Regulations on Speculation Weak, But Better Than Nothing
William K. Black: Regulations passed by CFTC gutted by industry pressure, but some progress given DC politics - October 23, 2011
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William K. Black, author of THE BEST WAY TO ROB A BANK IS TO OWN ONE, teaches economics and law at the University of Missouri Kansas City (UMKC). He was the Executive Director of the Institute for Fraud Prevention from 2005-2007. He has taught previously at the LBJ School of Public Affairs at the University of Texas at Austin and at Santa Clara University, where he was also the distinguished scholar in residence for insurance law and a visiting scholar at the Markkula Center for Applied Ethics.
Black was litigation director of the Federal Home Loan Bank Board, deputy director of the FSLIC, SVP and general counsel of the Federal Home Loan Bank of San Francisco, and senior deputy chief counsel, Office of Thrift Supervision. He was deputy director of the National Commission on Financial Institution Reform, Recovery and Enforcement.
Black developed the concept of "control fraud" frauds in which the CEO or head of state uses the entity as a "weapon." Control frauds cause greater financial losses than all other forms of property crime combined. He recently helped the World Bank develop anti-corruption initiatives and served as an expert for OFHEO in its enforcement action against Fannie Mae's former senior management.
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Washington. On October 18, the Commodity Futures Trading Commission voted three to two along party lines to limit the amount speculators can play or can speculate in the commodities exchanges. Now joining us to discuss the significance of this decision is Bill Black. Bell is an associate professor of economics and law at the University of Missouri-Kansas City. He's a former financial regulator, and author of the book The Best Way to Rob a Bank Is to Own One. Thanks for joining us again, Bill.WILLIAM K. BLACK, ASSOCIATE PROFESSOR OF ECONOMICS, UMKC: Thank you.JAY: So let me just say, if I--see if I understand this correctly. The old Rooseveltian regulations prohibited speculators from being involved in more than 30 percent of the commodities exchange, so that 70 percent of commodities', you could say, investors were people that were actually going to use the stuff, whether we're talking, you know, oil and gas or wheat or agricultural products. This regulation doesn't go back to that. It limits how much any individual person or company can speculate. So do I have that right? And let's start with that.BLACK: Yes, I mean, if you modify it slightly, by one-third of the volumes. But this rule, as you say, that's just been adopted doesn't limit overall volumes. It limits individual volumes of each trader.JAY: Now, the people that were pushing for reform, they wanted overall volume controls, because just limiting individuals, you could still wind up with what some people say is as much as 60 or 70 percent of volume now is speculation, and that this won't limit that. Is that a legitimate critique?BLACK: Without an overall volume limit, you can't actually stop the excessive speculation. That doesn't mean the rule will be completely useless. These limits on individuals might have the effect of significantly reducing the amount of speculation. But, you know, that's a guesstimate, and we're going to have to see what actually happens in the marketplace after they implement the rule.JAY: So in spite of the fact that what was being opposed by the commission wasn't the kind of regulation that many reformers wanted, it was still fought tooth-and-nail by the industry. So talk a bit about the political battle, 'cause, you know, I think we talked a little bit ahead of time off camera, and you thought it was an achievement in this political environment even to get this much.BLACK: Yeah, this is one of the most aggressive regulatory actions out of the Obama administration. And so that's one way of telling the story. The other way of telling the story is also true, that it was nowhere near as aggressive as it probably needs to be to be effective in stopping the problem. But this is symptomatic of how much the world has changed. Even if you adopt a rule that doesn't go more than halfway, it's not that the Republicans join you in a compromise; they attempt to prevent any reform of any [incompr.] And so both members of the CFTC voted against this who are Republican members, and the Republican representative in the House also indicated that he was a strong opponent of this action. And so you have to give some credit to the CFTC in being willing to go forward with the rule at all.JAY: Now, just to remind everybody, or for people that haven't followed the story, the context of this, just explain again why all of this matters so much to ordinary people. This isn't just something that affects investors. This affects the price of food and basic cost of living.BLACK: Indeed. That's exactly the point. This isn't simply business as usual. When food price commodities in particular go up very substantially because of speculation and manipulation, people die, lots of people die, and others are malnourished. And we're talking about hundreds of thousands of people potentially dying and millions of them being malnourished. So the problem for the folks who don't want any regulation is that what we're seeing in the marketplace is supposed to be impossible. [crosstalk] speculation, under their theories, is supposed to stabilize markets and make them more efficient. Instead what we've observed increasingly over the last about eight years is rampant speculation that leads to enormous fluctuations in prices, typically but not always having them go up in ways that are grotesquely excessive prices, even though the underlying economic events suggest the prices should be going down.JAY: Now, Michael--his name is Michael Dunn. He's one of the Democrats on the commission. He voted for these limits. At the same time, he's quoted all over the press as saying he's not even really convinced they're necessary, that there still isn't proof that this kind of speculation affects prices.BLACK: I mean, you can never prove causation, in a technical sense. I mean, that's what the scientific method says. We can only disprove things. But within the realm of the way we use causation in regular human speech, this is one of the most powerfully demonstrated links. It is precisely speculation--and everybody in the trade believes that it's speculation as well who isn't filing a statement completely in their particular financial interest. In other words, if you talk to traders, just a regular trader in the pit, they agree and they agree full-heartedly.JAY: Now, the Dodd-Frank bill that was going to regulate casino capitalism and was going to bring the system back from the abyss and all the rhetoric we heard in '08 when--before the banks were bailed out and there was still some fear in these people's hearts, this was supposed to be the thing to get limits on this kind of speculation. This was the--going to be the step to control things. Are you at all concerned that if this isn't really effective, what's been passed, that this is going to kind of let this regulatory commission and the law off the hook? Like, people will say, oh, they passed it, when in fact they didn't pass something that's going to be effective enough.BLACK: Yeah. Well, we know that dynamic, right? We've just lived through, depending on how you count it, eight to 13 years of it. They passed something completely ineffective. They're told that it's going to be ineffective in advance. And the idea is to be ineffective. Then it's put in place, it proves ineffective, and their conclusion is, see, see, regulation doesn't work. Well, that's just a self-fulfilling prophecy of failure. They designed it to fail. Again, this rule has a glaring weakness that you properly pointed out: the lack of overall volume. But it is possible that individual limits will result in damping down the amount of speculation. And that would be a good thing. But we're--we have to also look at that more fundamental point. Again, neoclassical economics says the speculator is the hero, the speculator is the person that not--doesn't drive prices incorrectly, drives prices in the right direction, makes everything work better, so that they reflect real economic forces. Nobody seriously believes that anymore. That has been completely discredited. So if this effort fails and, let's say, the Republicans are put back in charge in the next election of all three branches of the government and they gut the rules, then there's going to be such a disaster in the area of commodities that it might bite them really badly, because when these commodities go up in this manner, as I pointed out, a number--very large people--number of people die and are malnourished. But that's mostly in other countries. But if it simply produces a very substantial increase in food prices in the United States, then you're going to really upset a very large number of households, and that could hurt them politically.JAY: Now, just dig into the regulation they did pass a little bit. If I understand it correctly, the regulation essentially says that on the first 25,000 contracts that an individual company or person gets involved with, there'll be a 10 percent limit, and then a 2.5 percent above that level. What does all that mean?BLACK: That means a political compromise on the sides of the traders. I would urge your viewers not to get very much hung up into that and again to come to the eyes on the prize. The question is: is this going to reduce the overall speculative activity? Is that going to reduce, or even eliminate, in the best of all circumstances, these massive speculative rises and falls in commodity prices? And what else should we be thinking of? So one of the most effective things we could do is one of the central lessons of this entire crisis, and not just in the commodities sphere, and that is: excessive leverage is disastrously bad. And the right and the left in terms of economics tends to agree on this substantially. Well, commodities speculation is the zenith of grotesquely excessive leverage.JAY: Explain that, excessive leverage, to someone who doesn't understand that.BLACK: Okay. Leverage is simply how much debt do you have to equity. And so a US bank coming into the crisis might have leverage of maybe even 20 to 1. The European banks, because they passed Basel--or adopted Basel II more quickly and without any safeguards, often had leverage more like 50 to 1. And that meant that when they suffered a loss, that leverage acts like a magnifying glass, and it greatly magnifies--in the case of 50-to-1 leverage, it immensely magnifies your losses. So that was just in regular stuff, when they were doing all those mortgages and such. But in commodities, you have frequently been able to borrow far more with very little equity. And these things are done frequently off exchanges as well, which is again one of the potential loopholes to all of this. That's through financial derivatives, which is another topic, but it's a critical topic. If I can achieve the same purpose of speculating through a financial derivative that affects commodities but isn't subject to the CFTC rule, well, you know, that's even a bigger loophole. And so those are the things we need to concentrate on.JAY: I mean, isn't--that was--part of the argument, I think, of the industry is they were trying to claim that they are like end users, not really speculators, because they've speculated off market, and now they're hedging the speculation off market, and now they should be allowed to be considered not speculators, 'cause they're just hedging something real, except what's real is the casino bet over there. Am I understanding this correctly?BLACK: No. This is a variant on the old joke, you know, what is the definition of chutzpah. And the definition of chutzpah is you kill both of your parents and demand mercy as an orphan.JAY: Yeah. Thanks very much, Bill. Thanks for joining us.BLACK: Thank you.JAY: And thank you for joining us on The Real News Network.
End of Transcript
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