A lawsuit filed in a Florida district-court in 2013 alleged that JPMorgan, Goldman Sachs, and the London Metal Exchange (LME) artificially inflated aluminum prices. The plaintiffs accused the companies of anti-trust practices and racketeering, including the “manipulation of the aluminum market through supply price fixing.”[1] This sounds like what had led to the forced break-up of Rockefeller’s Standard Oil Company, though in that case exactly a century before, the restraint of trade had to do with the company’s main line of business (i.e., oil). In the case of the banks, however, owning commodity assets such as storage facilities and trading in raw materials do not constitute banking. This point triggers a larger question involving the repeal of the Glass-Steagal Act.
Should we allow banks to expand even beyond these functions to owning commodities and related real-estate? What does this do to the banks' systemic risk? Image Source: salisburyareafoundation.org.
Under Glass-Steagal, commercial banks were not permitted to engage in investment-banking activities, such as proprietary trading and market-making. The law’s repeal in the late 1990's is ironic, for in just a decade the notion of systemic risk would flash into the public’s consciousness under the label of banks being “too big to fail.”
Rather than confront systemic risk directly, U.S. lawmakers and regulators have consistently preferred focusing on incremental change in particular areas. For example, when the lawsuit was filed in Florida, regulators were “scrutinizing ownership of commodity storage facilities by major U.S. banks.”[2] Unfortunately, the scrutiny was limited to price-fixing and racketeering, and those regulators probably were not talking to regulators at the SEC who were still promulgating regulations as part of the Dodd-Frank Act of 2010, which was ostensibly geared to reducing systemic risk through providing for the “orderly liquidation” of banks and other financial institutions too big to fail.
Were the various government regulators to compare notes, they might ask each other whether branching off into trading commodities and owning storage facilities increase the banks’ systemic risk. By taking on market risk (i.e., of commodity and commercial real-estate markets) that is higher than the risks in commercial banking, the banks increase their systemic risk. Factor in the legal and reputational liabilities associated with price-fixing and racketeering and the systemic risk increases even more.
Therefore, beyond the question of collusion and restraint of trade in a side business, it can and should be asked whether banks should go into side businesses at all, given the matter of systemic risk. Focusing narrowly on whether lines formed at warehouses, and, moreover, debating secondary issues more generally, are at the very least distractions from the fundamental matter of systemic risk. To the extent that Dodd-Frank fails to curb such risk, we as a society put the economy and financial system at a higher risk of collapsing if we follow the government and the media in focusing too narrowly on just the possible wrong-doing of the bankers. Ironically, sustaining such a focus may be in the banks’ own financial interest.
Rather than confront systemic risk directly, U.S. lawmakers and regulators have consistently preferred focusing on incremental change in particular areas. For example, when the lawsuit was filed in Florida, regulators were “scrutinizing ownership of commodity storage facilities by major U.S. banks.”[2] Unfortunately, the scrutiny was limited to price-fixing and racketeering, and those regulators probably were not talking to regulators at the SEC who were still promulgating regulations as part of the Dodd-Frank Act of 2010, which was ostensibly geared to reducing systemic risk through providing for the “orderly liquidation” of banks and other financial institutions too big to fail.
Were the various government regulators to compare notes, they might ask each other whether branching off into trading commodities and owning storage facilities increase the banks’ systemic risk. By taking on market risk (i.e., of commodity and commercial real-estate markets) that is higher than the risks in commercial banking, the banks increase their systemic risk. Factor in the legal and reputational liabilities associated with price-fixing and racketeering and the systemic risk increases even more.
Therefore, beyond the question of collusion and restraint of trade in a side business, it can and should be asked whether banks should go into side businesses at all, given the matter of systemic risk. Focusing narrowly on whether lines formed at warehouses, and, moreover, debating secondary issues more generally, are at the very least distractions from the fundamental matter of systemic risk. To the extent that Dodd-Frank fails to curb such risk, we as a society put the economy and financial system at a higher risk of collapsing if we follow the government and the media in focusing too narrowly on just the possible wrong-doing of the bankers. Ironically, sustaining such a focus may be in the banks’ own financial interest.
[1] Melanie Burton, “Glencore, JPMorgan Sued Over Warehouse Aluminium Prices,” Reuters, August 7, 2013.
[2] Ibid.
