Wall Street Meets Its Match

In the showdown over the regulation of potentially toxic securities like credit-default swaps, the savviest and toughest battler for effective legislation turns out to be not Barney Frank or Chris Dodd, who chair the key House and Senate financial committees. Surprisingly, the best informed and most relentless crusader is a back-bench senator from Washington state, Maria Cantwell. If you want to see how one determined junior legislator can make a difference, Cantwell is your woman.

Cantwell, a big booster of Barack Obama, is determined to push his administration to deliver on fundamental reforms to the financial system -- and dismayed by what she's seen to date from Obama's staff. "If there are people at the Treasury and the White House who think that the way to get the economy going again is not to close these loopholes," she told me in an interview, "that's disgusting."

Cantwell, who just turned 51, is a former tech executive who won a squeaker of an election in 2000 by less than one-tenth of 1 percent of the vote. She is the kind of senator who is even better informed on the details of a complex issue than her highly competent staff. Washingtonian magazine once dubbed her a "Hill hottie," but in her efforts to reform the black holes of the financial system, and in her little-known but critical role in health reform, her undeniable charm is far less important than her tenacity and brains.

She tends to win arguments not with bluster or horse-trading but with deep knowledge of her subject and a refusal to be bluffed or to back down. For example, during the October markup of health-reform legislation in the Senate Finance Committee, Cantwell crafted an amendment, modeled on a Washington state program, that would allow states to negotiate with insurance companies on the terms of coverage for those eligible for subsidies and for other citizens buying in. By giving the government bargaining power, her amendment salvages some of the cost-containment goals of the more contentious "public option." And the committee adopted it by consent. "Senator Cantwell has done amazing work," her colleague Sen. Charles Schumer of New York told the committee. "The unsung hero of this bill is her amendment on costs." Moves like this are the hallmark of the truly effective legislator.

But the most lasting impact of her diligent approach to public policy is likely to come from her crusade for financial reform, particularly the fight over regulation of derivatives. Derivatives are securities at one or more layers of abstraction from real economic transactions. A mortgage loan, for example, is a real transaction. A bond backed by a sub-prime mortgage loan is a derivative. A package of such bonds is an even more abstract derivative. And a credit-default swap, which is an insurance policy against such packages of bonds going bad, is four levels removed from financial reality. At each stage of abstraction, derivatives invite pyramids of leverage and huge speculative profits for insiders -- as long as the bubble keeps inflating. When the bubble bursts, the losses can be as infinite as the capital is infinitesimal.

"Maria knows the complex issues pertaining to financial regulatory reform like the back of her hand, and she courageously uses that knowledge to combat the high-pressure lobbying by Wall Street," says Michael Greenberger, a former deputy to Brooksley Born, the Clinton-era regulator who tried to sound alarm bells about derivatives as early as 1998. Born, however, was ostracized by the rest of Clinton's economic team -- which included Larry Summers, now the top White House economic official. One of Summers' current deputies, Gary Gensler, was part of the team that boxed in Born's proposals suggesting the need for tighter government monitoring and regulation of swaps and other derivatives.

"There's a few people in the administration who still can't say that it was a mistake, and those are the same people, I think, who are slow-walking, thinking we're all going to forget about this regulatory reform that is needed," Cantwell said at a hearing in May. "I can assure you that we're not going to forget."

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When cantwell was running for Senate in 2000, derivatives were about the furthest thing from her mind. Her issues were defending Social Security, expanding Medicare, ensuring computer privacy, and reforming campaign finance. She was also a free-trader who supported the North American Free Trade Agreement. A senior executive at Seattle's RealNetworks, the company that pioneered Internet streaming of audio and video, Cantwell was billed in some quarters as a "multimillionaire business Democrat."

But that image missed who she really was. Cantwell grew up in a political family in Indiana. Her father, Paul Cantwell, held a number of political posts, including chief of staff to Andy Jacobs, one of the most progressive congressmen ever to represent the state. Not long after college, Cantwell moved from Indiana to Seattle and immediately got into politics, winning a seat in the state legislature at the age of 28.

In 1992, she won an upset victory for a U.S. House seat that hadn't gone Democratic in 40 years. As a freshman, she argued down Vice President Al Gore and killed his proposal for a "clipper chip," a sliver of computer hardware designed to facilitate government backdoor snooping. On that fight, she worked closely with the Electronic Frontier Foundation and got to know one of its leaders, Rob Glaser, the billionaire founder of RealNetworks. When Cantwell lost her seat in the 1994 Republican landslide, Glaser offered her the company's top marketing job, soon promoting her to executive vice president. When she resigned in 2000 to make her Senate run, she was able to draw on the value of her 110,000 shares of company stock at the peak of the market.

Winning by just 2,229 votes, to oust incumbent Slade Gorton, Cantwell immediately found herself thrown into the top issue then afflicting Washingtonians -- soaring electricity rates. Washington state, heavily dependent on hydropower, was suffering a drought. Utilities had to purchase electricity on the newly deregulated open market, making Washington one of the worst casualties of Enron's manipulation of electricity markets. In Seattle, electricity rates rose 60 percent. Washington state's Snohomish County Public Utility District found that market manipulation in the deregulated environment had cost consumers $1.1 billion.

Cantwell, serving on the Senate Energy and Natural Resources Committee, immersed herself in the details of electric-power regulation, which led her directly to derivatives abuses. Championing relief for Washington state ratepayers and sponsoring a bill voiding Enron's fraudulent contracts helped her win re-election in 2006 with 57 percent of the vote. She also authored a successful measure giving the Securities and Exchange Commission (SEC) and the Federal Trade Commission increased powers to combat market manipulation.

In 2007 and 2008, when oil prices were spiking, Cantwell led the effort to have the Federal Energy Regulatory Commission and the Commodity Futures Trading Commission (CFTC, the agency charged with regulating derivatives) investigate market-rigging. Many economists and most in the financial industry scoffed at the idea, contending that oil futures rising to more than $140 a barrel was simply the result of supply and demand. India and China, the story went, were increasing their purchases of oil. Markets, in their genius, were discerning the coming scarcity and were pricing petroleum accordingly. By bidding up the price, they were actually doing the world a service, since high-priced oil would signal investors to pursue development of other energy sources.

But as the CTFC and other agencies belatedly concluded in 2009, Cantwell had it right. Traders had manipulated energy derivatives, pushing up the price far beyond levels dictated by supply and demand. Far from playing their advertised role of smoothing out market movements, they increased price volatility. The exorbitant profits they took came directly out of the pockets of consumers. When the financial crash hit, and speculators headed for the exits, oil prices fell back down to a range of $40 to $60 a barrel.

Throughout all of this, where was the CFTC? The commission had been deliberately crippled by legislation passed in 2000 as a favor to Enron and to big trading houses such as Goldman Sachs. The legislation, with the Orwellian name the Commodity Futures Modernization Act, was initially sponsored by Sen. Phil Gramm, a Republican from Texas, but it had the backing of the Clinton administration and its allies among big financial houses. Among other things, the bill prohibited the SEC, CFTC, and state regulators from regulating swaps either as insurance or as securities -- or even as gambling!

Despite Cantwell's relentless investigations, the CFTC in 2007 and 2008 was still dominated by Bush appointees. The agency refused to issue regulations discouraging excessive speculation or requiring disclosure of trading positions, which would have allowed the commission to detect and head off such market manipulation. That challenge would fall to Bush's successor.

***

It came as a shock to Cantwell when Obama's nominee to head the CFTC turned out to be none other than Gary Gensler. "My reaction was, 'Oh my God, not again,'" Cantwell told me. Gensler was not only opposed to Born's proposals to regulate derivatives, he had been a senior trader at Goldman Sachs. And although he acknowledged the conflict of interest and kept away from derivatives policy during his first year at the Clinton Treasury in 1997?1998, he subsequently became an active participant.

Cantwell immediately put a hold on Gensler's nomination. After a lengthy meeting with Gensler on Jan. 15, Cantwell sent him a letter soliciting commitments on several regulatory issues involving derivatives. His reply, dated Feb. 11, was detailed, but it deftly fudged key questions. For example, would all derivatives contracts be required to be traded on exchanges regulated directly by the CFTC or only "cleared" in industry-sponsored clearinghouses, a softer remedy being promoted by the industry?

Little by little, however, Gensler came around to Cantwell's demands. He went on a charm offensive, meeting with consumer groups, speaking with the press, and promising a total change of heart. I was startled to get a phone call, out of the blue, from a White House handler saying that Gensler was eager to meet with me. (Due to scheduling problems, the meeting never took place.) However, Gensler sounded like such an ardent, born-again regulator that even Public Citizen, the consumer group founded by Ralph Nader, put out a press release supporting his confirmation. Remarkably enough, Gensler's conversion turned out to be the real deal.

One of the problems with derivatives is that the ones most prone to abuse are not traded on exchanges. They are sold directly from their originator to the customer, "over the counter." Therefore, there is no daily "price discovery" as in the case of an ordinary stock or bond, no transparency, and no competition. Derivatives are a bonanza for Wall Street, and over 90 percent are originated by the top four banks. The cure for this is to have all such derivatives traded on exchanges. A second problem is that derivatives lend themselves to market manipulation. The cure for that is to empower the CFTC to monitor and limit the trades and positions taken by major players. "They say that the insiders will always come up with new things, new ways of defeating regulation, new kinds of off-the-books games," Cantwell says. "That's why you need really bright lines." As negotiations over Gensler's confirmation dragged out from February to mid-May, Gensler ultimately agreed to most of Cantwell's positions. But Cantwell was taking no chances. She pressed Treasury Secretary Timothy Geithner to put these commitments in writing. In a key conversation in early May, Geithner balked. But moments after Cantwell got off the phone with Geithner, her phone rang. It was Larry Summers. After marathon negotiation sessions, Summers agreed to a letter committing in detail to fundamental reform. This is the kind of hardball seldom played by liberals, and it seemed to work. "We knew," Cantwell told me, "that if we ever were going to get something passed, we had to exert some leverage."

The letter, written by Geithner May 13, made explicit commitments about exchange trading, position limits, and new anti-manipulation powers for the CFTC.

A jubilant Cantwell took the Senate floor May 14. "For months," she said, "I have been urging the administration to move quickly to propose strong regulatory controls on these markets, require transparency in derivatives trading, and restrict market manipulation. With the announcement yesterday by Treasury Secretary Geithner, in a letter he sent to Senate and House leaders, the administration has come down decisively on the side of imposing order on a marketplace whose collapse made this current recession so much deeper and more painful for the average American than it needed to be."

She waived her hold on Gensler, but her suspicions were not entirely allayed. She still voted against confirming him. As Cantwell dryly said to me in an interview not long afterward, "It's not unheard of in D.C. to feign a commitment and then not fight hard to have the legislation pass."

That skepticism understated what was coming. Though Gensler fought inside the administration to keep his word to Cantwell, the Treasury Department released a white paper on June 17 that was weaker than the commitments in Geithner's May 13 letter. And the financial-reform legislation that Geithner sent to Congress in August was even weaker than the white paper. The loopholes were widened further by the House Financial Services Committee after an industry lobbying offensive that was supported by the 15 members of the New Democrat Coalition on the committee -- and these loopholes were not resisted by the administration.

The working draft of the House bill does not require all derivatives to be traded on exchanges. It completely exempts many categories of derivatives, such as those involving foreign exchange and trades in which one party is not a swap dealer or major swap participant. And it widens the loopholes allowing trades to be executed off exchanges, beyond the scrutiny of regulators.

"The Treasury Department should be ashamed of themselves," Cantwell told MSNBC in mid-October. She added, "What is moving through on the House side is a bill that supposedly has a new rule but it has so many loopholes that the loophole actually eats the rule. ... Current law with its loopholes would actually be better than these loopholes."

cantwell now finds herself closely allied with the man whose nomination she opposed, Gensler -- who really is a born-again regulator. He is at risk of becoming the Obama administration's own Brooksley Born. In a letter Aug. 17, Gensler bravely and explicitly criticized Geithner for weakening reform. In the case of exclusions for foreign-currency transactions, he wrote, "These exceptions could swallow up the regulation that the Proposed OTC Act otherwise provides for currency and interest rate swaps." He also criticized the proposed exclusion for transactions where one of the parties was not a swaps dealer. "This excludes a significant class of end users from the clearing and mandatory trading requirement," he wrote.

Cantwell is more blunt. "Under this provision," she says, "Enron could be an end user." She hopes that the Senate, which will take up derivatives later this winter, can undo some of the damage wrought by the House. Although in recent years the House has been more able than the Senate to produce strong consumer legislation, financial issues are quirky. Three House committees have jurisdiction over derivatives: Agriculture (when options and futures began, they were for products like winter wheat and pork bellies), Financial Services, and Energy and Commerce (since many derivatives involved energy trading). Agriculture Committee Chair Collin Peterson, one of the most conservative Democrats in the House, was nearly denied his chairmanship for voting too frequently with the Republicans. On the Financial Services Committee, pro-industry New Democrats added amendments to weaken the bill, and Chair Barney Frank has wavered on key issues.

By contrast, in the Senate, where Cantwell serves on the Energy and Natural Resources Committee, Banking Committee Chair Chris Dodd has a tougher view of derivatives regulation, as do the key Democrats on Energy and Natural Resources and on Agriculture. The new Ag Chair, Blanche Lincoln of Arkansas, has hired as staff director Rob Holifield, a close associate of Gensler.

Like Federal Deposit Insurance Corporation Chair Sheila Bair, another improbable crusader for stronger financial reform, Gensler enjoys a term appointment. Like Born, he cannot be fired, only isolated. The whispering campaign from the Treasury and the White House is that Gensler is a bit "utopian," meaning that he, unlike Summers and Geithner, is serious about reform. It strengthens his hand enormously to have an ally like Maria Cantwell.

"They seem to think that if Wall Street gets healthy again making all this money, some of it will wash through to the rest of the economy," Cantwell says. "Treasury has gone back on their original commitment to us. Gensler called Geithner on it. He's decided that he's going to be David to their Goliath. The battle lines have been drawn."

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