Last week's headlines were blazing with Congressional hearings on the Bernie Madoff fraud scandal and President Barack Obama's proposal for some non-retroactive limits (no disgorgement of ill-gotten riches!) to Wall Street "senior executives'" (whatever that means) compensation (excluding options to buy stock at discounted rates) for financial institutions whose libertine imprudence has been rewarded with taxpayer bailouts.
Meanwhile on February 3-4, the U.S. House of Representatives Committee on Agriculture was holding unheralded hearings on the draft "Derivatives Markets Transparency and Accountability Act of 2009." The bill is a revision of the "Commodity Exchange Transparency and Accountability Act of 2008," some of whose provisions IATP summarized in a short report on commodities market speculation and food security. The 2008 bill passed the House by a vote of 283-133. At the invitation of Committee staff, IATP submitted written testimony for the February 3 hearing to comment on the 2009 draft "Derivatives" bill.
The views of witnesses at the hearings (available here) can roughly be categorized into two camps. First, there were the Wall Street lobbyists who want to limit Commodities Futures Trading Commission (CFTC) regulation in order to enable "financial innovation" to contribute to economic recovery. They were concerned that limiting the number of contracts for investment instruments ("speculative position limits") derived from the value of underlying assets, such as corn, oil and real estate would eliminate Wall Street's ability to profit by managing price risks for its clients. These witnesses also criticized the bill's provisions to regulate the unlimited number of Over-the-Counter (OTC) trades among private entities that comprised a gargantuan "shadow" trading system unregulated by the CFTC. The bill would require that OTC trades be regulated on public exchanges, such as the Chicago Board of Trade. The proponents of current OTC practice maintained that the private trading system worked just fine for its clients and that the causes of the Wall Street meltdown were elsewhere, e.g., in subprime home mortgages, and not in the financial instruments used to spread the risk of the price collapse of those mortgages among investors.
Other witnesses supported the draft bill's provisions to expose to transparent and enforceable regulations the "shadow" system that flooded the commodities exchanges with speculative capital and "innovative" investment instruments, such as commodity index funds. One witness estimated that the agricultural and energy commodities bubble fueled by excessive speculation had cost the U.S. alone $110 billion in 2008. To allow the unregulated financial and trading system, bolstered by more than $1 trillion in taxpayer bailouts, to continue would be to invite further economic catastrophe. The National Farmers Union noted that its members could not sell their products at the high prices that prevailed until July 2008 because extreme commodity exchange price volatility meant that their buyers would not contract with farmers in advance of harvest. And now agricultural commodity prices have collapsed, while farmers are still paying high input costs.
While IATP supported many provisions in the bill, we were concerned about "exclusions, exemptions and waivers" for regulation of OTC trades and the stripping (from the 2008 bill) of a provision for a thorough CFTC investigation into the effects of speculation in agricultural commodities markets.
Soon the Senate agriculture committee will hold hearings not only on its bill to revise the Commodity Exchange Act, but also on the nomination of Gary Gensler, a Goldman Sachs partner and assistant secretary of Treasury during 1997-2001 at the beginning of deregulatory financial exuberance.
In a January 30 update to our commodities speculation report, I noted that former Secretary of Treasury Henry Paulson, Gensler's former boss at Goldman Sachs, had proposed that the CFTC be merged into the Securities Exchange Commission (SEC). New SEC commissioner Mary Schapiro supports the merger, the argument for which is essentially that the CFTC should not have regulatory authority and that Congress' agricultural committees should not have legislative oversight of Wall Street. If the White House supports the merger, a House and Senate compromise bill to regulate the commodity exchanges might never arrive on President Obama's desk for signature. Given the past inefficiency delays in U.S. government agency mergers (think the Department of Homeland Security), it could be a long time before there are tough disciplines on speculation in the commodity exchanges. And firms like Goldman Sachs, which made an estimated $1.5 billion in commodities speculation, a third of its net income in 2008, according to a November 19 Wall Street Journal, will be able to continue to induce price volatility and profit from betting on it. These firms can even bet on the "fear index" of price volatility itself totally unmoored from any underlying commodity value.
IATP's testimony to the House hearing quoted a market consultant's newsletter to indicate just how dominant the market power of the financial speculators was over the commercial traders who buy and sell futures contracts to manage the price risks of the raw materials they use. The Brock Report of May 23 states, "No [commercial] speculator today can have a combined contract position in corn that exceeds 11 million bushels. Yet the two biggest index funds [Standard and Poors/Goldman Sachs and Dow Jones/American Insurance Group] control a combined 1.5 billion bushels." By taking profits on the price increases induced by such dominance of the market, traders like Goldman Sachs made a killing.
But there has been a very high price to pay for such a killing. In 2008, the United Nations Food and Agriculture Organization (FAO) very conservatively estimated the global food import bill would top $1 trillion for the first time, an increase of 23 percent over 2007 and 64 percent over 2006. Much of this food import bill is paid with precious hard currency reserves by the two-thirds of developing countries who depend on imports for much of their food security. On January 26, at a UN Task Force Meeting on the Global Food Crisis, FAO Secretary General Jacques Diouf pointed to a very conservatively estimated 963 million people in 2008 who weren't getting enough to eat, an increase of more than 100 million since 2006. Diouf pleaded for much greater public and private agricultural investment in developing countries to improve their national production capacity, both for domestic consumption and for exports.
But investors need well-regulated markets in order to estimate price trends, costs and their investment rates of return. Public officials in charge of investments likewise need well-regulated markets, in order to judge investment proposals and what public financial contribution will be needed to secure an investment to improve domestic food security. They need well-regulated markets that honestly assess internationally influential commodities reference prices for agricultural export planning. Instead, the commodity exchange markets of the last decade have offered no such regulation, only an environment in which crony capitalists made killings, sure in the knowledge that they were too big to fail and that former Wall Streeters in the U.S. government would come to their rescue. Taxpayer bailouts are now in the hands of these monumentally undeserving financial institutions.
Yet it is not too late to regulate the commodity market exchanges, to prevent a further reign of Business As Usual, and to make those markets serve agriculture and food security. Indeed, a properly regulated futures and options market could have helped--in combination with managment of physical stocks--prevent the wild swings in rice prices, and consequent food riots. The draft "Derivatives Trading Transparency and Accountability Act of 2009" takes important steps toward making commodities exchange markets a real financial service, instead of a financial predator on food and energy security.
