Goosing the Market

The following is an excellent excerpt from the book MAKERS AND TAKERS: The Rise of Finance and The Fall of American Business” by Rana Foroohar from Chapter 6: “Financial Weapons of Mass Destruction: Commodities, Derivatives, and How Wall Street Created a Food Crisis” on page 185 and I quote: “Goosing the Markets – Most people think that giant multinational companies like Coca-Cola rule the world.  But as a recent scandal in the commodities market illustrates, they are nothing compared to Too Big to Fail financial institutions like Goldman Sachs.  This point was brought into sharp relief in the summer of 2011, when executives from Coke began publicly complaining that something dicey was happening in the aluminum market.   Prices for the metal had been going up, but demand hadn’t changed.  What’s more, the time it took Coke and other big consumer brands, like the beer company MillerCoors, along with metal fabricators like Novelis, to get the raw materials they needed to make their cans and other aluminum products out of the warehouses in the Midwest (where such metal is traditionally stored) was mysteriously rising as well.  The result was that Coke and other product manufacturers, desperate not to run out of supplies, were being forced to pay not only a higher price for the metal but also a premium for delivery.  “The situation has been organized artificially to drive premiums up,” said Dave Smith, Coke’s head of strategic procurement, at an industry conference in June 2011.  “It takes two weeks to put aluminum in, and six months to get it out.”

Guess who Coke, Coors, and their thirsty consumers were paying that premium?  Goldman Sachs.  It’s an amazing tale that provides a window into the complex and costly shenanigans that can result when banks move too far out of their traditional purview of simple lending and financial intermediation and into other types of business.  While the Goldman aluminum-hoarding scandal has less human significance than the food and fuel bubbles of 2008 and 2010, it has received significant legal attention and documentation.  It thus provides a sharp lens through which to understand the confluence of events that created the dysfunctional system in which financial institutions are allowed to both make the market and be the market.

The problem had been growing behind the scenes for years and had been followed by academics and some trade press, but it sprang onto the public radar in July 20, 2013, when the New York Times ran a front-page piece on how Goldman Sachs had taken advantage of a tiny loophole in a 1999 amendment to the 1956 piece of regulation known as the Bank Holding Company Act. The loophole allowed Goldman to buy up thousands of tons of aluminum and hoard it in twenty-seven separate Detroit warehouses to exploit regulations that had been set up by the London Metal Exchange (LME), a global commodities marketplace that sets industry standards for metals trading.  In a complex arbitrage of cross-border laws and decades-old legislative rulings that could be interpreted in myriad ways, Goldman was essentially able to do something banks traditionally hadn’t been able to do–control and release the supply of aluminum as and when it wanted.  The result: the price of the metal went up, meaning that Coke, Coors, and many other companies had to pay more, a lot more, to package their products.    Industry experts say that higher aluminum prices cost American shoppers somewhere between $3.5 billion to $5 billion between 2010 and 2013, since the companies passed on their costs in the form of higher consumer prices.

What was in it for Goldman?  Plenty.  For starters, the bank made money on aluminum storage and fees via a wholly owned company called Metro International Trade Services, which charged about 40 cents per metric ton per day to store the metal, yielding around $100 million in revenue each year.  metro created incentives for customers to cancel and reestablish  contracts for aluminum; the cancellation of a contract allowed Metro to move the metal, thus getting around LME stipulations has a certain amount of metal had to be moved out of  a particular storage area by a particular time (regulations that were meant to prevent hoarding).  Because Metro didn’t actually have to sell the metal to end users the money-go-round could keep going, and money could continue to be made on aluminum storage.  Without breaking any LME regulations, Metro was actually moving at least 3,000 tons of aluminum a day into other warehouses, sometimes just a few feet away.  This, of course, created a backlog for customers who actually wanted to buy and use the aluminum, higher premiums for the metal, and more rent revenue for Metro.

A few numbers give a sense of the magnitude of the scheme.  When Goldman bought metro in 2010, it took around 40 days to get aluminum out of the warehouse.  By 2014, the wait time was 674 days.  The amount of aluminum stored at Metro, meanwhile, grew from 50,000 tons in 2008 to 850,000 tons in 2010 to 1.5 million tons in 2013.  That year more than a quarter of the supply of aluminum available on the market sat in Metro’s warehouses.  The rest for storing aluminum grew from 41 cents a ton per day in 2013.  All this translated into hundreds of millions of dollars in profits for Goldman, as Metro’s earnings grew from $67 million in 2009 to $211 million in 2012 and wait times began to lengthen.

As strange as the market run-up was, Metro’s regulator, the London Metal Exchange, had reasons not to look at the issue too closely, since the LME itself earned 1 percent of all the rental revenue from warehouses it regulated.  This relationship gets at a major systemic problem in the financial markets, which is that people within the system are very often incentivized to do exactly what’s not good for the economy as a whole.  The LME’s warehousing board was made up of executives from the warehouses it regulated.  As amazing as this might seem, it’s quite a common situation in financial markets, which often leaves companies, in essence or even in practice, to self-regulate.  There was another troubling wrinkle in the story, too: As one of the world’s top derivative’s traders, Goldman Sachs may well have made a large chunk of money trading commodities-linked derivatives based on the privileged information that owning the raw materials would have provided.

The Goldman aluminum-hoarding tale underscores many elements of the dysfunctional market system ecosystem in which businesses are forced to operate.  First, it shows in a particularly concrete way how the commodities market can be controlled by speculators.  Second, it shows that much of what the speculators do may actually be legal, thanks to changes in the laws governing the boundaries between commerce and finance, changes that were made in large part because of heavy lobbying by the financial industry and support from finance-friendly politicians.  It is truly amazing that investment banks (Goldman wasn’t the only one) were allowed to hoard a basic natural resource in such a way that they managed to rip off one of the world’s biggest companies, Coca-Cola, not to mention the soda-buying public, and that it may have actually been legal because of a loophole in a law that was bought and paid for by the financial industry.   But in many ways, it is even more amazing that after years of investigation into the incident by the Commodity Futures Trading Commission, the Federal Reserve, the US Senate’s Permanent Subcommittee on Investigations, and the Justice Department, the experts still don’t have a full and definitive picture of who did what, or when, or how.  The sheer complexity of the situation, as well as many others like it, and the fat that no single regulatory body can get a handle on it, is a huge problem.  But the core issue, that of banks using their superior assets and information to become sharp competitors to industries they are supposed to support, results in a market distortion that is taking an untallied but undoubtedly large toll on business and our economy.

“I’m sure that Goldman used the information they had about aluminum to influence the market between 2010 and 2013,” says Cornell law professor Saule Omarova.  (Her paper on the problems inherent in banks both owning and trading commodities, “The Merchants of Wall Street: Banking, Commerce, and Commodities,” first sparked serious media interest in the topic.)  “But can I prove it?  No.  Can the CFTC?  I doubt it.  And if that’s the case, should Goldman be doing any of this?  Absolutely not.”

Part of the complexity of the commodities-linked derivatives markets, like derivatives trading markets as a whole, is that until quite recently they weren’t subject to very much federal oversight.  According to former CFTC head Gary Gensler, also a former Goldman Sachs derivatives expert (and now CFO of Hillary Clinton’s presidential campaign), prior to the 2008 crisis around 90 percent of the entire derivatives market was in an unregulated space, not subject to oversight or central clearing on public exchanges.  Gensler, who made it his business while at the CFTC to try to change that, has special insight into just how damaging that opacity can be.  In 1998, while working in the Clinton administration for then-Treasury secretary Robert Rubin, he was assigned the task of trying to sort out the potential financial implications of the implosion of the hedge fund Long-Term Capital Management (LTCM).  The culprit: a $1.25 trillion swaps portfolio gone bad.  Gensler remembers going out to LTCM’s headquarters in Greenwich, Connecticut, on a Sunday to investigate.  “It quickly became clear to me that we had no idea what the ramifications would be in our financial system, and where, because these trades were booked in the Cayman Islands,” he says.  “It was a terrible feeling.”

Derivatives–be they interest rate swaps, foreign exchange bets, or energy futures–have real-world impacts, as we’ve already seen.  Yet to banks, hedge funds, and the other institutions that trade them, they are simply another moneymaking vehicle, something to be bought and sold.  What’s more, most of us play a part in the cycle that drives up commodity prices and disproportionately enriches the financial sector, via your retirement savings.  After the bursting of the tech bubble, in the wake of the market downturn, institutional investors like pension funds and endowments, along with big asset managers like Fidelity, began looking for a new place to make money.  Commodities markets had always been attractive to certain risk-taking speculators, but they weren’t typically a place where institutional investors would put their funds.   Yet around 2004, as China’s energy needs were heating up and commodity prices were rising, a couple of Yale academics put out a paper heralding the virtues of commodities investing as a way to balance big portfolios, arguing that historically, commodities typically didn’t rise and fall in the same cycles as other assets such as stocks and bonds.  It was a catalyst for many big asset managers to start getting into the commodities space.  Amazingly, nobody thought too much about the fact that those academics had been funded to do their research by AIG Financial Products, which was looking to expand the portion of its business that allowed investors to buy index-linked bundles of commodities.   Of course, by 2008, AIG, which helped bring down the US and global economy with its enormous credit default swap bets, was in the news for bigger and more alarming reasons.  Academics pushing paid-for research that made a potentially risky market segment look safe were a minor thing by comparison.

In any case, the financialization of commodities has already begun to take off.  Institutional investors poured into the market for natural resources; between 2004 and 2007, the number of commodities futures contracts outstanding in the world nearly doubled.  Because commodities futures prices are the benchmark for the prices of actual physical commodities that people use on a daily basis, when speculators drive futures prices higher, it affects the real economy immediately.  (Indeed, it was during that time that food and fuel price inflation began to rise globally.)  In 2003, big investors were putting $13 billion into commodity index trading strategies.  By March 2008, they were pouring in $260 billion.   During that time, the prices of 25 commodities, from cotton to cocoa, cattle to heating oil, rose by a whopping 183 percent.  “Are institutional investors contributing to food and energy price inflation?  My unequivocal answer is, YES!” said hedge fund portfolio manager Michael Masters in testimony on the topic before the US senate Committee on Homeland Security and Governmental Affairs in May 2008.  “What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets. . . corporate and government pension funds, sovereign wealth funds, university endowments, and other institutional investors.  Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant.”

It’s a trend that has only strengthened since then, as a good chunk of the $4.5 trillion that the Federal Reserve dumped into the markets to try to buoy the economy following the financial crisis ended up either in commodities or in emerging market economies that were essentially plays on the commodity markets.  The fact that these markets have since collapsed, as hot money fled in the wake of the Fed’s pullback from quantitative easing, only shows just how financialized they’ve become.  Indeed, a 2015 report from the Bank for International Settlements concluded that the scale and volatility of the price collapse meant that oil, long seen as an essential fuel, was starting to behave like a “financial asset.”

Foxes in the Henhouse – Many of the biggest institutional investors who are now in the market for oil and other commodities have gotten there via banks like Goldman Sachs and Morgan Stanley, who run dedicated commodities trading desks that specialize in betting on the future prices of natural resources.  Both Goldman and Morgan, unfettered until 2008 by the prudential banking regulation imposed on commercial banking institutions, had since the 1980s been serious players in commodities trading.  As investment banks, they could pretty much do what they liked in the area.   Goldman, which started its namesake Commodity Index in 1991 (one of the key steps that allowed for the huge influx of pension money into commodities) already ran a large over-the-counter (OTC) derivatives trading business.  These types of trades were historically unregulated since they were done off exchanges.

Goldman also owned physical commodities–so many of them, in fact, that in 1994 the bank actually got a complaint from airport officials in the Netherlands regarding the large masses of aluminum it was storing around Rotterdam.  The piles had gotten so big that they were starting to reflect the sun in ways that were confusing local air traffic controllers.  Airport officials asked if Goldman could please throw a tarp over its metal stash to make the skies a bit safer.

Morgan Stanley was an even bigger player in the physical ownership and movement of commodities.  Between 2002 and 2012, its commodities unit generated an estimated $17 billion in revenue, trading both financial contracts and physical commodities.  In the early 1990s, its chief oil trader, Olav Refvik, struck so many deals to buy and deliver oil to large commercial users around the world that he was known as the King of New York Harbor.  The company had its own tank operation, a fuel distribution, electricity plants, fertilizers, asphalt, chemicals, and pipelines, all of which gave it special insight into the trading markets for these things.

What was already a hot business heated up further after the repeal of Glass-Steagall regulations in 1999.  Banks like Goldman Sachs and Morgan Stanley were suddenly facing competition from much bigger publicly traded and publicly backed institutions.  They needed to come up with more revenue fast, and trading was the easiest and most profitable way to do it.  Speculation in commodities got an even bigger boost from the passage of the Commodity Futures Modernization Act (CFMA) in 2000.  Not only did that law, in one fell swoop, exempt financial derivatives traded over the counter or off regulated exchanges from CFTC or SEC oversight; it also turned back centuries of common law that said it was fine to trade such instruments, but the government wouldn’t necessarily enforce the contracts unless the parties involved could prove that they were used for real hedging of real assets.  Now the CFMA made OTC derivatives speculation legally enforceable even if traders couldn’t prove it was being done for anything but pure speculation.  There was no longer any reason not to engage in as much speculation as possible, which helps explain why the OTC derivatives market has grown exponentially between then and now.  “Basically, that law made pure bets, for the first time in Anglo-Saxon legal history, enforceable in court,” says Cornell law professor and securities expert Lynn Stout, who has written extensively about the issue.  “I always joke that if Congress decided to legalize murder, they’d call the legislation the Homicide Modernization Act.”

Commodities quickly became a key growth area for banks like Goldman and Morgan.  They took a page from firms like Enron, who had pioneered “innovative” (read: speculative) markets for the trading of things like energy and utilities, leveraging both ownership and trading.  (No matter that they went up in flames; the financial industry was still eager to copy many aspects of the high-profit model.)  Between 2006 and 2008, Goldman alone made $3 to $4 billion per year on both ownership of raw materials and trading of commodities-linked derivatives.  As commodities trading volumes shotup, so did price volatility, meaning that real-world businesses like airlines and manufacturers, for which raw materials were a major cost, suffered disproportionately.  Some, like Delta Air Lines, got further into the commodities trading business themselves as a way to try to make money beyond just hedging their own bets (a common practice, as described in chapter 5).  But in general, the percentage of business done by real “physical hedgers,” meaning airlines, trucking companies, etc., began to decline relative to those who were trading commodities that they didn’t actually need for their business.  In 2000, physical hedgers accounted for 63 percent of the oil futures market; speculators accounted for the rest.  By April 2008, those percentages had shifted to 29 percent and 71 percent respectively.  Speculators now controlled the market.”


“From the leading edge of business journalism, Rana Foroohar has produced a powerful book about how financial manipulation has spread beyond the financial sector itself to colonize the American economy, to the enormous detriment of real, productive activities.  By mapping the rise of financialization and its effects, Foroohar sheds light on almost everything we now see, from the inequality debate to presidential politics to America’s global competitiveness.  A phenomenal achievement.”   —CHARLES FERGUSON, producer Inside Job


LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran


About tim074

I'm a retired dairy farmer that was a member of the National Farmer's Organization (NFO). Before going farming, I spent 4 years in the United States Air Force where I saved up enough money to get my down payment to go farming. I also enjoy writing and reading biographies and I write about myself as well as articles and excerpts I find interesting. I'm specifically interested in finances, particularly in the banking industry because if it wasn't for help from my local Community Bank, I never could have started farming which I was successful at. So, I'm real interested in the Small Business Administration and I know they are the ones creating jobs. I have been a member of Common Cause and am now a member of Public Citizen as well as AARP. I have, in the past, written over 150 articles on the Obama Blog ( and I'd like to tie these two sites together. I'm also on Twitter, MySpace and Facebook and find these outlets terrifically interesting particularly what many of these people did concerning the uprising in the Arab world. I believe this is a smaller world than we think it is and my goal is to try to bring people together to live in peace because management needs labor like labor needs management. Up to now, that hasn't been so easy to find.
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