As part of the Read the Bill campaign, we’ve been writing a series of case studies highlighting bills that slipped through Congress with little time for public input or for lawmakers to review. After reading the following, please go to ReadTheBill.org and sign the petition to tell Congress that bills should be made publicly available for at least 72 hours prior to consideration. And now, your case study: the Commodity Futures Modernization Act of 2000.

In the waning days of the 106th Congress and the Clinton administration, Congress met in a lame-duck session to complete work on a variety of appropriations bills that were not passed prior to the 2000 election. There were other, unmet pet priorities of some lawmakers that were under consideration as well. One of those pet priorities was a 262-page deregulatory bill, the Commodity Futures Modernization Act. Tucked into a bloated 11,000 page conference report as a rider, with little consideration and no time for review, this bill would be viewed only eight years later as part of the failure of our political system abetting a financial storm that brought the world to its knees.

The saga of the Commodity Futures Modernization Act begins in 1998. At the time, the economy was booming, stocks soared, and new instruments of trading were found to make more money while evading the oversight of regulatory bodies. Two of those growing instruments were financial derivatives and credit-default swaps. As these new financial instruments emerged a debate began over whether or not to regulate them.

The chairman of the Commodity Futures Trade Commission (CFTC) Brooksley Born issued a first call for her regulatory commission to have power to oversee financial derivatives. While previous legislative attempts had been made earlier, Born’s efforts were the most direct and threatening to the financial industry. During an April 1998 meeting of the President’s Working Group on Financial Markets, Federal Reserve chairman Alan Greenspan, Clinton Treasury Secretary Robert Rubin (and later Secretary Larry Summers), and Securities and Exchange Commission (SEC) chairman Arthur Levitt opposed Born’s efforts and attempted to derail her.

[A]n unregulated derivatives market ... could “pose grave dangers to our economy.”

Soon afterwards, Born released a “concept” paper with ideas of what regulation of derivatives and swaps could look like under the CFTC’s oversight authority. The response to Born’s paper was swift. The financial industry and government officials responded fiercely in opposition to Born’s ideas. Greenspan, Summers, and Senate committee chairmen all criticized her and her proposals.

In the midst of this debate Long Term Capital Management (LTCM), a major hedge fund employing some of the top economists, collapsed. LTCM was highly over-leveraged and held a big portfolio of swaps. In the end, during the government organized bailout of the company, LTCM recorded a loss of $1.6 billion on swaps alone.

Born felt that an unregulated derivatives market that spawned the LTCM bailout could “pose grave dangers to our economy.” In the end, Born lost her battle and, in May 1999, asked to be replaced as CFTC chairman. The new chairman, William Rainer, was more amenable to the positions of industry leaders and the major government officials Summers, Greenspan, and Levitt. Later that year, the President’s Working Group on Financial Markets released a report calling for “no regulations” of derivatives and swaps and began crafting a program to make that possible. Meanwhile in Congress, lawmakers were still up-in-arms over Born’s attempts to regulate the financial derivatives market and began working to pass their own set of deregulatory language.

Leading the charge in Congress were Sens. Phil Gramm (R-TX) and Richard Lugar (R-IN) and Rep. Thomas Ewing (R-IL). In May of 2000, Rep. Ewing introduced his Commodity Futures Modernization Act. While Ewing’s bill sailed quickly through the House, it stalled in the Senate, as Sen. Gramm desired stricter deregulatory language be inserted into the bill. Gramm opposed any language that could provide the SEC or the CFTC with any hope of authority in regulating or oversight of financial derivatives and swaps. Gramm’s opposition held the bill in limbo until Congress went into recess for the 2000 election.

Throughout the better part of the year Gramm, Lugar and Ewing worked with the President’s Working Group on Financial Markets—most specifically, Treasury Secretary Summers, CFTC Chairman Rainer and SEC Chairman Levitt—to strike a deal on the bill.

"Details of the final language are not immediately available."

Little attention followed Congress as the contentious 2000 presidential election was stuck in a stalemate as lawyers and khaki-clad protesters fought over the Florida recount to decide whether Gov. George W. Bush or Vice President Al Gore would be the next president.

During a lame-duck December session, while the media was focused on the recounts and court cases, Gramm and Ewing sought to strike a compromise on the Commodity Futures Modernization Act. The day after the Supreme Court ruled in favor of Gov. Bush, December 14, Ewing introduced a new version of the Commodity Futures Modernization Act. On December 15, with little warning or fanfare—aside from the overshadowed discussions on the floors of Congress—the new, compromise version was included as a rider to the Consolidated Appropriations Act for FY 2001, an 11,000 page omnibus appropriations conference report.

HedgeWorld Daily News, a trade publication for hedge funds and one of the few news outlets following the bill, stated, “Details of the final language are not immediately available. Congressional aides said Sen. Gramm did succeed in getting additional language protecting the legal certainty of swap, especially those traded by banks, which are the main users of the products.”

The final language, which the public was hardly aware of, contained some new sections not in the original Ewing bill that, for all intents and purposes, exempted swaps and derivatives from regulation by both the CFTC, which had already implemented rules that it would not regulate swaps and derivatives, and the SEC. Also, hidden within the bill was an exemption for energy derivative trading, which would later become known as the “Enron loophole” – this loophole would provide the impetus for Enron’s nose dive into full blown corporate corruption.

Ultimately, while the unregulated market in derivatives and swaps did not cause the economic downturn itself, it was a propellant of the crisis, accelerating the collapses of major financial companies across the globe. As of June 30, 2008, the global derivatives market had exploded to $530 trillion, while credit default swaps had grown from mere insignificance to $55 billion. When the credit crisis and the mortgage meltdown began to take hold, major firms found out the swaps made their investments far riskier than they could handle.

Bear Stearns, Lehman Brothers, and American International Group (AIG) all collapsed due to problems with the unregulated market of credit default swaps. The major banks were also heavily involved with credit default swaps. A report from the Comptroller of the Currency recorded in the third quarter of 2007 that the top banks in the credit default market were JP Morgan Chase, Citibank, Bank of America and Wachovia. Wells Fargo purchased Wachovia after it collapsed. Bank of America has received approximately $45 billion in TARP funds from the Treasury Department, mostly to offset losses from its acquisitions of Countrywide Financial in 2007 and Merrill Lynch in 2008. Citibank’s parent company Citigroup faced a complete meltdown during the end of 2008, received $50 billion in TARP funds from Treasury, and is breaking apart into smaller companies. JP Morgan Chase, while weathering the crisis far better than the other banks, still received $25 billion in TARP funds.

If ever there was a case where Congress should have given more time and listened closer, this was it.

Consensus is nearly universal that the failure to regulate financial derivatives trading and the subsequent explosion of credit default swaps, by passing the Commodity Futures Modernization Act, was a mistake. Deregulation supporter Chris Cox, a former SEC chairman under President George W. Bush and congressman from California, called the swaps “the fuel for what has become a global credit crisis.” According to Bloomberg, Alan Greenspan “acknowledges he’d been ‘partially’ wrong to oppose regulation of such instruments.” Former SEC chairman Levitt stated that if given the chance for a do-over he “would have pushed for some way to give greater transparency to products which turned out to be injurious to our markets.”

In the end, the country would have been better served had Congress not taken the 262-page Commodity Futures Modernization Act, which had trouble passing Congress on its own accord, and inserted it into a bloated 11,000 page conference report when no one was looking. If ever there was a case where Congress should have given more time and listened closer, this was it. Now, we’re all paying for it.

Today, President-Elect Barack Obama named the key members of economic team including Timothy Geithner as Treasury Secretary and Larry Summers as head of the National Economic Council. Notably, many in Obama's economic circle are acolytes of former Clinton Treasury Secretary Robert Rubin, the subject of much talk in the wake of the bailout of Citigroup. Rubin, a revolving door spinner between Wall Street and Washington, began his career at Goldman Sachs, moved to the National Economic Council, then Treasury, and in 1999, left government and joined Citigroup. Rubin's story provides a telling story about the conflicts of interest that can occur when a high-ranking official moves so seemlessly between the public and private sector.

In this New York Times article addressing Citigroup's economic troubles, Rubin appears as a key player, in both the deregulation that allowed the bank to become so large and unwieldy and as an adviser to the bank urging riskier behavior:

The bank’s downfall was years in the making and involved many in its hierarchy, particularly Mr. Prince and Robert E. Rubin, an influential director and senior adviser.

Citigroup insiders and analysts say that Mr. Prince and Mr. Rubin played pivotal roles in the bank’s current woes, by drafting and blessing a strategy that involved taking greater trading risks to expand its business and reap higher profits. Mr. Prince and Mr. Rubin both declined to comment for this article.

When he was Treasury secretary during the Clinton administration, Mr. Rubin helped loosen Depression-era banking regulations that made the creation of Citigroup possible by allowing banks to expand far beyond their traditional role as lenders and permitting them to profit from a variety of financial activities. During the same period he helped beat back tighter oversight of exotic financial products, a development he had previously said he was helpless to prevent.

...

But while Mr. Rubin certainly did not have direct responsibility for a Citigroup unit, he was an architect of the bank’s strategy.

In 2005, as Citigroup began its effort to expand from within, Mr. Rubin peppered his colleagues with questions as they formulated the plan. According to current and former colleagues, he believed that Citigroup was falling behind rivals like Morgan Stanley and Goldman, and he pushed to bulk up the bank’s high-growth fixed-income trading, including the C.D.O. business.

Former colleagues said Mr. Rubin also encouraged Mr. Prince to broaden the bank’s appetite for risk, provided that it also upgraded oversight — though the Federal Reserve later would conclude that the bank’s oversight remained inadequate.

Once the strategy was outlined, Mr. Rubin helped Mr. Prince gain the board’s confidence that it would work.

The conflict of interest line is often easy to draw when involving revolving door moves from Washington to K Street. When high-powered officials move into other parts of the private sector they still maintain large amounts of influence in Washington, and have just as much of a need to influence officials as lobbyists. (Citigroup's lobbying expenses are close to $6 million for the year.)

In Rubin's case, the industry into which he went has fallen into complete turmoil roiling not only economic markets but politics in Washington. Yet, Rubin remains a top transition adviser to President-Elect Obama and, as noted above, his proteges are among Obama's top picks for economic positions.

Despite Rubin's hand in the current crisis and his revolving door tale, the line between his work and the new Obama appointments is not so clear. While Rubin came from the private sector, Geithner, Obama's Treasury pick, does not. Geithner has spent nearly his entire career in the public sector from positions in the Treasury Department, the IMF, and the New York Federal Reserve. This is quite a change of pace from the recent history of Treasury Secretaries. All three of President Bush's Treasury Secretaries were CEOs, with the current occupant Hank Paulson, like Rubin, the former CEO of Goldman Sachs. Going back more than 30 years, only George Schultz, Treasury Secretary under Nixon, and Larry Summers came into the job without a stint in the private sector. (They both came from acadamia.)

As Rubin's revolving door tale shows, conflicts of interest can pop up during government service and for years to come afterwords. The importance of controling these kind of situations is seen in the types of appointments like Geithner's and the revolving door restrictions that Obama has said he will implement.

For more discussion of revolving door policies, see this Sunlight Policy Review post from last week.