Michael Greenberger (former Chief of Staff to Brooksley Born): Secret deals with CFTC staff led to futures markets with 80% speculation
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. When the debate broke out in 2008 and 2009 about the financial crisis, one of the critical issues was the role of derivatives, the role of commodities trading, and especially the role of what was called excessive speculation. And there’s been a lot of debate about just how much does speculation drive up things like food prices, energy prices. Now joining us to talk about that and what public policy might be in people’s interest about commodities and such is Michael Greenberger. Michael teaches at the school of law at the University of Maryland. He was previously, between 1997 and ’99, director of Division of Trading and Markets at the Commodity Futures Trading Commission, and he worked for Brooksley Born. He is also a technical advisor for many groups and congressmen. Thanks very much for joining us.
PROF. MICHAEL GREENBERGER, FMR. DIRECTOR, TRADING AND MARKETS DIV., CFTC: Pleasure to be here.
JAY: So let’s just start with that basic question: to what extent does speculation or excessive speculation affect the price of energy and food?
GREENBERGER: Well, as we sit here today, there’s little doubt that excessive speculation, that is, speculation that’s unnecessary to the structure of the hedging markets for food and energy, is causing a inflationary bubble. And the American consumer, and, for that matter, consumers worldwide, are paying an unnecessary premium for food and energy, which goes into the pockets of big banks and Wall Street traders and has nothing to do with developing supplies of scarce commodities.
JAY: Well, before we explore more of what excessive speculation is, what do you consider not excessive speculation?
GREENBERGER: Well, you have to understand this in a historical context, and it really goes back to the beginning of the 20th century. In the beginning of the 20th century, the only derivative product or futures product that was extant were futures contracts that allowed farmers and consumers of farm products to hedge their pricing exposure. In other words, when a farmer began to plant a seed, he wanted to be guaranteed a certain price when the crops were brought out of the ground. So you could buy what were insurance contracts that gave you a hedge and an insurance for a fair price for the growth of your product. Similarly, those who used those products–for example, bakers and millers–similarly went into those markets to make sure they weren’t paying too high a price. And the tension between the consumer and the producer caused the futures markets to be a fair reflection of what supply-demand would designate prices to be. In the beginning of the 20th century, farmers figured out that in the trading venue which was in Chicago at the various futures exchanges, the traders could manipulate the price up and down by overwhelming the market with speculative bets on price direction. And what the farmers determined, and for that matter the bakers and the millers determined, was they couldn’t use these markets as insurance contracts, because the speculators were driving the prices in such a fashion that the markets became unusable.
JAY: Give an example of how that would work. I mean, how does a speculator do that?
GREENBERGER: Well, a farmer, when they’re hedging, is thinking about a fair price to get at the end of the farm season. He needs to interact with the consumer of farm products, who wants a fair price as well. The farmer wants the highest price; the consumer wants the lowest price. And the tension between those traders who are forming these contracts makes the price adhere to supply-demand fundamentals. If speculators get involved, they don’t care what a fair price is. If they conspire or work together or flood the market, they can say, okay, let’s drive the price way up by bidding the price up irrelevant to any economic needs. In those days also–it’s not true today, and I can explain why, but in those days also, they would bid the price down and try and short the market. But they were destroying these markets [that are] for the use of hedging to protect the farmer and the consumer of farm products directly, and the consumer indirectly, who benefited from the tension of this price-development mechanism. In the first piece of legislation Franklin Delano Roosevelt sent to the New Deal Congress was a response to this problem, an answer to the farmers’ concerns about speculation. And he and the New Deal Congress, in passing the Commodity Exchange Act of 1936, had a simple resolution to this matter, and that was, market by market, limiting the involvement of speculators. To some extent there is good speculation, in that it allows the farmer and the consumer in this market to have liquidity and get in and out of contracts, and the speculator creates that liquidity. But there’s a tipping point when there is excessive speculation. Liquidity concerns go out the door, and prices become unmoored from price-demand fundamentals. What Roosevelt and the New Deal Congress said: we’re going to put limits on speculation in those markets. And from 1936 to the early ’90s, those markets functioned very smoothly. There were price variables, but the price variables dealt with supply-demand. For example, if there was a short supply of wheat, the price would go up.
JAY: By limits you mean how much any one party could own or control. Is it similar to what’s being called position limits now?
GREENBERGER: Yes. And it’s not a party. It’s a person who is in the market who has no need to hedge physical supplies that they are growing or buying. It is people who just want to bet, who don’t touch the underlying commodity but want to bet on price direction. And historically, from 1936 to 1990, a smoothly functioning market, whether you’re talking about wheat or you’re talking about crude oil or you’re talking about metals, was 70 percent commercial handlers trying to hedge their prices and adhering the price to supply-demand fundamentals, and 30 percent speculators, who are in the market betting on price direction, but are actually helping the market by assisting the producers in creating liquidity in the market.
JAY: So this, for example, is an airlines that hedges their cost of fuel for the year, versus that someone’s just making a bet.
GREENBERGER: Exactly. Someone wants to bet on the direction–now, fuel–jet fuel is not a commodity, and what the airlines use is crude oil as a derivative. So they’ve hedged in the crude oil markets. But a speculator would go into the market, say, I don’t even know what a barrel of oil looks like, but I want to bet it’s going to go up or I want to bet it’s going to go down. What happened in the 1990s is, almost under the radar screen, the big Wall Street banks, beginning with Goldman Sachs, created stealth exemptions to these limitations, to allow them to get more heavily involved in the market as speculators, but going under the radar screen. And essentially the principal vehicle these big banks used–and today the two foremost banks are Goldman and Morgan Stanley–is they wanted to offer their customers the ability to bet on the price direction of food and energy. So they would take in–and they do today–take in bets from customers. Just like you go to a horse race and you go to the betting parlor and you say, I want to bet on a certain horse, they invite wealthy investors to come in and bet on the direction of a basket of 25 food and energy commodities. The bettor does–just like you don’t own a horse when you go to the horse race, the bettor wouldn’t even know what kind of wheat they’re betting on, but they’re placing money down. You have to be wealthy to do this with Goldman, with Morgan Stanley, to bet, and they can only bet that the direction will go up, the price will go up. Goldman and Morgan Stanley now have to go into the futures market, where there are people who are legitimately hedging their commercial bets. They, from 1990 to the summer of 2008, not even going to the CFTC commission but to the staff, got secret exemptions that allowed them to lay off their risk from their betting parlor by placing offsetting bets in the futures market. Now, if you just follow the thread, Goldman and Morgan Stanley are taking bets from their customers the price will go up; therefore, they will lose if the price goes down. They, like a bookie, don’t want to be in that position, ’cause they’re–through their analysts, are pumping up the price anyway. So they go into the real futures market, where there are consequences to the transaction, and they bet there that the price will go up, to offset the bet with their customers. They got exemptions from the Franklin Delano Roosevelt position limits. That allowed them to do it. And their theory was, hey, we’re hedging just like the airlines are hedging, ’cause we’re in the betting business and we’re hedging our bets. In the summer of 2008, when oil went to a world record high of $147 a barrel, Democrats in the House of Representatives unearthed all these exemptions and were able to discover that markets that were thought to be 70 percent commercial and 30 percent speculative were then 70 percent speculative and 30 percent commercial. Dodd-Frank has a provision in it that says, essentially, we must go back to the old Roosevelt idea and protect these hedging markets from excessive speculation. That is to say, roughly speaking, 30 percent speculation is okay. We now have in these markets 80 percent speculators, most of whom wouldn’t know what a barrel of oil looked like, and only 20 percent commercials who were trying to hedge their bets. As a result of that, and because the betting instruments only allowed you to bet that the direction of the price will go up, we are seeing these bubbles. In 2008, for example, oil went to $147. During the recession, investors pulled their money out. It went back down. In July 2008, it was $147. By December-January, it was down to $33. As the economy started to improve and speculators drove back in, it raced back up to $75 a barrel by the summer of 2009. At that point, the chairman of the CFTC said, hey, we’ve got to do something about this. That led to legislation where Congress passed a provision that said you’ve got to keep speculators out of these markets, they are sending false signals, inflating the market unnecessarily, and these markets have no relationship to supply-demand. Unfortunately, in January 2011, the CFTC issued a proposal–which it’s not even clear that a majority of commissioners would support in the final text–that basically did not implement what Congress intended, and essentially preserved the status quo ante. What does that mean? We’ve got oil markets, wheat markets, copper markets, rice, with 80 percent speculation, 20 percent commercial, and the markets are veering willy-nilly. The demonstration is in the most recent meltdown that we’ve seen in the stock market: the oil market completely followed the Dow Jones going down when there was worry over the S&P downgrade. And now that the stock market’s getting footing, crude oil is going back up again. So it is not a supply-demand factor that is governing the price of these products; it is how much money speculators have to put in those markets. And there are dozens of world hunger groups who are at the table right now, saying that in Third World countries people are starving because Wall Street speculators have this little betting parlor going on and are artificially inflating the price of these commodities.
JAY: Now, we were told that the CFTC is planning to regulate position limits and come up with a number like 10 percent, and they’re trying to work at the regulation, but that lobbyists are slowing them down, but that there is some intent to do that. Is that the case?
GREENBERGER: Well, most progressives groups–and, by the way, Dodd-Frank has caused the CFTC, over a broad range of financial regulation, to deal with 50 different rules that they have to create. Ninety percent of them are very controversial. If they’re properly implemented, they undercut the too-big-to-fail banks, who are fighting like crazy to preserve their oligopoly over all markets. This rule on position limits, going back to the Roosevelt idea that speculators should be driven from these markets, is the most controversial. All the rules have had 20,000 comments. Twelve thousand of those comments have been focused on position limits. The big banks, the big hedge funds, the big private equity firms want to have phony regulation here to make it appear that something’s being done, but actually preserving the status quo ante. The progressive groups that have testified on this–unions, consumer groups, the ARP, environmental groups, public interest groups–are saying that the proposal is a phony, it doesn’t do anything, it’s regulation in name only, and want to put out of business the gambling that is going on in these markets. And the damning thing about this is, once you understand this, it is not that hard to–difficult–it is not that difficult to understand how the American consumer is being taken to the cleaners. But so far there’s been no effort by any policymaker, whether it’s in the executive branch or the legislative branch, to clearly explain to the American people that Wall Street is putting money in its pockets that has nothing to do with developing oil, developing natural gas, developing–producing metals, producing farm products. It’s going–it’s a betting parlor, and the money is going directly into the pocket of wealthy people. And when the American public is paying $4 a gallon for gasoline, none of that payment really has very much to do with developing new sources of energy and everything to do with putting pockets–money in the pockets of Wall Street.
JAY: So if you were writing the regulation on position limits, what would it say?
GREENBERGER: What I would say is anybody who is involved in a betting parlor and, like a bookie, laying off their risk is got to be subject to the very toughest position limits. Right now, the rule, it does exactly what Wall Street wanted. Wall Street said, we’re bettors, and we’re laying off our risk like a bookie; so therefore we’re commercial interests, and we should buy up all the contracts we want. And the proposed rule says, yes, that’s right, you guys have at it, and then for everybody else we’ll have limits. You’ve got to knock the bettors, the betting parlors, which are banks, out of this market, make them subject to position limits. If that happens, most economists who’ve examined this–and many have–will say the price of these commodities will drop substantially.
JAY: Thanks very much for joining us.
GREENBERGER: Pleasure to be here.
JAY: Thank you for joining us on The Real News Network.
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