CFTC: The Other Captured Regulator
By Wayne Jett
After last week’s takeover of Fannie Mae and Freddie Mac by the U. S. Treasury on terms precisely crafted to destroy all remaining value of existing preferred and common shares, this week faced a high hurdle for presenting another governmental debacle worthy of comment. That is true, at least, if the SEC’s continuing mute-blind-deaf routine while naked short sellers have their way with Lehman Bros., Washington Mutual, Merrill Lynch and every other target they choose is put on “ignore” for the moment.
What deserves the limelight of public scrutiny momentarily is a ridiculously innocuous hearing by the House Agriculture Committee on September 11 which heard only one witness. The witness was Walter Lukken, acting chairman of the Commodities Futures Trading Commission. Lukken presented a report of CFTC’s study undertaken in May at Congress’ request to review “the amount of index money flowing into the commodity markets and whether this passive investment is impacting the price discovery process that consumers and producers rely on.”
Translation: In May, Congress told CFTC to look again for evidence that the price of crude oil was pushed higher by highly capitalized speculators, and to report back by September 15.
Congress’ mandate to CFTC arose in the context of doubling of prices for oil and gasoline during the past year. Highly credible expert witnesses testified on Capitol Hill during May and June opining that market fundamentals would have crude oil below $45 per barrel were it not for “speculators.” During each hearing, CFTC’s representative (occasionally Mr. Lukken himself) seemed to be the only blind man at a sharp-shooting competition. If other experts are right, CFTC is failing its duty to assure integrity in commodities futures trading, and economic consequences to Americans and the world require urgent remedial action.
Escape and Evasion
Complaining of a meager annual budget of only $111 million, CFTC strained mightily and blew the task assigned. CFTC staff gathered data from dealers in SWAPS, the financial instruments commonly bought by index funds as means to take on risks and opportunities of crude oil ownership. Having done so, Lukken then restates issues to be addressed by the study so as to avoid the question Congress wanted answered. Rather than tell Congress whether speculators pushed up the price of crude oil, Lukken chose to answer (1) how much commodity index trading is occurring both on-exchange and OTC, in total and by commodity; (2) what are the major types of index investors; (3) what types of clients use SWAPS to trade OTC commodities; and (4) did SWAP clients exceed position limits with combined on-exchange and OTC positions? Huh?
Parallax Reasoning on Display
Those questions may be interesting and even relevant, but they are not what Congress wanted to know. The closest CFTC came to addressing the real issue was its statement that during the first six months of 2008, the net amount invested by index traders in NYMEX crude oil futures increased by more than 30 per cent from $39 billion to $51 billion. But not to worry, CFTC says, because the only reason the amount invested in NYMEX futures contracts by index funds jumped 30 per cent was due to the 46 per cent increase in the price of crude oil from $96 to $140 per barrel. Were it not for that increase, says Lukken, the amount invested would likely have dropped, since the number of open futures contracts actually declined 11 per cent (45,000 contracts) from 408,000 to 363,000.
That, ladies and gentlemen, is a prime illustration of parallax reasoning, which is (or ought to be) what occurs when a person undertaking to establish a premise changes position before completing the task.
CFTC reported that “total notional value” of NYMEX open futures and options contracts as of June 30 was $405 billion. But that does not include the open interest of such contracts traded on the Intercontinental Exchange (ICE) or OTC. Nor does it tell us whether the amount increased or decreased relative to six months earlier. Having left Congress without crucial data, namely the amount of crude oil futures trading in the “dark” ICE market, CFTC hastens to explain away the 30 per cent increase in index capital invested in NYMEX crude futures during that period by asserting it is inconsequential because it involved fewer contracts at higher prices!
Making Sense of It
The question at hand, chairman Lukken, is whether the trading practices involved in crude oil futures and options transactions (all of them: NYMEX, ICE and OTC) produced artificial increases in stated price of the commodity. The price of crude oil increased 46 per cent in the six months, index capital value at the end of the period was up 30 per cent, and the number of open contracts was down 11 per cent at the end of the period. That means index investors made hefty profits, took some off the table and reinvested the rest.
It certainly does not mean trading practices had no effect in pressing prices higher. To the contrary, throughout the six months, as each futures or options contract approached expiration, the index investor would sell the contract and either retain the profit or (in most cases) re-invest in another contract.
As Congress showed more intense interest in eliminating any manipulation of crude oil prices during May and June, some index traders and others took money off the table, moving prices lower. But as most speculators in crude oil stayed in the game during the first half of 2008, dealers in futures and options contracts could edge the price of re-purchase ever higher. Is CFTC not at all interested in determining whether that occurred?
Broken Pricing Mechanism
For decades, the price paid to producers of crude oil worldwide has been determined by a communications connection between producers and futures traders in U. S. markets. That mechanism is too opaque to say with certainty that it is broken or malfunctioning. The cost of energy is far too important to the world, however, to delay any longer action to assure that free market balancing of supply and demand sets that cost reliably and fairly.
CFTC is not up to the task assigned to it, not because the people there are unintelligent or overworked. To perform so ineptly, the agency must be pressed by influential forces to act as it has. The same is true of the SEC. One might think the Bush administration would have an economic czar to see that such failures of policy and performance don’t happen.
Oh … you say there is one … and it’s the Treasury secretary? Well, that answers it. Czar Paulson favors a dollar with ricocheting value, private companies sliced and diced by naked short sellers, and oil prices pumped to the max as Congress sits bound and gagged. Thus, it is so.
Those who prefer legislative action to address oil price manipulation ought to encourage Congress within the next two weeks. If Congress adjourns for the election without acting, manipulators will be home free with higher oil prices under their Christmas trees. Lumps of coal for everyone else. ~