Last week, the U.S. Senate Agricultural Committee held a hearing to review Gary Gensler’s record, the first step in confirming him as the head at the U.S. Commodities Futures Trading Commission (CFTC). Gensler is a former partner in the investment bank Goldman Sachs and a former assistant secretary of the Treasury during the Clinton administration. You can view the Webcast. Before we comment, here's a little background to the hearing.
A January 7 New York Times editorial called the Gensler nomination “more troubling” even than the nominations of other former Clinton administration officials and their protégés to join Obama’s economic team. The editorial noted that in 2000, Gensler supervised legislation to exempt credit default swaps from CFTC regulation. The swaps exemption allowed financial speculators, such as Goldman Sachs and Lehman Brothers, to trade commodities futures contracts without the speculative position limits (total value of futures and options contracts held by an entity) that apply to commodities traders and processors. Futures and options contracts are supposed to act as an insurance-like means to guard against wild price swings for commodities buyers and sellers. But according to a January 11 segment of CBS’ “60 Minutes,” removing speculative position limits induced price volatility to the point in 2008 that the price of oil spiked $25 a barrel in a day with no change in supply/demand fundamentals.
As commodity prices driven by speculation rose, Goldman Sachs and other speculators made a killing while consumers, particularly in developing countries, got killed. Agricultural commodity price spikes contributed to retail food price increases that led the United Nations Food and Agricultural Organization to estimate very conservatively that more than 100 million people have been added since 2006 to the 850 million who don’t know where their next meal is coming from.
On February 13, the U.S. House of Representatives Committee on Agriculture approved the “Derivatives Trading Transparency and Accountability Act of 2009,” spearheaded by Chairman Collin Peterson. Among other provisions, the Act would 1) close the swaps loophole and set commodity specific speculative position limits for all market players in U.S. commodity exchanges; 2) require that all contracts be traded on public exchanges and be reported to the CFTC, so the regulators would know the size and trends of the markets they are authorized to regulate; and 3) disaggregate agricultural and non-agricultural futures contract data reported to the CFTC, so that regulators could act to prevent food price spikes triggered by speculation in precious metals or oil futures. IATP submitted invited testimony about the House bill. The Senate has yet to pass a bill to regulate commodities speculation.
At the confirmation hearing, Gensler promised to “tell the truth, the whole truth and nothing but the truth” in responding to the senators’ questions. It was an easy oath to fulfill, since with one exception, if tough questions were asked of the candidate, they were not asked in the Senate hearing room. Before Gensler spoke, Senators Mikulski, Cardin and former Senator Sarbanes, all from Maryland, testified to his community involvement in Baltimore and professional qualifications to head the CFTC. They and a couple other senators announced their support for his nomination.
In Gensler’s statement to the committee, he assured the senators of what they wanted to hear. He will work with Congress to reform the CFTC to prevent excessive speculation, to close loopholes and to regulate the Over-the-Counter trades, including swaps, whose deregulation helped to bankrupt financial markets, freeze credit flows, undermine the production of goods and services, and boost unemployment around the world. Following eight years of Bush administration “signing statements” that often ignored or reversed the will of Congress, Gensler’s assurances of cooperation between the legislative and executive branches were sweet music to senatorial ears.
Gensler responded to questions about his role in the 262-page last-minute addition to the Commodities Modernization Act of 2000, drafted largely by financial services industry lobbyists. Future investment banker Senator Phil Gramm introduced the “drop-in” on the day after the U.S. Supreme Court’s Bush v. Gore decision that decided the presidential election. In hindsight, Gensler said that he should have fought harder for stronger regulation of financial markets. In 2000, Credit Default Swaps had a minuscule market share of financial derivatives. Who could have known that CDS sales would go sky high following deregulation? “We failed to protect the American people” he said, vowing to do better this time. And the senators all but said “Amen.”
But there was one tough question, posed by committee chair Senator Tom Harkin. Senator Harkin recalled the fierce opposition in 1998 of Federal Reserve Bank Chair Alan Greenspan, Treasury Secretary Robert Rubin and Obama administration advisor Larry Summers to proposals by then CFTC chair Brooksley Born. She warned them repeatedly that exempting CDSs and similar “innovations” from CFTC regulation posed enormous risks for the entire financial system. They suppressed her campaign to regulate. Then Senator Harkin asked Gensler whether he was party to those discussions. Gensler replied that he had recused himself from that debate since his former (and future) employer, Goldman Sach, had (and has) a direct material interest in CDSs. Senator Harkin accepted that response because to not have done so would have led to more questions to which Gensler would likewise have had to respond with recusal.
One question in need of an answer is what role, if any, did Gensler play in the successful petition in 2004 of then Goldman chief executive officer Henry Paulson to the Securities and Exchange Commission to exempt Goldman and a handful of other investment banks from having the capital reserves required of other banks to cover losses from their trading. (The New York Times’ Stephen LaBaton reported the exemption petition story on October 3, 2008, the day before Congress voted to bail out preferred banks under the Troubled Asset Relief Program (TARP).) The exemption gave Goldman and the other favored banks a huge competitive advantage over banks that had to maintain prudential reserves. Goldman and the other exempted banks could take the billions liberated from reserves and make bets on commodity index funds, collateralized debt obligation, CDSs and other “innovations.”
Once housing prices started to collapse in 2006 and commodity prices began to collapse in July 2008, Goldman was among the firms that did not have sufficient reserves to cover their losses from financial instruments based on the value of housing and commodity assets. They still made money, if not quite as much, by betting on prices to fall and helping to induce that fall. Nevertheless, Goldman received $25 billion of the $700 billion TARP bailout of imprudent and presumably otherwise insolvent financial institutions. If it were discovered that Gensler had supported the SEC exemption on reserve requirements for favored investment banks, what credibility would he have in now asserting to the senators that he supports requiring all financial institutions to have adequate reserves to cover trading losses?
Gensler easily eluded responding to another question that will bear directly on the future of the CFTC, namely, its continued existence as an independent agency. He wouldn’t support “merging just for the sake of a merger.” As we noted in a February 9 blog, former Secretary of Treasury Paulson and SEC chair Mary Shapiro are among those who support legislation to merge the 500-person CFTC into the much larger SEC. If such a merger takes place, the House bill to amend the Commodities Exchange Act will vanish into history, along with the CEA itself and the CFTC. Gensler’s role in the CFTC could end far before the 2012 limit of his appointment.
Given the SEC’s notoriously lax regulation of Wall Street, it would not be surprising if a merger of the CFTC into the much larger SEC extended the reign of deregulated commodity exchanges. In a future weakly regulated market, the Masters of the Universe will be able not only to bet on derivatives affecting food and energy security, but also on the next big “asset class”—climate derivatives and the greenhouse gas (GHG) emissions credit trading market. If the GHG credit trading market is to reduce the GHG emissions that cause climate change—and some doubt it can -- then the market must be rigorously regulated to prevent speculators from driving GHG traders out of the market by inducing extreme GHG price volatility. The planet and its people can ill afford another decade of the CFTC "No Action" letters, this time in response to commodity exchange rule violations on GHG credit trading.
