FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
“Special Purpose”
Speech by Commissioner Bart Chilton to the American Gas Association/Annual Energy Market Regulation Conference, New York, NY
October 3, 2013
Introduction
Good morning. Thanks for the invitation to be with you today. I used to work in the same building that houses your office in D.C., in the Hall of States. You must be the signature tenant there because every morning walking through the lobby I saw those big silver letters on the wall spelling out “American Gas Association.” As a Commissioner, I’ve learned a lot more about you than your name and have seen the remarkable work you do in the energy industry. So, it really is good to be here.
Maybe I'm just another speaker at another conference ... a vehicle with which to get to the next break. Or, perhaps it is not a coincidence that we are here together. Maybe it isn’t happenstance. Maybe there is a reason not yet known. So, we’re here for this little ride—whatever happens in these next few minutes. Perhaps there is something you, or I, are supposed to remember about what we discuss. Sometimes a discussion or dialogue may trigger bits of awesome. Or, it might not even be something that is said, but a feeling or emotion, an instinct or an inclination to do this or that, or to not do this or that. Something even seemingly small might alter or change things up. It might be something important only to you or your family, or perhaps your coworkers or it could be of monumental significance. Who knows? I won't presume to know the true reason we might be here. Maybe it is just a stop between point A and point B. It probably is close to Bloody Mary:30 for some folks.
I'm gonna ask your indulgence for the next few minutes, for our talk today, right here and now ... I'm gonna ask you to do me a solid. It may be very worthwhile. We'll see. Let's try something together. Let's all assume we have a special purpose (not a special purpose like in The Jerk, "Wait a minute, what's happening to my special purpose?) But that you have a true purpose—perhaps unknown—in being here. Every day, even a day as mundane as October 3rd, has a special purpose. Let's just try it. C'mon, it'll be an adventure. Okay? Ready, go.
October 3rd
Look at it this way: you never know what might happen on a day like today. On this day, in 1951 right here in this city “The Shot Heard ‘Round the World” occurred. Remember what that was? Any baseball fans here? Yep. That’s the day the New York Giants’ Bobby Thomson hit a game-winning homerun in the bottom of the 9th to beat the Brooklyn Dodgers and win the pennant.
And given that I come here from D.C. and given what’s going on in the capitol city these days, it’s also appropriate to mention that on this day in 1955 the Mickey Mouse Club debuted on ABC. On this day, that same year, Captain Kangaroo premiered on CBS. Both shows had the special purpose of educating and entertaining children. Oh, and anybody like buffalo wings? On this day, in 1964, they were first made in where? Buffalo, New York at the Anchor Bar.
But, it was also on this day—five years ago today that President Bush signed the Emergency Economic Stabilization Act of 2008 to try to keep Wall Street titans from tumbling and taking the whole economy down with them. And yes, that’s the $700 billion dollar bailout we’re talking about.
FCIC
Whether you agreed with that bailout or not, it’s important to have a look at history. How many of you have heard of the Financial Crisis Inquiry Commission—the FCIC? It was set up by Congress for the very special purpose of looking back to figure out how we got into the economic fiasco that started in ’07 and ‘08. The FCIC website asks the question: “How did it come to pass that in 2008 our nation was forced to choose between two stark and painful alternatives—either risk the collapse of our financial system and economy, or commit trillions of taxpayer dollars to rescue major corporations and our financial markets, as millions of Americans still lost their jobs, their savings and their homes?”
That was their mission. They noted widespread failures in financial regulation and excessive borrowing and risk-taking by Wall Street. So regulators, after a decade of regulation-gutting, didn’t have the tools to crack down when they needed to and were instead spectators to the spectacle like everybody else. The captains of Wall Street were cruising their ships along at full throttle and there was no governor to slow them down.
As a result, though, Congress passed and President Obama signed into law, the most sweeping set of financial reforms in our history—the Dodd-Frank Wall Street Reform and Consumer Protection Act. (By the way, today—October 3rd is the Obamas’ anniversary—a pretty special day with a purpose for the first couple.) But, Dodd-Frank was necessary if we were ever going to protect ourselves from the kind of financial meltdown that occurred in 2008. It had a special purpose. It’s bringing transparency to the once dark over-the-counter (OTC) markets where complex and crazy deals went on—the very things that caused the collapse and calamity.
Bloomingdale’s
Here’s another bit of history for ‘ya. On this day, in 1872, in this city, the Bloomingdale brothers opened their first store. What does that have to do with anything? Well, I bring it up because they seized on a new concept—the department store—and took off like gangbusters all because of selling hoop skirts—hoop skirts! Today, it’s a massive company with more than 40 huge, high-end department stores and it’s a Fortune 100 company.
Well, in markets we have some players who are seizing on new concepts for special purposes. Let’s talk about a couple of them. And, like Bloomingdale’s, the first one is massive.
Massive Passives
First, we have seen a “financialization” of commodity markets by a group of traders I call Massive Passives. Portfolio diversification was the rage in the middle of the last decade and investors sought out the derivatives world and dumped roughly $200 billion into U.S. regulated futures markets.
Say a pension fund wanted to diversify into commodities; there’s nothing wrong with that from my perspective. Nevertheless, the type of trading activity they undertake is different than what speculators have typically done. Instead of getting in and out of markets these massive funds—pension funds, some hedge funds, exchange traded funds (ETFs), and the like—buy and hold their market positions. So they are both massive in size, and fairly passive in their trading strategy. Massive Passives. Like Bloomingdale’s, they are a relatively new concept.
But, here’s the trouble: too much concentration in markets can influence and contribute to price abnormalities. Heck, just one massive passive can impact price if it’s large enough.
Take 2008, when crude went from right around $99 at the beginning of the year to more than $145 in July, then all the way back to $31 in December. All of that took place without much change in supply or demand, right? I am far from convinced that Massive Passives had no role in that market distortion, as some others seem to think.
Congress got worried about these guys too and included in the Dodd-Frank Act a provision for speculative position limits. Those limits would ensure that regulators have the ability to stave off excessive speculation in markets.
To date, the limits aren’t in place. There’s fierce opposition out there and big speculators with a lot of money and lawyers are taking us on. But I expect that later this month we’ll put out a proposal for a new position limits rule. You may have heard that our first one was thrown out by a court that sided with the speculators. We’re appealing. So, new rule and an appeal. One way or another, I hope we will have position limits soon so that we can avoid the wild energy price swings like we saw in 2008.
By the way, if the CFTC fails to enact limits by the end of the year, I think Congress should simply take our rule that we will soon either propose or consider, and put it into the reauthorization of the Agency. There has not been the advocacy or interest in getting this done at the Agency like Congress and the President instructed. If we can’t do it, and it remains unclear if we can, Congress should do it for us.
A Brief Primer on Technology
Now, here’s something else that’s new in markets, another relatively innovative concept. On this day in 1985, the space shuttle Atlantis made its maiden flight. Isn’t technology wonderful? Who would have thought we’d have an international space station someday and the technology to transport astronauts there and back?
The same goes for markets. Even ten years ago, who would have guessed we’d be trading in milliseconds and conducting tens of millions of trades a day?
It’s about a thousand miles from New York to Chicago. An article a while back in the Financial Times pointed out that communications cables laid between the two cities meant that a message could be delivered in 14.5 milliseconds—70 round trips per second. Now that’s fast. But not fast enough for some who use those cables to trade commodities—the high-frequency traders I call cheetahs because of their lightning speed. It’s been reported that at least one company has cut that time down to 13.1 milliseconds and that microwave capability could get it under 10 milliseconds. Chipping away at those milliseconds is being done for a very special purpose, to gain a competitive advantage in markets.
Here’s some data that’s hard to get your head around, too. Over the last year, we at CFTC analyzed 20 million trading seconds. Of those 20 million, we pinpointed 189,000 seconds, primarily around the open and close of markets. In those 189,000 seconds we found something astounding: Cheetahs traded at rates of 100 to 500 trades per second in a major commodity market!
But these cats can be dangerous. By the way, on this day in 2003, Roy Horn of Siegfried and Roy was injured by a tiger during a show in Las Vegas. Fortunately, he recovered and ironically, it’s his birthday today, October 3rd.
So yes, these cats are dangerous. A study late last year, which was conducted in conjunction with the CFTC, said in essence that cheetah trading imposes quantifiable costs. Aggressive cheetahs make a lot of money, and they make the most when they trade with small, traditional traders. A cheetah trading with a fundamental trader—like maybe some of you are—makes $1.92 on a $50,000 trade, but if that same trade is made with a small trader, the number goes up to $3.49.
But that’s not the only issue. There’s also a concern about “wash” trading, where cheetahs (and sometimes others) trade with themselves. They make a bid or offer and they hit it themself. Sometimes it happens innocently enough. Two traders on different sides of the same trading floor may hit each other. But, it happens too much to all be accidental. By putting a price out and hitting it yourself, you’re not taking any risk but you create the impression that a legitimate trade has occurred. If that is the special purpose, it’s a problem. That entices others to get into markets before they realize the liquidity isn’t real and the markets may move in a direction that artificially aids that cheetah’s bottom line. Wash trading is not only wrong; it is illegal. That’s because it’s unfair to other traders, and it can impact price discovery which is unfair to consumers.
Wash blocker technology is available and I’ve called on the exchanges to get it put in place so we don’t have this potentially market-moving fantasy liquidity.
Let Banks Be Banks
So those are two examples of how our markets are changing and how new players have entered the fold. Now, let’s talk about more traditional market participants and how they too are changing up our financial world.
Did you know that today is a bank holiday in Germany? See how many things you’re learning about this special day. It has a special purpose. On this day, in 1990, East and West unified. It is German reunification Day. Thus, it’s a bank holiday.
Now watch this transition: let’s talk about banks! Specifically, let’s discuss what the large investment banks have been able to do for the last decade as a result of amendments to the Bank Holding Company Act (of 1956). That law was put in place to prevent excessive concentration of financial and economic power. But that’s not the way it is today. Banks can now be involved in activities that are obviously not “financial.”
Big banks today are into all sorts of other businesses: commodities, warehousing of commodities, and even the delivery mechanisms associated with those commodities. At the same time, they are heavily involved in the actual trading of the commodities. What worries me is that they may have the capacity to influence prices through the related business ownership. They own a warehouse. They can charge storage. They can impact delivery, and they can trade the commodities.
Of course the prices of commodities are supposed to be based upon supply and demand. However, what if you control the supply or the demand? Seems like perhaps—I don’t know—maybe there’s a conflict of interest there? Certainly there’s the potential for a conflict.
This policy is really part of that Decade of Deregulation I talked about before that led us to the brink in 2008. Like then, this bank ownership issue is getting dangerous in my opinion.
For me, it’s simple: banks should get back to the special purpose of … banking. However, for those who want to consider the policy merits of the matter in more detail, the first thing they might wanna do is get all of the ownership information. What do the banks own?
Well, it isn’t that easy to find. It seems like the information is something that the public should be able to easily locate and click on a link to find out. After all, the large investment banks have access to cheap money at the Fed window and for no other reason than that they need to be transparent.
And whose fault is this? Yep—policymakers. See, starting in 2003, the Federal Reserve Board began issuing orders for banks that essentially allowed them to participate in commodity trading activity and actually deal in physical commodities at the same time.
Prior to that, two “special” large banks got some extraordinary treatment in the Gramm-Leach-Bliley Financial Services Modernization Act of 1999. There is a provision in that Act, the effect of which exempted them from the bank ownership prohibitions.
I’m cool with banks making boatloads of cash, just not owning the boats; and in some cases they do, in the form of—gas people, help me out here: that’s right, oil tankers. They should make their profits through what they know and what they have done in the past … banking. That’s their special purpose. The banks built communities. Let’s help them do that again. Get back to making loans, helping to create jobs and assist in restoring our economy. Congress should not only do away with the statutory exemption that has been used by those two big banks, but also do away with the ability of the Fed to allow any commodity-related ownership by the banks whatsoever.
Whistling Away
One last topic. On this day, in 1913, the federal income tax law was signed—with a one-percent rate. Since that time, the government has closed several times. Here we are again. I mentioned the Mickey Mouse Club earlier. I would hate to compare our government to the Club, heck I’m part of it, but D.C. sure has had some Mickey Mouse challenges in recent days. It’s Goofy! And, it has created a crisis in and of itself.
I call it a crisis because of all the things I’ve already talked about that need the full attention of regulators, be it Massive Passives, cheetahs, banks or all the day-to-day oversight and enforcement functions we play. Our agency needs to be at one-hundred-percent or the crooks are gonna get away. We wouldn’t be able to track guys who were trading champagne and kickbacks for market manipulation like we did last week in the case of ICAP. That’s why I’ve written to members of Congress asking them to consider allowing us the emergency and temporary use of our whistleblower and education fund during shutdowns. Our agency shouldn’t be shut down or crippled for even a day because of funding. We shouldn’t take our cops off the beat.
Oh, and speaking of whistling; here’s another one: On this day, in 1960, the Andy Griffith Show started on CBS. Remember the theme song and the whistling? And, in Washington, folks need to stop whistling away and work together on things like the budget and the debt ceiling.
Conclusion
So you see, you never know what’s gonna happen on any given day. Will someone hit a homerun in the bottom of the ninth today? Will any new TV shows premiere tonight? (I’d be willing to bet it’ll be a reality show if it happens.)
I had a special purpose in coming here today: to discuss with you some important topics that affect you and your great association every day. Every day has a special purpose. What will yours be today as an individual and an association? I appreciate you letting me carry out my special purpose by inviting me here. Thank you and happy October 3rd.
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