Sloshing aside still more credit meltdown guts, we come upon a small, glistening 262-page organ known as the Commodity Futures Modernization Act of 2000. Let's sponge it off and see if we can see what's oozing out of those ducts.

Introduced in the House by Thomas Ewing, the CFMA was largely written by and championed by Senator Phil "Mental Recession" Gramm, and it was his impetus which had the Senate companion version slipped into that year's omnibus reappropriations bill (H.R. 4577). Per usual GOP majority practice, it was never debated in either the House or the Senate.

So, what exactly does it do?

Well, for one it exempts certain over-the-counter derivatives (on OTC markets including electronic exchanges) from regulation by the Commodity Futures Trading Commission, the SEC, or, indeed, any federal regs at all aside from basic contract & fraud enforcement. Private electronic exchanges for new commodities derivatives (called “swaps”) sprang up overnight, mostly for energy futures.

Hardly surprising, since this section of the law was drafted by Enron lobbyists working cheek-by-jowl with Phil Gramm, and so was born the so-called "Enron loophole" (pdf). Through the miracle of laissez-faire policymaking, Enron was able to – more or less legally – manipulate wholesale energy supplies and reap the benefits on a derivatives market operating without any of the transaction rules for preventing price collusion and similar monkey business on a regular exchange.

It should surprise nobody that Phil’s Law, like the gift that keeps on giving, specifically exempts Credit Default Swaps from regulation. Creating two financial disasters with one law has to be some kind of record, but that is exactly, by letting OTC swaps go completely unregulated for the past 8 years, what the CFMA has done.

And Enron is small potatoes compared to the CDS market. With a nominal value around $62 trillion dollars, four times the size of the total US stock market, CDS is a monster, all of it unregulated, most of it uncollateralized (because unregulated), and it has been at the core of the credit market meltdown.

I’m not qualified to explain Credit Default Swaps, how they work, and how they are used by various institutional investors, except to say that they are generally used as a hedge, even a type of insurance, for CDO investors seeking to protect themselves against default of the mortgages underlying their securities. Thing is, up until the real estate market began its slow leak earlier this year, speculators had been running hogwild on the assumption real estate values would continue rising forever and ever hallelujah. Nobody wanted to get off the gravy train. And because of CFMA, none of them were required to collateralize their paper. $62 trillion is a lot of worthless paper, if it comes to that.

Imagine if you bought homeowner’s insurance on the off chance your house would burn down in a fire. Then your house burns down in a fire. Now imagine your insurance company is the next-door neighbor’s kid. An enterprising little sucker, he’s got about three thousand bucks stashed away in a savings account. In other words, he couldn’t afford to repaint your house, to say nothing of covering the market value. At the same time, you went out and got a second mortgage, partly on the strength of this fancy policy you bought yourself. Your mortgage lender just smiled and nodded, all of you blithely assuming the house was never, never going to catch fire. That’s the CDS market in a nutshell. And it’s legal thanks to Phil Gramm.

It’s important to remember what was happening in Congress on Dec. 15, 2000. Just three days earlier, the Supreme Court had handed down a decision on a little case called Bush v. Gore, and at the same time Republicans in Congress were threatening to bring the federal government to a standstill – by refusing to pass the same omnibus appropriations act CFMA is tacked on to. And of course it was GOP SOP to forestall any debate. To say that there may have been less than the usual scrutiny of the bill as written is a bit of an understatement.

So on a Friday evening in one of Washington’s craziest weeks in decades, Phil Gramm slipped the CFMA by reference into H.R. 4577, saying that it would “protect financial institutions from overregulation” and “position our financial services industries to be world leaders into the new century.”

At bottom, this is a story of deregulation gone terribly wrong, and laissez-faire philosophy misguided in the worst possible way. Or maybe it's a story of simple greed. Gramm and his wife made billions from Enron, and made millions in exchange. Gramm pushed for UBS to be allowed to take over US financial institutions, and now he sits on the board of UBS. Maybe it's a bit of both.
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Before you criticize someone, you should walk a mile in their shoes. That way when you criticize them, you're a mile away and you have their shoes. -JH

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Before you criticize someone, you should walk a mile in their shoes. That way when you criticize them, you're a mile away and you have their shoes. -JH