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Interview: Arthur Levitt

“The failures in our regulatory and oversight mechanism that brought us to where we are today were far more consequential than merely the decision not to regulate swaps.”

As head of the Securities and Exchange Commission (1993-2001), Levitt opposed Brooksley Born's attempts to regulate derivatives. He's since had a change of heart. This is the edited transcript of an interview conducted on July 29, 2009.

This film starts in the mid-90s. ... Help characterize [former Federal Reserve Board Chair] Alan Greenspan at that time -- and who he was and what he represented in terms of the economic policies of the country.

Alan is a good friend, and I knew him before I came to Washington and knew him well when he was there. We played golf and tennis together; we saw a good deal of one another.

He was probably the most highly respected and most revered person in the city at that time. He was more than an economist. He is a very broad-gauged individual with large numbers of friends and a tremendous following in Congress, where people hung on every word -- most of which they didn't understand, but because it was Alan, they thought it was great.

Now, keep in mind, I have a theory about these government jobs, whether it be chairman of the Federal Reserve or head of the SEC [Securities and Exchange Commission] or the FTC [Federal Trade Commission] -- to some extent, the Wizard of Oz jobs. It's not the rules; it's not the regulations -- it's what they say. It's the issues they stake out and how they come across.

Alan was a great wizard. No one understood what he said, but he said it in such a way that everybody bought it. Everybody hung on every word. And he was a good enough politician that he had great respect on both sides of the aisle, and very few people wanted to take him on or challenge him, because he knew so much more than they did, and if he didn't, he certainly appeared to.

In a nutshell, what was his economic philosophy?

It's been reported pretty broadly that Alan was a laissez-faire, Ayn Rand, free-market economist. I think that's simplistic. He was much more than that. He was thoughtful, careful, measured, not at all impulsive, very traditional and pretty set in his ways.

Robert Rubin -- help characterize him for me.

Bob was gracious, intelligent, outgoing, accessible, friendly, warm, extremely knowledgeable and balanced and a very superb listener.

His sway, his clout as Treasury secretary? What did he have? What did he bring to it? What did he advocate for and against?

He had the confidence of the president. You don't need to go much further than that to be an effective Treasury secretary. He not only had the president's confidence, he had the respect and affection of the people that worked for him. He had a broad history of exposure to every policy-maker in Washington. Traditionally, there are tensions between various agencies, between the Fed and the SEC, between the Treasury and the Fed and the SEC and the Comptroller's Office.

We'd known one another for any number of years so that the traditional tugs and pressures that ordinarily create less than efficient relationships between the agencies simply didn't happen here. Alan and Bob and I had known one another away from government. I think we all liked one another and respected one another.

I always hear about Rubin acolytes all throughout the government, [Secretary of the Treasury] Tim Geithner being one of the most notable now, [former Secretary and current Chair of the National Economic Council] Larry Summers as well. In what sense were they acolytes? What was the philosophy, the Rubin approach, if there was such a thing?

The Rubin approach was an open, friendly, participatory approach. When faced with a difficult issue, Rubin's style was typically to say: "You know, I don't really know much about this issue. What do you think?" That's pretty engaging. And he instantly won over the person, who now felt that he knew more than Bob Rubin did. Bob knew a good deal about what he said he didn't know very much about. But in that way, he was able to draw out other people.

Help me with Summers. ... What was Larry's standing in all of this?

The book on Larry was that he was tough and officious and dictatorial and unreasonable. I never found that to be the case. I found him extremely intelligent, extremely willing to listen to reasoned ideas and very helpful to me personally and the SEC as an institution. Our funding was threatened at various times by the Congress, and Larry was ready, willing and able to defend us. I think he did a very good job, and we worked extremely well together. ...

[Former Chair of the Commodity Futures Trading Commission] Brooksley Born.

Didn't know Brooksley Born. I was told about Brooksley Born. I was told that she was irascible, difficult, stubborn, unreasonable. I've come to know her as one of the most capable, dedicated, intelligent and committed public servants that I have ever come to know. I wish I knew her better in Washington, and I wish my view of her was more rounded by personal exposure. ...

In my life I've had so many occasions of finding my impressions were incorrect and revising them, depending upon the circumstances, depending upon what stage of life I happen to be or what other factors were bearing on it. You've asked me about these people, and I've come to know all of them reasonably well. I've got to say to you that I have just huge affection and admiration and trust in Brooksley Born.

Based on?

Based on seeing a good deal of her in recent months, in talking to her about what I regard to have been a bad judgment that I made during that period when she was urging the President's Working Group to allow her to regulate swaps. You tend to gain some perspective when you recognize that you might have made a mistake.

I've talked to [people] who say that what happened between CFTC and the President's Working Group, and really Alan Greenspan, was really a function of an intramural squabble between the SEC and CFTC. ... Was it? Was that the beginning of the struggle?

I think there was tension between the staffs of the SEC and the CFTC. That's historical, and that goes for Treasury and the Comptroller's Offices, always a certain amount of turf battle going on. No matter how well the leadership may go along, the staffs were constantly concerned that their leaders were caving in to the other agencies.

Brooksley really wanted to regulate a fairly bread-and-butter product, a swap. It's not the CDOs [collateralized debt obligations] and CLOs [collateralized loan obligations] and the toxic vehicles that we're talking about today. And whether we regulated them or not probably wouldn't much have changed where we are at today.

However, the argument made against doing this was that there are trillions of dollars of notional contracts out in the world today. To regulate these products now would throw them into question and create international financial turmoil.

Now, you have to keep in mind that the President's Working Group is made up of maybe 20, 25 people. In my judgment, only three people really mattered in that group: the secretary of the Treasury, the chairman of the Fed and the chairman of the New York Fed. The rest of the group tended to follow the leadership of those all-powerful financial officers.

Now in this case, this tight-knit group persuaded me that we really would face a situation of financial turmoil if we tried to undo these existing contracts. My staff tended to agree.

I can't ever recall talking directly to Brooksley about this. And where I really missed a beat was in not saying: "Yeah, you're right. We would have thrown these contracts into total confusion. Let's grandfather them. But going forward, let's regulate them. And more importantly, trillions of dollars and no clearing facility? Let's mandate a clearing facility." And I didn't do that.


I just didn't. I got caught up in the argument and didn't think about this very obvious next step. So it was clearly a mistake. I certainly testified in Congress subsequent to that, and was somewhat less accepting of what we had done. But I could have done much better. I could have made a difference.

There was a meeting April 21, 1998. She's there, you're there, Rubin is there, Summers is there, Greenspan is there. And Greenspan turns to her -- we've had people in the meeting tell us -- and really she's talking about doing this concept release [a report released to the public outlining a proposed rule change], and really Mr. Greenspan lets her have it, as apparently only he can do. Do you remember that?

I don't.

It's a substantial moment in her life where people say she kind of drained. But you have no memory of it?

No. Are you certain I was there?

People have told me you were there.

I really don't remember. ...

When the concept release is released May 7 now, a fairly unusual thing happens, which is that Rubin, Levitt, Greenspan publicly ask Congress to disavow the concept release, or whatever she's trying to do, and ask Congress to step in and act, give direction. Do you remember where that idea came from? Were you in a meeting where that happened?

I really don't. I don't know how much it had to do with the pending Gramm-Leach-Bliley legislation, whether it was part of that. I honestly don't know. ...

Did what she was proposing with the concept release ever really have a chance given the times, given the move toward Gramm-Leach-Bliley, all of that movement in that deregulation direction? Did she ever have a chance of stepping up and kind of swimming against the tide?

Probably not, because of the power of the secretary and the chairman of the Fed. In the power structure of Washington, it would be very difficult on an issue of this kind, with the Congress solidly backing those two officials, for any agency head to have turned that around.

Did you understand the derivatives? Did you understand the swaps?

Yeah. There was nothing mysterious about swaps. Again, they are not the product that people look upon today as being so dangerous and complex and risky. Swaps were a very appropriate product used to help manage risk and add liquidity to our markets. If I had a magic wand and could ban all derivatives, I wouldn't wave that wand. I think properly used, derivatives are a very important financial tool. ...

How did you react when you heard about what was happening with LTCM [Long-Term Capital Management]?

I guess I wondered at the time whether the failure of LTCM would have resulted in some sort of economic meltdown. I've never been persuaded that that was necessarily the case. I've seen a number of times in the financial history of the country where we've stepped in -- Drexel Burnham, Hadenstone and LTCM -- where I wondered, would this have resulted in Armageddon? And you never know, of course, and it's probably better to have been proactive than to roll the dice. But it was a big moment, and my notice came from the chairman of the New York Fed, Bill McDonough, and I certainly was supportive of the efforts to salvage that situation.

The President's Working Group tends to get together around moments like that, yes?

No, they tend to get together on a fairly regular basis. I'm not a great believer in the effectiveness of that body. The power differential is so significant that the head of a fairly small agency just doesn't have the status of the others.

Now, I can't recall a single member of that group opposing the arguments against Brooksley Born. I can't remember anyone raising their hand and saying, "Brooksley's right." Do you have any information to the contrary?

Absolutely not. She's the single voice.

OK. Let's not lose sight of that.

And what does that say to you?

It says to me that in a group of this kind, there will be a disparity in power. And it would take an extraordinarily outspoken, knowledgeable, pugnacious person to fight the losing battle against the titans who led that group.

CFTC itself, as an agency or as I guess a commission, or whatever it is --

It was a backwater commission in those days. ... At that point, it was an ill-funded, politically controlled agency that was superseded by the SEC, which had a longer tradition, greater funding and a much stronger following in Congress. I think that's changed, and I think that's all to the good.

Even so, even if she had prevailed in the argument, how could that agency have ever regulated anything?

Oh, I think it could have.


Yes, absolutely.


Just the way any agency regulates. They had an enforcement staff; they had people. They certainly could have put out a regulation that if it were passed could have been effective for that particular product, which was the plain vanilla swap. But there was much more to it than that. ...

I say that the failures in our regulatory and oversight mechanism that brought us to where we are today were far more consequential than merely the decision not to regulate swaps. They were broad failures of oversight, and if I had to pinpoint any aspect of it -- it really had more to do than anything else -- it's campaign finance, where literally for 20 years in Democratic and Republican administrations we had deregulatory Congresses. Of course, there were some exceptions. There were the [Rep.] John Dingells [D-Mich.] and the [Rep.] Ed Markeys [D-Mass.] and some others, and Sen. [Carl] Levin [D-Mich.], who were protectors of the SEC.

But by and large, certainly during my eight years in Washington, there wasn't a single pro-investor initiative that we brought before the commission that we didn't have tension from the Congress, opposition from the Congress, on behalf of constituents whose contributions and lobbying efforts didn't do the best they could to thwart our efforts to choke us for resources, to threaten us with irrelevancy. It was a constant, never-ending tension.

Now, it's these same overseers who allowed a runaway period of exuberance, of lack of control, of permissiveness, of inadequate accounting standards, that when the WorldComs and Enrons hit, the very same people became latter-day Elmer Gantrys, calling for regulations that were so costly and over the top that they made very little sense. And that's been kind of the history of the country's regulatory status, that during normal times Congress doesn't want to rock the boat. When there's a scandal, when their constituents are out there bleeding, in pain, Congress will then act, and very often overreact.

When you talk about the constituency that paid for Congress, who is that?

Various business groups that cared about regulatory issues that were before a commission, the Congress, the CFTC. Accounting groups, major issue. Groups that were concerned with market structure -- these were the stock exchanges, the electronic marketplaces, the legal community that had clients that had very specific problems with the regulatory agencies.

Remember, both the CFTC and SEC were essentially investor protection agencies. And I think if you balance the interest that faced the Congress in normal times -- not when the country faces an economic catastrophe, but in normal times -- the clout of the business community, fueled by the Chamber of Commerce, the Business Roundtable, that is going to have a greater impact than consumer groups.

Now, that's changed today. It's changed because we have a populist environment fueled by the worst economic crisis in the history of America, and we're going to see a totally different dynamic with different problems. Our Congress tends to act only at a time of crisis. And heaven knows, we've gone through that, and are going through that.

Yes, because even after LTCM --


Mild by comparison, but everybody for a little while was saying, "Hey, let's do something about this." But that impulse passed.

It passed quickly. And indeed, this impulse will pass less quickly, but will pass if our markets continue to perform reasonably well. There will be a correlation between the kind of intelligent regulatory reform and the progress of our markets.

Let's go back to Alan Greenspan for a moment. ... As the 2000s are going along and 9/11 has happened and other things start to happen, what's he doing? What's he worrying about?

I think Alan worried about the markets all the time. Alan cared passionately about U.S. markets, probably knew more about them than anyone in the history of the country. Was extremely thoughtful, sensitive, intelligent. Was not close-minded, was open to hearing presentations. He was firm in his philosophy, and we certainly differed in a number of respects, but I would have to say that I regard Alan Greenspan as one of the greatest public servants in modern history, in spite of what some regard as his failure to anticipate the problems in an overleveraged environment. We were lucky to have him as chairman of the Fed.

He didn't seem to be concerned about where's the regulation, how do we manage this bubble?

I would say that more often than not, I had to prove to Alan why this regulation or that regulation made sense. I've always regarded the Federal Reserve as being the banker's protective association -- more concerned with safety and soundness than investor protection. And my obsession was investor protection. I couldn't care less about safety and soundness; that was part of the system. But if you don't have the confidence of investors, if you don't have the protections that are offered by private rights of action and the enforcement activities of the SEC, you have a universe of investors that don't trust, and we can't have markets that aren't trustworthy.

After the 2008 meltdown last fall when he sits before Congress, ... it's got to be an incredibly painful moment for him, that sort of mea culpa moment. What did you think when you saw that happening to him?

I thought that this is a stand-up guy that is realistic; that knows that life in Washington places people at the mercy of factors that are very often beyond their control; that good markets made all of us in that era look smarter than we really were. And when things change, we pay a price for that.

And I think all of us who went through this period all made mistakes, and wish that we had done some things differently. I don't think there's anybody who's served more than a year or so in Washington that wouldn't say the same thing.

And now the proposals are all out there, and there's the president's proposal and there's other ones. ... What's your favorite proposal that's likely or that has a chance?

I was co-chair with [former SEC Chair] Bill Donaldson of the Investors Working Group, and Brooksley Born was a very important member of that group. We felt that systemic regulation should not be housed with the Federal Reserve Board and should be the function of a separate, either individual or committee, working with regulators in a coordinated fashion to warn them of systemic risks, to alert them to problems, and if necessary to take action. We felt that the Federal Reserve Board, with their concerns for monetary policy and certain inherent conflicts, that may make the policy-making decisions of a systemic regulator much more difficult. So we view Treasury's recommendation somewhat differently.

The likelihood of the administration, the likelihood of Congress of supporting this idea?

I think Congress has a lot of reservations about vesting the power in the Federal Reserve Board, and it wouldn't surprise me to see an alternative not too dissimilar from our recommendation emerge. ...

When Born issued the concept release, there was a fear that the markets would all go to London. How prevalent was that fear? How important was that consideration?

During that period of time, every regulatory effort that the commission conceived of was met by an industry's insistence that the markets would all move to London. I never bought that notion; I never cared if they all went to London. And that argument is still being used today, and it's specious. Regulations we're likely to see in other parts of the world are probably more draconian than anything we're likely to come up with.

So those arguments are ridiculous, and the irony of all this is that barely a year before the current market meltdown occurred, a group of eminent academics -- including the dean of the Columbia Business School, Sen. [Charles] Schumer [D-N.Y.], [New York City] Mayor [Michael] Bloomberg and others -- convened a group to say that the problem with U.S. markets was that they were overregulated and we were losing listings to London. To think that the metric of evaluating the U.S. economy was the number of listings lost by the New York Stock Exchange to the London Stock Exchange is so patently ridiculous, it's laughable today.

It's like an ongoing fear-based strategy, though, isn't it?

Yes, it is. ...

In that period, you said the argument [against Born's proposal] was that you'd be retroactively canceling contracts that existed. Where was that argument coming from? Who were you hearing that from? ...

Bob Rubin and Alan Greenspan.

And how were they getting it?

It was a fact. It was a fact that there were trillions of dollars of notional contracts that would be thrown into total chaos. They were right; they were absolutely right. Having said that, great, let's grandfather them, and going forward, let's keep this from growing the way it did in an unregulated environment.

How did it happen that that didn't happen, that idea of "Let's grandfather it"?

Nobody was farsighted enough or bold enough. Or who knows why an idea does or does not occur?

Born says that within their concept release, it was stated that they would grandfather.

I cannot recall that. I cannot recall anyone saying that to me. And it's something that I should have known about and done something about.

Do you think the swaps played any role in the crisis?

I think I would argue that the swaps had very little to do with what eventuated.

But if you regulated the swaps, if you'd gone down that road, would that have led to --

Yes, of course.

I guess that's the connection, that if you got one part of it, you'd have gotten the other?

Absolutely. If you decided derivatives were not products used just by very sophisticated professionals who knew how to protect themselves, once you cross that bridge, the rest is easy.

After you leave, what's the state of regulation of the financial services, just in general? What happens over the next eight years? Is it a period where there's continuing deregulation of the industry?

Listen, we had more regulation. We changed from markets with obscene spreads and collusive behavior by the over-the-counter market to an electronic market where billions of dollars a year were transferred from brokers' pockets to investors' pockets. We blew the whistle on the accounting conflicts; we implemented regulation, full disclosure. We probably were the most regulatory commission in spite of congressional pressure. ...

posted october 20, 2009

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