washington lawyer and a longtime friend of Born. “Could Alan Greenspan take that?”

Greenspan dismisses the notion that he had problems with Born because she is a woman. He points out that when he took a leave from his consulting firm in the 1970s to accept a job in the Ford administration, he placed an all-female executive team in charge.

It was not the first time that Born, 68, had pushed back against convention.

Her doggedness over a career spanning more than 40 years propelled her into the halls of power in Washington. She was a top commercial lawyer at a major firm, as well as a towering figure in the area of women’s rights, and a role model for women lawyers. She was on Bill Clinton’s short list for attorney general.

One of seven women in the Class of 1964 at Stanford Law School, she graduated at the top of her class, and was elected president of the law review, the first woman to hold either distinction. She is credited with being the first woman to edit a major American law review.

In the early 1970s, at a time when women had few role models at major law firms, she became a partner at the Washington, D.C., firm of Arnold & Porter, despite working part time while raising her children.

She helped establish some of the first public-interest firms in the country focused on issues of gender discrimination. She helped rewrite American Bar Association rules that made it possible for more women and minorities to sit on the federal bench, and she prodded the group into taking stands against private clubs that discriminated against women or blacks.

She was used to people trying to push her around, or being perceived as a potential troublemaker. She remembers being shouted down during an ABA meeting in the 1970s when she proposed that the organization take a position supporting equal rights for gay and lesbian workers. A former ABA president stood up and said, “that the subject was so unsavory that it should not be discussed . . . and was not germane to the purposes of the ABA,” she recalls. She lost that fight, although the group reversed its stand years later.

“She looks at things not just from a technical perspective or the perspective of an insider. She looks at the perspective of outsiders and how people without power are going to be affected,” says Esther Lardent, a Washington lawyer who worked with Born on various ABA matters. “That is a theme constantly running through her life and career.”

“She is a very polite and low-key person but she is never somebody who steps back from a disagreement or a fight if it is a matter of importance to her,” Lardent adds. “Did that make people uncomfortable? Did that make the men who dominated the leadership fail to take her seriously enough? I am sure that was the case.”

SHE WAS BORN in San Francisco. Her mother, an English teacher, and her father, the head of the city’s public welfare department, were both Stanford graduates.

An early mentor was her mother’s best friend from Stanford, Miriam E. Wolff, JD ’40, who became a deputy state attorney general and judge and the first woman to ever head a major port.

Born entered Stanford with the thought of being a doctor, but switched majors after a career counselor interpreted her answers on a series of vocational tests. In those days, women were assessed for their interest in nursing or teaching, men for the professional jobs, including law and medicine. The tests were even color coded—pink for women, blue for men.

Born says she insisted on taking both. Her mother, who had a master’s degree in psychology, felt that was the only way her daughter’s professional interests could be evaluated properly.

She scored high on being a doctor—and low on being a nurse. But rather than suggest she pursue a career as a physician, the counselor said the test proved that her interest in medicine was not genuine and that she was really only interested in making a lot of money. Born quit premed and majored in English.

“It was a turning point. What can I say? I was 18 years old. I didn’t know any better,” Born says. “Unfortunately, I was, you know, a member of the society as it was then. I was hurt by the advice, and kind of believed in it. I don’t believe in it now. It is ridiculous in retrospect.”

A decade later, one of the public-interest firms she founded challenged the tests as discriminatory.

Law school was welcoming and intellectually stimulating, even if some people were still getting used to the idea of having women around. Male law students got their own dormitory; women were left to make their own housing arrangements in off-campus boarding houses or apartments. “I also had . . . one student in my class tell me I was taking the place of a man who had to go to Vietnam and was risking his life because of me, which was sobering to say the least,” she recalls.

Making a mark in the classroom could also be a challenge. Some professors refused to call on women, thinking it rude or unbecoming. She remembers an episode in her first year when her professor appeared to have the class stumped after quizzing several men about a problem. “The little girl has it!” she recalls the professor declaring, after she blurted out the right answer.

“I was very worried that I would not do well and that I would disgrace myself, and women,” Born says. “I worked very hard during my first year because I was afraid I would flunk out.” In those Darwinian times in law schools, that was not an idle concern: professors tried to weed out all but the most qualified students, and about a third were dismissed from school after the first year. That would not be her fate.

“She was off the charts,” says Pamela Ann Rymer, JD ’64, a judge on the federal appeals court in Pasadena. “Brooksley never wore it on her sleeve. She is not quiet, but she is a very unpretentious kind of person, just plainly and obviously with a brilliant mind.”

Despite her grades, Born was passed over for a clerkship on the U.S. Supreme Court, the most coveted opportunity for a young lawyer. Stanford’s top students were good candidates for the clerkships, but a faculty committee decided to recommend two men for the positions even though Born had a superior academic record. It was a bitter introduction to a gender-biased legal culture. “They were sure I would understand that it would be unseemly for women to be clerks on the Supreme Court,” she says of the committee members. “I felt very disappointed and angry.”

Undaunted, she headed to Washington, and arranged an interview on her own with Arthur Goldberg, then one of the most liberal members of the high court. Goldberg would not hire her either but recommended her to a judge on the federal appeals court in Washington. Henry Edgerton, who wrote an opinion that became a basis for the landmark Supreme Court decision in the Brown v. Board of Education school desegregation case, gave her a clerkship. (Law school professor emerita Barbara Babcock also clerked for Edgerton.)

A year later, taken with the Washington scene and its place on the front lines of the civil rights movement, Born scrapped plans to return to San Francisco. “I wanted in,” she says. Arnold & Porter, a firm with a liberal tradition of public service, offered her a job, and she started work the same day that a former name partner of the firm, Abe Fortas, was sworn in as a justice of the Supreme Court.

The firm was one of a few that were beginning to hire women and treat them on par with men. But there were challenges, especially for those interested in a career and a family. Many firms up to that point refused to hire women who were married or who were interested in children.

The lone woman partner at Arnold & Porter at the time was married to Fortas and was renowned for her “misanthropic toughness,” including a preference for “thick cigars,” according to Charles Halpern, an associate with Born at the firm in the 1960s. “Our swimming pool has two deep ends,” Halpern recalls her once saying, “so that people aren’t tempted to drop by with their small children for a swim on a hot summer day.”

Born soon faced a difficult choice. She took a one-year leave when her then-husband got a Nieman fellowship at Harvard, where her first child was born. Returning to Washington, she tried to juggle full-time work and child rearing but it quickly became apparent that the arrangement didn’t work.

“I went to the partner I was working with the most and said I just didn’t think I could do this,” she says. “I thought I had to resign.” To her surprise, the partner suggested she work three days a week with the understanding she would not be considered for partner until she returned full time.

In 1974, when she had a 4-year-old and a 2-year-old, she was still working part time. The firm promoted her anyway. The family-friendly development was a stunning breakthrough at a time when law firms were focused on billable hours and the bottom line, and little else. It further raised her profile.

“When I met her I was in awe of her because the idea that she could be a partner in that firm was just unbelievable,” says Tucker, her longtime friend. The women bonded after being asked to teach a course on women and the law at two Washington-area law schools, and being horrified at what they found during their research. “We were surprised to find the degree to which discrimination was embodied in the law,” Born says. “It was a real consciousness-raising experience.”

Lawyer Marcia Greenberger sought out Born in the 1970s when she was named to start a new women’s rights project in Washington. Born agreed to chair an advisory board for the project, and became a guiding force, mentor and opener of doors, leveraging her contacts and credibility, Greenberger says. One of the first broad-based challenges to how universities were implementing Title IX—the 1972 law requiring equal programs and activities for women and men—was brought after Born passed along the name of a colleague who was incensed at the poor athletic facilities his daughter was forced to use at her school. Born also helped win Ford Foundation grants that enabled the project to hire its second lawyer. What is now called the National Women’s Law Center today has a staff approaching 60 and a budget of almost $10 million. Born remains chair of its board of directors.

Clinton named her to head the CFTC in 1996. She was not without experience: at Arnold & Porter she had represented the London Futures Exchange in rule making and other matters before the commodities agency.

She also knew how markets could be manipulated, having represented a major Swiss bank in litigation stemming from an attempt by the Hunt family of Dallas to corner the silver market in the 1980s.

“Brooksley had the advantage of knowing the law and understanding the fragility of the system if it weren’t regulated,” says Michael Greenberger, her former adviser at the CFTC. “She could see that the data points, by lack of regulation, were heading the country into a serious set of calamities, each calamity worse than the one before.”

Under a Republican predecessor, the CFTC had in 1993 largely exempted from regulation more exotic derivatives that involved just two parties. The thinking was that sophisticated entities negotiating individually tailored derivatives could look out for themselves. More generic derivatives still had to be traded on exchanges, which were subject to regulation.

By 1997, the over-the-counter derivatives market had more than doubled in size, by one measure, reaching an estimated $28 trillion, based on the value of the instruments underlying the contracts. (It has now reached an estimated $600 trillion.)

And some cracks were already surfacing in the landscape. Several customers of Bankers Trust, including Procter & Gamble, sued for fraud and racketeering in connection with several OTC derivative deals. Orange County, Calif., had gone bankrupt in part because of an OTC derivative-trading scheme gone awry.

What is more, all the growth had taken place at a time of economic prosperity. Some people were beginning to ask what would happen if the market suffered a major reversal.

“The exposures were very, very big and if it was your job to worry about things that could go wrong, and I think it was, this is one of the things you couldn’t help but notice,” says Daniel Waldman, a Washington lawyer who was the CFTC general counsel under Born. “It was only your blind faith in the participants that could give you much comfort because you really did not know much about the real risks.”

‘There was no transparency of these markets at all. No market oversight. No regulator knew what was happening,” Born says. “There was no reporting to anybody.’
“There was no transparency of these markets at all. No market oversight. No regulator knew what was happening,” Born says. “There was no reporting to anybody.”

She chose what she thought was a middle ground, circulating a draft “concept release,” to regulators and trade associations, which was intended to gather information about how the markets operated. She and her staff suspected the industry was trying to exploit the earlier regulatory exemption.

But even the modest proposal got a vituperative response. The dozen or so large banks that wrote most of the OTC derivative contracts saw the move as a threat to a major profit center. Greenspan and his deregulation-minded brain trust saw no need to upset the status quo. The sheer act of contemplating regulation, they maintained, would cause widespread chaos in markets around the world.

“We would go to conferences and it would be viciously attacked,” Waldman says. “They would just be stomping their feet and pounding the tables.” With Born unlikely to change her mind, the industry focused on working through the other regulators.

Born recalls taking a phone call from Lawrence Summers, then Rubin’s top deputy at the Treasury Department, complaining about the proposal, and mentioning that he was taking heat from industry lobbyists. She was not dissuaded. “Of course, we were an independent regulatory agency,” she says.

The debate came to a head April 21, 1998. In a Treasury Department meeting of a presidential working group that included Born and the other top regulators, Greenspan and Rubin took turns attempting to change her mind. Rubin took the lead, she recalls.

“I was told by the secretary of the treasury that the CFTC had no jurisdiction, and for that reason and that reason alone, we should not go forward,” Born says. “I told him . . . that I had never heard anyone assert that we didn’t have statutory jurisdiction . . . and I would be happy to see the legal analysis he was basing his position on.”

She says she was never supplied one. “They didn’t have one because it was not a legitimate legal position,” she says.

Greenspan followed. “He maintained that merely inquiring about the field would drive important and expanding and creative financial business offshore,” she says. CFTC economists later checked for any signs of that, and came up with no evidence, Born says.

“It seemed totally inexplicable to me,” Born says of the seeming disinterest her counterparts showed in how the markets were operating. “It was as though the other financial regulators were saying, ‘We don’t want to know.’”

She formally launched the proposal on May 7, and within hours, Greenspan, Rubin and Levitt issued a joint statement condemning Born and the CFTC, expressing “grave concern about this action and its possible consequences.” They announced a plan to ask for legislation to stop the CFTC in its tracks.

At congressional hearings that summer, Greenspan and others warned of dire consequences; Born and the CFTC were cast as a loose cannon.

Reverting to a theme Born claims he raised at their earlier lunch, Greenspan testified there was no need for government oversight, because the derivatives market involved Wall Street “professionals” who could patrol themselves.

Summers, Rubin’s deputy (and now director of the National Economic Council), said the memo had “cast the shadow of regulatory uncertainty over an otherwise thriving market, raising risks for the stability and competitiveness of American derivative trading.”

Born assailed the legislation, calling it an unprecedented move to undermine the independence of a federal agency. In eerily prescient testimony, she warned of potentially disastrous and widespread consequences for the public. “Losses resulting from misuse of OTC derivatives instruments or from sales practice abuses in the OTC derivatives market can affect many Americans,” she testified that July. “Many of us have interests in the corporations, mutual funds, pension funds, insurance companies, municipalities and other entities trading in these instruments.”

That September, seemingly bolstering her case, the Federal Reserve Bank of New York was forced to organize a rescue of a large private investment firm, Long Term Capital Management, which was a big player in the OTC derivatives market. Fed officials said they acted to avoid a meltdown that could have impacted the wider economy.

But the tide of opinion that had risen up against Born was irreversible. Language was slipped into an agriculture appropriations bill barring the CFTC from taking action in the six months left in her term.

“I felt as though that, at least, relieved me and the commission of any public responsibility for what was happening,” she says. Clinton aides sounded her out about a second term, but she said she wasn’t interested and left the agency in June 1999.

A year later, Congress enacted the Commodity Futures Modernization Act, which effectively gutted the ability of the CFTC to regulate OTC derivatives. With no other agency picking up the slack, the market grew, unchecked.

Some observers say now the episode and infighting showed how even a decade ago a patchwork system of regulating Wall Street was badly in need of reform.

“The fact that the . . . issue created such a threat to the marketplace to me confirmed the fact that something was not right,” says Richard Miller, a lawyer and editor of a widely read newsletter on derivatives. “How could we have a system that hangs together by such a narrow thread?” Miller testified at the time that the idea Born proffered should at least have been considered.

The Obama administration has pledged an overhaul of the financial system, including the way derivatives are regulated. Worrisome to some observers is the fact that his economic team includes some former Treasury officials who were lined up in opposition to Born a decade ago.

Born, who retired from her law firm in 2003, is not playing a formal role in the process. An outdoor enthusiast, she was planning a trip to Antarctica this winter, as the Obama team was settling in. “The important thing,” she advises, “is that the new administration should not be listening to just one point of view.”