There was something surreal about Washington this week. On one end of Capitol Hill, erstwhile masters of the financial universe from Goldman Sachs were being pilloried for shorting the housing market as it imploded and laughing all the way to the bank. “Unbridled greed,” charged Senator Carl Levin (D-Mich) to which the Goldman Gang seemed to say, “No duh.”
Meanwhile, on the other end of town, the 18 members of the President’s bipartisan deficit reduction commission gathered in a nondescript room across Lafayette Park from the White House to kick off a task even more daunting than unraveling Goldman’s exotic derivative trades: crafting a bipartisan plan to reduce the federal budget deficit, now at $1.4 trillion and growing fast. Calling the political atmosphere “toxic,” panel co-chair Alan Simpson told veteran anchor Andrea Mitchell on MSNBC: “If we can’t establish some trust … some shred of patriotism, we might as well leave and continue the bitching and whining and moaning.” Quipped Mitchell: “Good luck!”
A day later, a fiscal summit sponsored by the Peter G. Peterson Foundation assembled an even more prominent lineup of erstwhile political titans who, in a turning of the tables worthy of a Greek tragedy, have become villains in the latest derivatives drama playing out in Washington. As former President Clinton conceded to a packed crowd at the Ronald Reagan Center, he and his team have taken “a few licks.”
Clinton: derivative regrets
With the nation facing the gravest fiscal challenge in its history, you might think that Clinton, who turned a $340 billion deficit inherited from Ronald Reagan in 1992 into an $86 billion surplus by 2000, would be beset by questions about how to bridge deep partisan divides over fiscal policy. Instead, he finds himself talking derivatives – more specifically, why he didn’t regulate the exotic financial instruments that Warren Buffet aptly warned in 2003 could turn into “financial weapons of mass destruction.” Earlier this year, Clinton told ABC that he had gotten bad advice at the time from Larry Summers and Bob Rubin, and was wrong to take it, though he doubted he could have gotten anything through a GOP Congress. Still, he said, “I wish I had been caught trying. I mean, that was a mistake I made.”
What’s wrong, Clinton says, is the ‘casino’ side of the
business, not the ‘legitimate’ use of derivatives.
But the questions keep coming. As he left the Fiscal Summit, the former budget balancer was mobbed by press peppering him with questions on all things Goldman. No, he told us, he didn’t see any evidence that Goldman, which he noted had also bet some $100 million that housing would recover, had broken any laws. Yes, he regretted he hadn’t at least started a debate over derivatives when he was in office. “I wish I had done that,” he told me. What’s wrong, he says, is the “casino” side of the business not the “legitimate” use of derivatives – say for farmers to hedge against falling crop prices. Clinton says Congress needs to understand that the “gambles” offer “no larger purpose for the American economy.” Quipped the former President as he pirouetted out of the conference hall: “You don’t have to be all broke-out with brilliance to tell the difference between an agriculture derivative and what this was.”
Greenspan: seemingly unrepentant
Former Fed Chairman Alan Greenspan‘s success at taming inflation once earned him such epithets as the Maestro and the Oracle. But that was then. Now he’s regularly vilified for his repeated rejection of even the slightest regulation of the exotic derivatives that turned the housing bubble into the financial equivalent of the Hindenburg disaster. In 2003, he told Congress: "The benefits of derivatives, in my judgment, have far exceeded their costs." More recently, he said: "I was right 70 percent of the time, but I was wrong 30 percent of the time." Others are less forgiving. One angry blogger calls him a “lying sociopath,” noting that he was hired in January 2008 by hedge fund owner John Paulson, who bet against the housing market with derivatives engineered by Goldman, and who is now at the center of the SEC lawsuit.
The “canary in the coal mine”, Greenspan says, is the 10-year
Treasury bill and 30-year Treasury bond .
At the Peterson Conference, Greenspan deftly steered clear of the topic, and slipped out of the conference while the lights were out.
He did deliver a chilling warning, however, that a global economic recovery and increasing bank lending could push interest rates up “very quickly,” which given our heavy indebtedness would worsen the deficit undermining confidence among global investors. Noting that in 1970 the interest rate surged 400 basis points (4%) in a few months, he warned: “People don’t realize how quickly that can happen.” The “canary in the coal mine” he says is the 10-year Treasury bill and 30-year Treasury bond: “If that starts going up significantly, we’re in trouble.” Then we have got to move “very quickly” to avoid a financial crisis. How much time is there left? “I think we have a year.”
Rubin: wielding “a wooden bat”
Also appearing at the Fiscal Summit was Bob Rubin, former co-chairman of Goldman Sachs and Treasury Secretary under President Clinton. Back in the 1990s, Rubin was revered by many for his role in persuading the President-elect to back off his promise of a middle-class tax cut and focus on deficit reduction -- a move that helped bring down interest rates and set off a decade of economic growth and the longest bull market (118 months) in stock market history. Rubin, who had cut his teeth at Goldman as an arbitrageur and bond trader, also understood well how leverage and financial engineering could exacerbate a crisis.
At the time, he argued for tougher capital requirements for derivatives at the time but lost to Larry Summers. As Rubin recalled in his book, In an Uncertain World, “Larry characterized my concerns about derivatives as a preference for playing tennis with wooden racquets—as opposed to the more powerful graphite and titanium ones used today.” Friends say Rubin has smarted of late over Clinton’s lumping him with Summers in providing “bad advice.” That may explain why Clinton lavished praise on Rubin, who introduced him at the Fiscal Summit, as the “best Treasury Secretary since Alexander Hamilton.”
“I am more worried about this than anything in my
lifetime in terms of our economic future.”
Whether you agree or disagree with that assessment, Rubin’s warning about the risk of a financial crisis triggered by excessive debt was all the more chilling for prior prescience on derivatives. Said Rubin: “I am more worried about this than anything in my lifetime in terms of our economic future.”
One clear point of agreement: it’s time to put the mistakes of the past behind us, and focus on what can be done now to prevent a massive financial meltdown triggered not by a housing bubble but a debt bomb. From Clinton to Rubin to Greenspan to former Fed Chairman Paul Volcker, Budget Director Peter Orszag and many more, the message at the Fiscal Summit was consistent: unless we take action soon to reduce long-term deficits, we risk a financial crisis of epic proportions. If Clinton, Greenspan and Rubin can get the public to listen this time, these victors-turned-villains may help change the ending of this story – and their role in it.
The Fiscal Times , an independent business venture, is funded by Peter Peterson, but is not affiliated with his foundation.