In a February 4 speech at the Georgetown University Law School, Commissioner Sharon Bowen, of the Commodity Futures Trading Commission (CFTC), responded concisely to one of two questions she was asked to discuss: “Is Wall Street reformed? The short answer is no.” The following blog illustrates just a few details entailed in that “no.”
CFTC Chairman Tim Massad was summoned to the House of Representatives on February 10. Members of the Committee on Agriculture, which oversees CFTC’s legal obligations, asked him why the CFTC isn’t doing more with less to make it easier for Wall Street hedge funds to make a killing from the automated trading systems (ATS) that remain under-reported and thus “dark” to regulators. As the Wall Street Journal reported on January 26, “The market upheaval [in oil, stocks and currency prices] has provided near-ideal conditions for so-called commodity trade advisors or CTAs, hedge funds that use computer programs to guide how they trade.” ATS-exacerbated extreme price volatility is a very profitable playground for the still unregulated automated traders.
Of course, Chairman Mike Conaway of the Committee on Agriculture presents the purpose of the hearing in a different light: "Over the past couple of years, agriculture, energy and other commodity producers have faced a collapse in market prices. For many end-users [of commodity contracts], hedging in derivatives markets is the only way to plan for the future and survive these challenging economic times. Yet, in their hour of need, market participants are contending with regulatory missteps that have upended derivatives markets. Five years into Dodd-Frank, end-users have fewer service providers, face higher costs to access hedging services and see liquidity fragmented across arbitrary regional lines . . . I look forward to speaking with Chairman Massad on his plans for 2016 and how the CFTC will bring more order to the markets it regulates and more certainty for the end-users who rely on them."
There are a lot of assumptions in Chairman Conaway’s statement, beginning with the suggestion that farmers and ranchers and other commodity producers receiving below cost of production prices must off-set the price collapse by competing with the hedge funds and banks in the derivatives market. According to this statement, THERE IS NO ALTERNATIVE, e.g. the inventory management that attempts to balance supply and demand in all other economic sectors. But if you are a farmer or a rancher or a commodity advisor to agricultural producers without access to a High Frequency Trading terminal, you won’t be able to compete.
Chairman Conaway could call a hearing to investigate the causes of the price collapse in the beef cattle market, as documented in the Ranchers-Cattlemen Legal Action Fund-United Stockgrowers of America request in January to the Senate judiciary committee. R-CALF notes, “During the third and fourth quarters of 2015, cattle prices collapsed farther and faster than during any time in history and the unprecedented volatility in the cattle futures market rendered it useless for price discovery purposes.” Instead of investigating the cattle price collapse, Chairman Conaway has heeded Wall Street complaints to prevent the CFTC from monitoring the cross-border trades whose defaults triggered the Great Recession. Chairman Conaway repeats the Wall Street characterization of its cross-border evasion of such monitoring as “liquidity fragmented across arbitrary regional lines.”
One of the sources in the R-CALF request to investigate manipulation of the beef cattle market states that the price volatility cannot be explained by supply, demand, animal disease, adverse weather events or other fundamental factors. Instead the source proposes that price volatility in the Chicago Mercantile Exchange electronic market in cattle futures contracts has been driven by High Frequency Trading (HFT), a faster variant of automated trading systems.
HFT defenders argue that HFT traders must “spoof” other traders with algorithms placing trade orders with cancellation orders before the trades can be completed. “Spoofing,” this argument goes, prevents other HFT algorithms from hunting for large orders, to take advantage of their price information a nanosecond before other market participants. However, spoofing, by inflating the market with instantly vanishing capital, also exacerbates price volatility to the point where cattle and other commodity producers cannot hedge their price risks.
Chairman Conaway, who comes from the great beef cattle state of Texas, could have asked the CFTC to investigate HFT trading in the beef cattle futures market. But he didn’t make that request, because the hearing was pre-programmed, like that of an ATS. Chairman Conaway wants to convict the CFTC of Dodd Frank “regulatory missteps” that the Chairman and his Wall Street and meatpacker patrons want to blame for the failure of markets to enable transparent price discovery for commodity producers and users. Furthermore, if he were to make that request, Chairman Massad could reply, ‘we could undertake such an investigation and others if the CFTC had a budget to do so.’
In September 2014, Chairman Massad gave an interview to the Futures Industry Magazine about what he hoped the CFTC would accomplishto implement the Dodd Frank financial regulatory reform legislation. He came to government service in 2009 after twenty-five years of providing legal advice to Wall Street on the Over the Counter (not exchange traded or reported to regulators) instruments whose cascading defaults triggered the banks’ bankruptcies. He supervised part of the taxpayer-funded bailout of Wall Street and their major corporate clients, the Troubled Asset Relief Program. In other words, Chairman Massad knows from A to Z the industry that Dodd-Frank is attempting to reform.
In this interview, Chairman Massad noted frankly, “Unfortunately, we don't have the budget I would like to have to really make sure we can be doing all that we should be doing. We've got to rely on the industry to regulate itself, in many respects.” The reliance on industry self-regulation is one consequence of the anti-regulatory “starve the beast” practice of denying regulators the funds to uphold the law of the land. The CFTC budget is set by Congress, whose Republican majority voted to repeal major portions of Dodd Frank in 2011 and campaigned against Dodd Frank in the 2012 elections. Since then, most Republican members of Congress and some Wall Street Democrats have worked with Wall Street to help to prevent implementation of Dodd Frank.
Following Congress’ approval of the must-pass omnibus budget bill in December, Chairman Massad didn’t mince words: “The failure to provide the CFTC even a modest increase…sends a clear message that meaningful oversight of the derivatives markets, and the very types of products that exacerbated the global financial crisis, is not a priority. The CFTC’s appropriation simply doesn’t match our vast responsibilities, especially as the markets we oversee have grown enormously in size, importance and technological complexity.”
Why does the CFTC need a larger budget to pay for more computer and human resources? Dodd Frank expanded CFTC authority beyond agricultural contracts to cover energy, base and precious metals, interest rate, foreign currency exchange rates and other assets whose underlying value is the basis for Wall Street derivatives contracts. The initial face value of the traded contracts has increased about 40 fold compared to the unregulated or industry self-regulated pre-Dodd Frank markets. Dodd Frank also requires reporting to the CFTC the derivative contracts that Wall Street declared to be too “customized” to report. Purportedly customized trades between two parties without adequate capital reserves to cover losses resulted in the 2008 default cascade among the largest banks and hedge funds. While Wall Street has accepted that there be clearing houses to mediate and prevent default in such trades, it continues to resist the standardized, near real-time reporting of trades required of futures and options traders. About seven years after the Wall Street meltdown, the CFTC released a request for comment on proposed common data elements for customized “swaps” reporting.
Even if the CFTC were able to finalize its proposed rule on automated trading systems in 2016, Congress is very unlikely to vote for the necessary budget for the agency to prevent High Frequency Trading from driving market volatility, not just in the beef cattle market but in all commodities. President Obama’s February 9 proposal to Congress, which would increase the Fiscal Year 2017 CFTC budget by 32 percent to $330 million, is regarded as dead on arrival. Republican budget committee chairs have refused even to schedule meetings with the White House budget director, a rebuke without precedent in U.S. presidential budgetary history. The Republican majority once again has not presented its own budget proposal.
Chairman Conaway’s hostility to the CFTC budget does not extend to all budgets for agriculture. For example, he supported a $3 billion increase in the 2014 Farm Bill budget for subsidies to crop insurance companies after having voted to cut the Farm Bill by $20 billion over ten years in the non-binding but electorally useful resolution to balance the federal budget. Of the crop insurance vote, Chairman Conaway stated in November, “I’m as much of a budget hawk as anybody else. But at the end of the day, we have to be smart about how we do it.”
However, it’s apparently one thing to vote to increase the budget for crop insurer subsidies by $3 billion to please your constituents and quite another to increase the CFTC budget by a mere $90 million or even $20 million, if that increase displeases your Wall Street campaign contributors. It must be hard, in a rock solid Republican district, to vote beyond the two-year horizon of your electoral career. But the market “order” and the “certainty” for commodity hedge funds that Chairman Conaway demanded of Chairman Massad on February 10th will not be found by further weakening the CFTC.
One of the forecasters of the 2008 global bank defaults, Satyajit Das, wrote last month about how unreformed bankers, contracts and markets could trigger another Great Recession: “The root causes of the life-threatening 2008-2009 financial crisis remain unaddressed. Debt levels are higher now, and imbalances remain. . . Deep seated structural problems, including inadequate infrastructure, lack of institutions, corruption and environmental degradation, are now impinging on [global economic] activity.” None of these structural problems will be solved by attacking financial regulators and denying them resources to do their statutory duties.
The Dodd-Frank reforms are an important—if incomplete—step toward more effective price risk and volatility management and market transparency. Rather than taking stock of the progress so far and building on it, legislators continue to chip away at the gains and to starve regulators of the resources they need. Attacking the regulator will always be more remunerative in Washington than investigating the regulated, the law be damned.