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 202 and I quote: “Simplify, Simplify, Simplify – If, at this point, you are feeling overwhelmed by the sheer size and complexity of the problems, that’s the idea. The purpose of this chapter is to show that behind price inflation and volatility in any commodity, be it aluminum or wheat, stands an entire dysfunctional market ecosystem that must be understood and addressed. One of the common reactions to financial scandals like the one surrounding Goldman and aluminum is for the media, the public, and even the regulators to zero in on a tiny part of what is a very large problem. But the whole point of this story is that aluminum hoarding in Detroit warehouses happened because of a long history of legislative decisions, legal tweaks, corporate changes, and vested interests both in Washington and on Wall Street. This history, combined with a corrosive incentive structure, has created a situation in which a bank with absolutely no need to own a natural resource is not only allowed to do so but is enabled to stockpile it in a way that ensures the companies that do need it can’t get it. This drives up the prices and creates market volatility, which in the end means that customers have to pay more.
Jim Collura is vice president of government affairs at the New England Fuel Institute and one of the founders of the Commodity Markets Oversight Coalition, a group of mostly small and midsize businesses, such as heating oil distributors and gas stations, that was set up in 2007 in response to growing volatility in the commodities markets. He remembers how disturbing it was to come to grips with just how complex the system was, and with all the ways in which businesses were beholden to the very banks that competed with them. “The same financial institutions that were making the commodities markets more volatile were also the ones that were providing risk management services to our companies, or investing their pension plans, or owning the pipelines that our assets ran through,” Collura says. It was a situation that was at best distorted and at worst ripe for manipulation.
This is not what markets were set up to do. Most people can agree on that. So why haven’t legislators and regulators been able to fix the problem? In part because they’re focusing too much on small details: What’s the precise ratio of equity banks should hold to offset risks if they own 5 percent of a pipeline versus 15 percent? Does each individual institution have enough insurance to offset its own risks? Important though they are, these separate pieces of the puzzle can make us lose sight of the big questions that we should be asking instead, those that would galvanize real change in the system: Is it healthy to have a system in which banks compete directly with their customers, using superior information and resources to best the very businesses they were set up to serve? Is that really what we want our financial system to do?
The answers are obviously no. But getting to a better place requires an understanding that complexity is, as is often the case, the enemy of the public good. Complexity is ripe for arbitrage, which is what finance does best. To put finance back into the service of the real economy, you have to simplify, simplify, simplify. To do that, you have to increase transparency about what’s happening in the first place. in the commodities arena, former CFTC chairman Gary Gensler fought the good fight for stricter regulation of derivatives, bringing a large chunk of the swaps market out of the shadowy darkness and into central clearinghouses where it can be more easily regulated. In the United States most commodities-linked OTC derivatives are now subject to central clearing. The CFTC has also made big progress on real-time reporting and registration of brokers, so that people actually know who’s doing the trading.
But achieving even this level of regulation has been a long, hard slog. Thanks to its relentless lobbying of Congress, the administration, and regulators both in the United States and overseas, Wall Street has succeeded in carving out important loopholes in the Dodd-Frank derivatives rules. The loopholes make it possible, for example, for banks and hedge funds to continue their opaque, risky trading of foreign-exchange derivatives in international markets (something former Treasury secretary Timothy Geithner personally signed off on). Is it any wonder, then, that this was the very area in which the next global financial scandal would pop up? In 2015, six global banks, including JPMorgan Chase and Citigroup, were fined a cumulative $5.6 billion to settle charges that they rigged foreign exchange markets. The news followed only a few years on the heels of another similar price-fixing scandal in the Libor, or interbank lending, market. These developments left Gensler and others calling into question whether the banks had really learned anything from any of the previous scandals (or gave a hoot about the large fines they had to pay, which for top banks may still not make much of a dent in yearly profits).
The CFTC has certainly done its best to make it harder for US financial institutions to hang their dirty laundry in the Caribbean. But their jurisdiction is very limited. Roughly 70 percent of the overall OTC futures and swaps market remains opaque, leaving plenty of room for financiers to game the system. And the antiregulatory lobbying continues; in 2014 the financial industry succeeded in pushing back Dodd-Frank rules that would have forced them to put risky credit default swaps in affiliate companies that weren’t federally insured–yet another example of how the problems of 2008 are still with us.
So how do we solve these problems? The Federal Reserve, which is the top oversight body for Too Big to Fail Institutions, could do more to limit the banks’ virtually unfettered freedom to manipulate commodities markets, particularly since it has the jurisdiction to decide which of the banks’ activities are indeed “complementary” to their financial activities and which aren’t. The Fed also has the ability to decide if such activities are simply too risky–either for the banks, or for the financial system as a whole.
Even the threat of reform could have an impact. In the wake of the Goldman aluminum scandal, Fed chair Janet Yellen said that the central bank would consider new guidelines that could limit some activities of banks in the commodities arena. But big banks aren’t out of the commodities game just yet, although new rules being proposed by the Fed may force them to hold more capital against possible risks should they decide to stay in. As just one case in point, the head of Morgan Stanley’s trading division recently promised to continue to “service the supply and risk-management needs of our clients across the oil, power and gas, and metals sectors.”
It actually wasn’t a bad time for the banks to make their sales; commodity prices have been decreasing recently, in part because the Fed has slowed the flow of easy money into the markets, which fueled so much speculation to begin with. That’s why experts like Saule Omarova say that the banks’ divestments don’t represent a triumph for the real economy so much as they do good trading bets for the banks themselves. The banks are getting out of the market at the right time, just as they got in at the right time. Without tougher, clearer rules, they could jump back in at any time as well.
Are such rules coming anytime soon? And even if they do, will they definitively separate banking from commerce in risky areas like commodities? Certainly those proposed so far don’t? Many reform advocates are skeptical that they ever will. “I’m not expecting any giant news on this front,” says Lisa Donner, executive director of Americans for Financial Reform, a coalition advocating for tighter regulation of Wall Street. Part of the problem, she says, is that no regulators, including the Fed, seem to be asking the profound questions: Why do we have a system that allows finance to be a hindrance to commerce rather than a lubricant to it? How is it that banks could create a bottleneck in raw materials and then profit from it at the expense of their customers? How might we reshape things in a systemic way so that can’t happen? Instead, regulators have so far focused on tweaking the administrative aspects of existing laws while maintaining the silos that make the system so hard to police. They might have good intentions, but they are failing at fixing the problem.
“In my view, the Fed has both the legal mandate and the regulatory capacity to address these issues in a more comprehensive way, which is necessary in order to bring the financial markets back in service to the real economy,” says Omarova, who wonders if it will take even bigger crisis to fundamentally change the laws governing how banks engage in commerce. It’s a point that was brought into sharp focus by Senator John McCain during the release of the 2014 Senate report on the banking sector’s influence in the commodities markets. “Imagine if BP had been a bank,” he said, referring to the Deepwater Horizon oil spill, which cost that company billions of dollars in damages. “It could have led to its failure and another round of bailouts.”
Unfortunately, says Omarova, “regulators are taking on these relatively low-stakes technical questions about additional capital and insurance, but they aren’t asking the big questions–is it a good policy to allow big banks to accumulate so much power, not only over finances, but also over our food, fuel, and other raw materials. What kind of a society will we have if a handful of banking giants end up controlling the country’s energy, metals, and agricultural supply chains?” It’s quite telling that the law gives the Federal Reserve the power to determine what a “complementary” activity is, and whether conducting it would pose “a substantial risk to the safety or soundness of depository institutions of the financial system generally.” But it doesn’t say anything about what impact such activities might have on businesses, consumers, and American families.
It’s a legal issue that goes far beyond even the crucial commodities markets. Remember, the Bank Holding Company Act of 1956 (the legislation that was so unfortunately tweaked by Gramm-Leach-Bliley) was really about power–and specifically, about ensuring that banks don’t have too much of it relative to the rest of the economy and to society. If there’s anything that the aluminum fiasco showed, it was that surely the balance isn’t yet right. One telling detail is how many companies affected by the aluminum scandal have been reluctant to speak out about the issue. In response to my interview requests for this book, SABMiller, the parent company of MillerCoors, responded with a one-line email: “On this occasion we will decline the interview opportunity but thank you for getting in touch and asking us.” There was no response to further emails asking why the company declined to speak about the incident.
The Coca-Cola Company has been somewhat more vocal, with executives blogging about how they are still concerned that the London Metal Exchange hasn’t done enough to stop the hoarding of aluminum. (According to a rather sarcastic Coke blog post from June 2015, the waiting time for metal shipments has fallen from a peak of 650 days to “only” 400 days.) Yet interestingly, none of the public comments about the matter mentions Goldman or any other banks, and public relations representatives at the companies declined to comment for this book about the banks’ involvement in the issue. No wonder. Coke has been a longtime investment banking client of Goldman Sachs, and at the time of the LME complaint, it had recently hired the bank to advise it on a $12 billion acquisition. “If I were Coca-Cola’s general counsel, I wouldn’t want my company to start a big fight with Goldman Sachs, either,” says Omarova. “What if we need to raise debt on the public markets tomorrow and need an underwriter? What if we plan a merger and need transaction advice? What might Goldman research analysts do to our share price if they wanted to? Coke needs Goldman. They are everywhere.”
You could argue, of course, that Coke and other American businesses can simply fight fire with fire and lobby for their own causes in Washington, just as the banks have done. Like it or not, that’s the way in which our political system allows various interest groups to counter one another so that no single entity can become too powerful. Yet the aluminum scandal also shows how hard it is for any entity, even one of the largest companies in the world, to escape the orbit of the most powerful financial institutions. They make the markets. They are the markets. They trade the products in the markets, and, as this story shows, they can also own the things that are being traded in those markets. If that’s not an oligopoly, I’m not sure what is. It’s also one of the best arguments I’ve heard for reinstating a modern version of the Glass-Steagall Act and for closing the loopholes that allow banks to engage in commerce. American industries simply shouldn’t have to compete in their core businesses with their own bankers.
And what of the world’s poorest people, the one billion who still don’t have enough to eat each day, in part because of Wall Street speculation? They’ve gotten a break over the last couple of years as commodities prices went down–not because of traders’ goodwill, but because emerging market growth has slowed and the era of central-bank-fueled easy money came to an end. That will change at some point in the future, and when it does, there will be nothing to stop Wall Street from brewing up another food bubble, unless our policy markers (or, less likely, the banks themselves) take action to rein in financial speculation in the commerce markets.
Before moving on from her post at the World Food Programme, Josette Sheeran gave a moving TED Talk on the problem of global hunger. “If we look at the economic imperative here, this isn’t just about compassion,” she said. “The fact is studies show that the cost of malnutrition and hunger–the cost to society, the burden it has to bear–is on average six percent, and in some countries up to 11 percent, of GDP a year. Well, the World Bank estimates it would take about 10.3 billion dollars to address malnutrition in those countries. You look at the cost-benefit analysis, and my dream is to take this issue, not just from the compassion argument, but to the finance ministers of the world, and say we cannot afford to not invest in the access to adequate, affordable nutrition for all of humanity.”
It’s a laudable goal. However, tackling it will first require not only compassion from world leaders, but real change in Wall Street’s business model.”
(YOU NOTICE IN THIS SEGMENT, THEY ARE STILL TALKING ABOUT THE ALUMINUM SCANDAL WITH GOLDMAN SACHS AND HOW EASY THEY COULD MAKE THAT SCANDAL PROFITABLE FOR THE BIG BANKS, THEY COULD CONTROL THE FOOD PRICES AND EVENTUALLY THE OIL PRICES WITH BIG, UNREGULATED INVESTMENT BANKS, RUN BY BIG UNREGULATED HEDGE FUNDS PROMOTING THEIR WORTHLESS, TOXIC DERIVATIVES EVEN WORSE THAN THE BITCOIN, WHICH WAS BEING PASSED OFF AS REAL CURRENCY THAT FELL ON ITS FACE. NOW, I HEAR THE FACT THAT THEY ARE TRYING TO PEP UP THE OLD JUNK BOND MARKET WHICH IS RIDICULOUS BECAUSE THE BANKS ARE SUPPOSED TO BE RUN BY HONEST CONSERVATIVES, WHICH MOST REPUBLICANS SHOULD FAVOR BUT, AS OF UP TO NOW, ISN’T HAPPENING BECAUSE OF BILLIONAIRES LIKE THE KOCH BROTHERS, SHELDON ADELSON, AND OTHERS. YOU CAN EASY SEE WHY UNHEARD OF PEOPLE LIKE SEN BERNIE SANDERS ALMOST BEAT SEC OF STATE HILLARY CLINTON ON THE ONE FACT THAT THE FIVE BIG INVESTMENT BANKS ARE CONTROLLING OUR ECONOMY BY BUYING OFF BOTH PARTIES WITH HUGE CAMPAIGN CONTRIBUTIONS THROUGH THE BIG BANK LOBBY. WE’LL SEE WHO IS GOING TO TALK LIKE PRES FRANKLIN ROOSEVELT IN THE THREE PRESIDENTIAL DEBATES BETWEEN REPUBLICAN DONALD TRUMP AND DEMOCRAT HILLARY CLINTON. I HOPE HILLARY CLINTON GIVES SEN BERNIE SANDERS A CABINET POSITION. YOU HAVE TO GIVE SEN ELIZABETH WARREN CREDIT FOR GETTING ON THE SENATE BANKING COMMITTEE AND TELLING US WHAT IS GOING ON AND SHE IS ONE OF THE MAIN PERSONS THAT STARTED THE CONSUMER FINANCIAL PROTECTION BUREAU AND POSSIBLY A GREAT PRESIDENTIAL CANDIDATE IN THE FUTURE. THIS IS THE LAST EXCERPT FOR THIS BOOK AND THE NEXT BOOK I’LL BE PUTTING EXCERPTS FROM IS “LOST TYCOON: THE MANY LIVES OF DONALD J. TRUMP” BY HARRY HURT III WHICH I’LL START PUTTING ON MONDAY, AUGUST 29, 2016.
LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran