Page 76 - untitled
P. 76
SECURITIZATION AND DERIVATIVES
a leading consumer products company, reported a pretax loss of million, the
largest derivatives loss by a nonfinancial firm, stemming from OTC interest and foreign
exchange rate derivatives sold to it by Bankers Trust. Procter & Gamble sued Bankers
Trust for fraud—a suit settled when Bankers Trust forgave most of the money that
Procter & Gamble owed it. That year, the CFTC and the Securities and Exchange Com-
mission (SEC) fined Bankers Trust million for misleading Gibson Greeting Cards
on interest rate swaps resulting in a mark-to-market loss of million, larger than
Gibson’s prior-year profits. In late , Orange County, California, announced it had
lost . billion speculating in OTC derivatives. The county filed for bankruptcy—the
largest by a municipality in U.S. history. Its derivatives dealer, Merrill Lynch, paid
million to settle claims. In response, the U.S. General Accounting Office issued a re-
port on financial derivatives that found dangers in the concentration of OTC deriva-
tives activity among major dealers, concluding that “the sudden failure or abrupt
withdrawal from trading of any one of these large dealers could cause liquidity prob-
lems in the markets and could also pose risks to the others, including federally insured
banks and the financial system as a whole.” While Congress then held hearings on the
OTC derivatives market, the adoption of regulatory legislation failed amid intense lob-
bying by the OTC derivatives dealers and opposition by Fed Chairman Greenspan.
In , Japan’s Sumitomo Corporation lost . billion on copper derivatives
traded on a London exchange. The CFTC charged the company with using deriva-
tives to manipulate copper prices, including using OTC derivatives contracts to dis-
guise the speculation and to finance the scheme. Sumitomo settled for million
in penalties and restitution. The CFTC also charged Merrill Lynch with knowingly
and intentionally aiding, abetting, and assisting the manipulation of copper prices; it
settled for a fine of million.
Debate intensified in . In May, the CFTC under Chairperson Brooksley Born
said the agency would reexamine the way it regulated the OTC derivatives market,
given the market’s rapid evolution and the string of major losses since . The
CFTC requested comments. It got them.
Some came from other regulators, who took the unusual step of publicly criticiz-
ing the CFTC. On the day that the CFTC issued a concept release, Treasury Secretary
Robert Rubin, Greenspan, and SEC Chairman Arthur Levitt issued a joint statement
denouncing the CFTC’s move: “We have grave concerns about this action and its
possible consequences. . . . We are very concerned about reports that the CFTC’s ac-
tion may increase the legal uncertainty concerning certain types of OTC deriva-
tives.” They proposed a moratorium on the CFTC’s ability to regulate OTC
derivatives.
For months, Rubin, Greenspan, Levitt, and Deputy Treasury Secretary Lawrence
Summers opposed the CFTC’s efforts in testimony to Congress and in other public
pronouncements. As Alan Greenspan said: “Aside from safety and soundness regula-
tion of derivatives dealers under the banking and securities laws, regulation of deriv-
atives transactions that are privately negotiated by professionals is unnecessary.”
In September, the Federal Reserve Bank of New York orchestrated a . billion
recapitalization of Long-Term Capital Management (LTCM) by major OTC
