Brooksley Born On JPMorgan Chase Loss: Nothing's Changed Since LTCM

Derivatives Cassandra On JPMorgan: Told You So

To Brooksley Born, JPMorgan Chase's trading blowup looks a lot like the Long-Term Capital Management debacle of 14 years ago.

It's "happening all over again," Born told The Huffington Post on Monday. "We have to learn from these experiences, and we don't seem to be doing it yet."

Born, head of the Commodity Futures Trading Commission from 1996 to 1999, was one of the earliest observers to warn about the dangers of unregulated derivatives. She was thwarted in her efforts to impose regulation in the late 90s despite the cautionary tale of LTCM, a hedge fund that needed a government bailout in 1998 after making risky bets on credit derivatives and government bonds. As a Public Citizens report released Monday, "Forgotten Lessons of Deregulation: Rolling Back Dodd-Frank's Derivatives Rules Would Repeat a Mistake that Led to the Financial Crisis," points out, Born and other regulation advocates at the time cited LTCM as a prime example of the need for regulation and the risks of the market's opacity.

JPMorgan's $2 billion trading loss suggests the need for derivatives regulation is as urgent as ever.

"As long as we don't have derivatives reform in place, this kind of loss can occur without any advanced warning," Born, now a retired partner at the law firm Arnold & Porter, said.

Born made her comments just hours after word came out that JPMorgan had chosen a successor to Ina Drew, who is stepping down as head of the risk management office that incurred the loss. The bank's new chief investment officer will be Matthew E. Zames, whose first job in finance, according to The New York Times, was as a junior trader at, of all places, Long-Term Capital Management.

As DealBreaker notes, Zames also helped clean up after the debacle of Bear Stearns early in the financial crisis.

Late last week, JPMorgan revealed it had sustained major losses from bad bets on credit derivatives, the same vehicles that contributed to the financial crisis in 2008. Born famously sounded the alarm about these products as early as 1997, when she told Congress that opaque derivatives could "threaten our regulated markets or, indeed, our economy without any federal agency knowing about it," according to The New York Times.

At the time, those warnings met fierce resistance from others in the Clinton administration, particularly Alan Greenspan, chairman of the Federal Reserve, and Robert Rubin, secretary of the treasury. No regulation was ever implemented. The clash was later chronicled in a "Frontline" documentary titled "The Warning."

Elements of the Dodd-Frank financial reform law, passed in the wake of the financial crisis, are meant to address some of Born's concerns. But the new regulations are not yet in place, Born noted, and the financial industry has been lobbying tirelessly to water them down, "and that resistance is still under way.”

So far, much of the reform focus in the wake of the JPMorgan news has turned to implementing the so-called Volcker rule, which would ban federally insured banks from making bets with their own money, known as proprietary trading. On Friday, for example, Sen. Carl Levin (D-Mich.) told CNBC that the bank's bad bets underscore the importance of the Volcker rule.

"If the regulators do what [the Volcker rule] says ... this activity would not be permitted. ... The purpose of Dodd-Frank was essentially to bring back a cop on the beat on Wall Street," Levin said.

Born told The Huffington Post that two other reforms specifically would help prevent future derivative-driven losses like the one JPMorgan sustained. Derivatives should be traded on exchanges, she said, so as to bring them out into the public eye. Currently, trading in many derivatives, including those bought by LTCM and JPMorgan, takes place behind closed doors. Born also advocated the creation of derivatives clearinghouses that could assess and manage the risk that financial parties are looking to take on.

"If you have an opaque market, nobody knows what the problems in it might be," Born said. "Derivatives regulation is absolutely necessary for the safety of our financial system. Something like [the JPMorgan loss], or something many times worse, could happen at any time, and we don't know about it. Nobody knows."

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