Blindly Trusting Regulators is not the answer, either

– Mike Milken, the onetime junk bond king

Roger Lowenstein is one of the country’s most prominent financial journalists and the author of five best-selling business books. Lowenstein joined the Wall Street Journal in 1979 and wrote the Journal’s signature “Heard on the Street” stock market column. His book, “The End of Wall Street” is a first-rate chronicle of the 2008 financial collapse. Lowenstein appeared April 27 at Sarasota’s Forum Truth to discuss his concern that no one trusts Wall Street.

Lowenstein argued that a combination of easy credit and avaricious borrowers ultimately contributed to an asset bubble and subsequent meltdown. Regulators such as then-Federal Reserve Chairman Alan Greenspan, then-Deputy Treasury Secretary Larry Summers and then-Secretary of the Treasury Robert Rubin distrusted regulation as a way to rein in speculation. Instead, they believed that the markets could self-correct. In 1994, Greenspan told a congressional hearing, “Risks in the financial markets, including derivative markets, are being regulated by private parities. Greenspan totally stonewalled any regulatory remedial steps during his 1987-2006 tenure as Fed chairman.

Lowenstein points out the explicit failure of regulators to effectively legislate against derivatives — a central part of every financial crisis since the stock market crash of 1987. In 1998, Greenspan, Summers and Rubin stifled efforts by Brooksley Born, chairman of the Commodity Futures Trading Commission to regulate the trillion-dollar derivatives market. In the spring of 1998, Born’s agency issued an exploratory document intended to spur a discussion of capital-adequacy rules, margin requirements and appropriate disclosure for derivatives.

Summers called Born and said “There are 13 bankers in my office. They say if this (exploratory document) is published, we will have the worst financial crisis since World War II.”

Greenspan, Summers and Rubin told Born that “the regulation of derivatives was not fit for discussion.” Rubin asked Born whether she “would like an education in the applicable law from Treasury’s general counsel.” Rubin was overlooking the credentials of Born, who had been elected president of the Stanford Law Review in 1963.

Within six months, the hedge fund Long-Term Capital Management lost $ 4.5 billion, mostly on derivatives. This rocked the global markets. Ultimately, a powerless Born –a modern day Cassandra — was forced to resign.

Lowenstein argues that Wall Street cannot calibrate risks precisely enough to prevent catastrophic meltdowns and markets cannot regulate themselves.

The 2008 financial collapse involved all of the following: government ignorance, policy recklessness, Wall Street hubris, ratings-agency incompetence and Main Street avarice.

What is the long-term repercussion and legacy of our worst economic downturn in 80 years? Throughout the world, no one trusts Wall Street.

Lowenstein bridles at pernicious “Greenspan-ism” — that is, a confidence that burgeoning markets for securities and derivatives could regulate themselves. Lowenstein writes, “The mistake of the Fed and other regulators was failing to see that the relative financial stability of the postwar era was largely a result of the regulation put in place during the New Deal and after.”

But Lowenstein, too, suffers from myopia. He fails to see the flip side of his belief in the resurrection of New Deal regulatory practices.

After reading “The End of Wall Street,” we should remain cynical about whether regulators, legislators and the ordinary citizen have the answers to preventing future economic crises.