Speculators and Price Volatility: The Case of Gasoline

According to The Huffington Post, “Oil prices took a nosedive [on May 5, 2011] in a historic selloff, erasing weeks of gains and indicating that the months-long climb in energy prices may have hit a ceiling. Crude oil plunged 10 percent as startled investors unloaded their positions and a weeklong decline accelerated into an outright freefall. The price of U.S. crude went from triple digits to double digits, falling below $100 after opening at close to $110. Brent crude, a European benchmark, lost $12 at one point in a sell-off that exceeded the one following Lehman Brothers' collapse.”  The question, for course, is why, the answer of which can lead us to consider some public policy recommendations. Understanding the previous price rise is a first step both to answering this question and for evaluating public policy solutions.

The price of oil had been increasing, according to the Huffington Post, “as fighting escalated in the Middle East and investors feared a supply shortage.” Even as the Organization of Petroleum Exporting Countries was pledging to correct any oil supply disruption, the price of a barrel of crude continued to rise. Before the drop, Brent was up 50 percent compared to the same time the year before. Indeed, the rise could not be explained in terms of actual supply being threatened, as Libya represented only 2 percent of world supply at the time.

The fear was likely of a domino-effect that could potentially compromise even Saudi crude—as if Sunni protesters in Bahrain would spill over into Saudi Arabia (rather than tanks from the latter “spilling over” into Bahrain).  The fear, in other words, may have been exaggerated—even facilitated by speculators taking advantage of the general sense of instability in the Middle East. "Clearly these markets were overblown," said Nariman Behravesh, chief economist of IHS Global Insight. "We've been saying all along the fear factor has probably added 10 to 15 dollars to the price of a barrel." The ensuing “freefall” might have been a correction for this “fear factor.”

However, that the oil-price drop was accompanied by other commodities and even stocks could suggest that larger forces were involved. According to Reuters, “World stocks fell and the 19-commodity Reuters-Jefferies CRB index dropped more than 4.9 percent, heading for its biggest weekly decline since December 2008.” An oil-centered drop alone could be expected to result in higher stock prices as expected lower gas prices would be expected to have a stimulating effect on the U.S. economy. So it would appear that broader factors were at play—things that could have triggered the fear-correction.

Reuters reports that “(w)eak economic data from Europe and the United States fed concerns that have battered commodities all week. German industrial orders fell unexpectedly in March while U.S. weekly jobless claims hit eight-month highs, sparking a fourth day of profit taking in early trade. . . . Additional pressure came from news OPEC was considering raising formal output limits when it meets in June to convince oil markets it wants to bring prices down and reverse the impact of fuel inflation on economic growth.” However, it is not clear that the market was being so rational.

"This is just a market that rolled over and started feeding on itself," said John Richards, head of North American strategy for the Royal Bank of Scotland, according to the Huffington Post. "There was no triggering single event of news that would account for this. It's just much more the market's own internal dynamics taking prices down here," Richards added. “Internal dynamics” sounds a lot better than “feeding on itself.” The latter implies a growing disjunction between price and the “underlying” supply and demand for the commodity, whereas the former intimates a self-sustained system tending to equilibrium. 

Broadly speaking, the question may be whether a market for X tends internally to a homeostatic state of equilibrium or a schizogenic condition wherein a maximizing variable breaches any equilibrium-enforcing features. In ecological terms, by analogy, the question is whether a species tends to maximize its growth even at the expense of the overall ecosystem. In terms of the oil commodity market, the question is whether people simply betting on the price without any intended future use effectively divorce the market price from the actual and expected supply and demand. Moreover, does the disjuncture increase such that the betting acts as a maximizing variable at the expense of any equilibrium-tending mechanisms of the market itself?

Even if the “freefall” drop in the price of oil evinces a return to equilibrium closer to supply and demand, the disjuncture itself caused people to put off vacations and spend less on even necessities, and generally feel poorer. There is thus an ethical question regarding the legitimacy of betting on a commodity that people need. This includes not only oil, but food as well. Specifically, is the freedom to bet on necessities (even if necessities in the short run) worth the ensuing harm to consumers? Moreover, is trading on a commodities market inherently intended or designed for bets or, more narrowly, to arrive at a price whereby consumption demand meets supply? What, in other words, if economic liberty undoes the purpose of a market?

According to Bart Chilton, a top regulator at the Commodities Futures Trading Commission (CFTC), the number of speculative bets on oil and food were at record levels at the time of the price increases in both oil and food. President Barack Obama created an oil market fraud group in April to provide enhanced regulatory scrutiny of potential fraud and manipulation in the oil futures and derivatives markets, but most speculation was perfectly legal at the time so the reach of the group was rather limited in comparison to the problem.

Eric Holder, the U.S. Attorney General, wrote in a letter to the group, "Of course, there are lawful market forces that lead to price fluctuations and to differences between wholesale and retail price trends in these markets.” He urged the group “to identify whether fraud or manipulation played any role in the wholesale and retail markets as prices increased. If wholesale prices continue to decrease, fraud or manipulation must not be allowed to prevent price decreases from being passed on to consumers at the pump." However, manipulation in the form of betting was legal at the time. Even so, the financial reform bill passed in 2010 requires the CFTC to craft rules reining in excessive speculation. Nevertheless, citing inadequate market data, the agency failed to meet a key deadline on those rules in early 2011.

Accordingly, U.S. Sen. Bernie Sanders (D-VT) sent a letter to President Obama on the day of the “freefall” urging that regulators impose limits on oil speculation. “There is mounting evidence that the skyrocketing price of gas and oil has nothing to do with the fundamentals of supply and demand, and has everything to do with Wall Street firms that are artificially jacking up the price of oil in the energy futures markets,” Sanders wrote. “In other words, the same Wall Street speculators that caused the worst financial crisis since the 1930s through their greed, recklessness, and illegal behavior are ripping off the American people again by gambling that the price of oil and gas will continue to go up.” The question is whether “artificially jacking up” prices of commodities that people need ought to be illegal, and, if so, whether such a law could even be enforced.

Should futures traders be required to take delivery and use the commodity they have purchased? If so, people seeking to hedge risk may not be able to do so. Is not the “too big to fail” story about too much risk? Perhaps other means of hedging could be used. Furthermore, it may be that the government officials were not going far enough structurally. Were they to have incorporated anti-trust law, applying it strictly, perhaps a more competitive oil market would obviate the baleful effects of speculators. Even if there would be some opportunity costs in the reduced economies of scale enjoyed by oil companies (and gas stations), a market mechanism running on more competition would be worth that cost to the particular firms. The common good outweighs that of individual companies.

In going after “excessive” speculation or oligopolies, the devil may be in the details. For example, regulation may be difficult to write—assuming the corporate lobbyists do not obstruct it from even getting to that point (e.g., the failure of the CFTC to issue regulations)—not to mention enforcement. In a system of corporate capitalism, moreover, representative democracy may not be able to provide a homeostatic remedy after the horse has run out of the barn.

Sources:

Matthew Robinson, “Oil Crashes 10 Percent in Record Rout,” Reuters, May 5, 2011.

William Alden, “Oil Prices Plunge in Record Sell-Off,” The Huffington Post, May 5, 2011.

Zack Carter, “Eric Holder to Fraud Squad: Oil Price Plunge Should Benefit Consumers,” The Huffington Post, May 6, 2011.

Ownership and Compensation Conflated: The Case of Bill Gates and Paul Allen at Microsoft

Paul Allen claims in his memoir that Bill Gates tried on more than one occasion to reduce Allen’s relative ownership interest in Microsoft. Of course, the veracity of Allen’s explanation can be questioned even if the ownership changes in percentage terms are a matter of public record. Whereas The Wall Street Journal focused on Allen's credibility in making his claim, I see a case study on the difference between ownership and compensation for labor.

Allen claims in his book that in the mid-1970's, when he and Bill Gates were two college dropouts based in New Mexico, Gates asked for 60% of their partnership because of his greater contributions to the creation of software for running the BASIC programming language on an early PC, the MITS Altair 8800. Allen insists he had assumed that the partnership was evenly split, but he agreed Gates' request anyway. Several years later when the two men established Microsoft as a formal partnership, Gates asked to change their respective shares in the business to a 64-36 split, a demand to which Allen again agreed. However, in the early 1980s, Gates rebuffed Allen after he asked for an increase in his own Microsoft shares because of his work on a successful Microsoft product called SoftCard. Allen writes that he was deeply disappointed in Gates’ response; after all, the two men had known each other since they were students at a prestigious private school in Seattle. "In that moment, something died for me," Allen writes in his memoir. "I'd thought that our partnership was based on fairness, but now I saw that Bill's self-interest overrode all other considerations. My partner was out to grab as much of the pie as possible and hold on to it, and that was something I could not accept." Allen recounts that he sucked it up and thought, "OK…but one day I'm out of here."[1]  Gates had put money above not only friendship, but also a stable, enduring partnership. 

In 1982, Allen eavesdropped on a discussion between Bill Gates and Steve Ballmer, who would go on to become the company's CEO, in the Microsoft offices in Bellevue, Washington. Allen claims in his memoir that he heard the two men talking about his recent lack of productivity and how they might dilute his equity in the company by issuing options to themselves and other shareholders. Allen said he burst into the room and confronted the two men, both of whom later apologized to him and backed down from their plan. "I had helped start the company and was still an active member of management, though limited by my illness, and now my partner and my colleague were scheming to rip me off. . . . It was mercenary opportunism, plain and simple."[2] To be sure, Allen admits that his work was limited by an illness. Gates's attempts to lower Allen's stake in the company reflected Gates' concerns that Allen wasn't working hard enough and wasn't committed to the company, say people familiar with the relationship.[3] That was one reason, those people say, why Gates had put a provision in the first partnership agreement that would allow him to buy out Allen if Gates thought there were irreconcilable differences. In his memoir, Allen refers to the provision but does not include a reason for it, or why it was not mutual. 

The link between productivity or work accomplished and ownership stake may, however, not sufficiently distinguish between compensation and ownership. To be sure, additional ownership shares can be part of a compensation package, but Gates sought to change the founding ownership agreement by reducing his partner's share of ownership, which attends to founding the company. In other words, Gates should arguably have gone after Allen's salary and additional stock options, for those are more oriented to the quality of work and productivity. If a person owns a business, he still owns it if he performs badly for a year; of course, what he could take out as salary might be less than the prior year. 

1. Nick Wingfield and Robert Guth, "Microsoft Co-founder Hits Out at Gates," The Wall Street Journal, March 30, 2011.
2. Ibid.
3. Ibid.

Anna Hazare: A Modern Incarnation of Gandhi?

On August 21, 2011 in New Delhi, India, tens of thousands marched in support of Anna Hazare, then in the sixth day of his hunger strike in support of the Jan Lokpal anti-corruption bill. He told the crowd, “Even if the prime minister comes, I will not withdraw my hunger strike until the [bill] is passed in the Parliament. I can die but I will not bend.”[1] What a unique and intriguing statement! To be sure, the man's “professed unwillingness to compromise,” as well as his “occasionally belligerent tone, . . . attracted criticism.”[2] Even so, he inspired mainly hope, particularly from the young. His main constituency, however, was the middle class, who felt alienated and unfairly treated. Hazare self-consciously embraced the model of Gandhi. That model, including the principled unbending, is no stranger in India, yet I am surprised that it took until 2011 for a societal figure so Gandhi-like to emerge and galvanize a mass protest using Gandhi’s methods. Of course, the likeness between the two men could be overstated. How much like Gandhi was Hazare and his political action? For example, would Gandhi have stopped eating simply out of preference for one of two bills before the Parliament? Putting a stop to widespread violence is arguably much more significant than reducing corruption. Also, the demand that conduct be changed is more direct than that a law be enacted unless to abolish an unjust one. 

                              

The uncompromising rectitude plays out differently in the two cases  Gandhi's underlying moral concern made his unwillingness to compromise laudable. Such stubbornness can fall on its face in a legislative context in which political compromise is inherent to the process. In appealing directly to the people for their malicious behavior to stop, Gandhi sidestepped the incrementalism of legislative politics. 

For a refusal to compromise to be a virtue, some pretty convincing principles must be at stake and a clear distinction must be drawn. In other words, a serious moral wrong must be involved. Typically, such a wrong involves great human suffering. Wide-scale  corruption, especially if it involves extortion of the poor and middle class incurs human suffering, but arguably not that which is involved in widespread societal violence that even results in death. In subjecting himself to death, Hazare may thus have been acting disproportionately. Taking up the mantle of Gandhi's method is perhaps not as simple as it may appear. 

1. Jim Yardley, “Thousands Back Antigraft Hunger Strike in New Delhi,” New York Times (August 22, 2011). 
2. Ibid.

On the United Technologies-Raytheon Merger: The Macro Level of Analysis

In analyzing a merger, incorporating the macro context is vital. For very large mergers, for instance, public policy concerns inevitably surface even if they are typically ignored not only in merger analyses, but also by in societal and even governmental public discourse. Analysis at this level takes a societal standpoint, including on the relationship of business and government. This does not diminish the salience of firm-level analysis, for even how the respective organizational cultures would mesh is very important to a functional merged company. This is even true regarding the respective business-ethics climates, for it is not a given that a healthy organizational culture dominates an unethical one.

In June, 2019, United Technologies “doubled down on the aerospace market with an all-stock deal to merge with defense contractor Raytheon Co., after UTC executives early chose to exit from the escalator and air-conditioning businesses.”[1] The anticipated combined company, “valued at more than $100 billion after planned spinoffs, would be the world’s second-largest aerospace-and-defense company by sales behind Boeing.”[2] The annual revenue for 2019 would be $74 billion. UTC’s CEO at the time estimated a billion dollars in cost-savings. Additionally, spending on research could be increased.

On the macro scale, the merger would intensify the consolidation in the aerospace and defense industry. Better terms from supplies and the Pentagon had been putting pressure on contractors “to cut costs and invest more of their own money in new technologies, such as space systems and cyber security.”[3] Consolidation has a major drawback, however, in that competition and thus trade can be stifled. Society, through its government, rather than consolidated industries must resolve anti-trust problems, and this is difficult when those industries have significant power over legislative bodies and regulatory agencies. Hence, for example, anti-trust law had not been applied to the five largest American banks even after their complicity in the financial crisis of 2008. In fact, the bankers were able to use government funds to pay themselves bonuses!  So the question can legitimately be raised whether anti-trust law even can be enforced when the consolidated company or industry is not in favor.

If very large consolidated companies can rebuff regulatory attempts to constrain or limit those companies, then even very unethical managements can enjoy perches of power that are worrisome from a societal standpoint. In the late 1990’s, for example, Hughes Aircraft merged with Raytheon Missile Systems. In 2002, dioxane, a carcinogenic chemical that Hughes Aircraft/Raytheon had been using as a solvent, was discovered in the ground water under South Tucson, Arizona. Previously, Hughes had used cancer-causing trichloroethylene since 1981, and several local residents had won settlements on that chemical from Hughes.[4] Perhaps Raytheon’s management fail to use adequate oversight over Hughes, especially given that company’s track record, or was the purchasing company tacitly involved. Something to ponder for a company on the cusp of growing substantially through another merger in 2019, for an environmentally callous group to be so big would indeed be a big deal.

At the company level, a board of directors subservient to management or even a sordid corporate culture, such as that of Enron, can be enough to thwart efforts to clean up from unethical conduct. Wells Fargo, for instance, faced an entrenched corporate culture in “efforts” to stop charging customers for unordered products. Plutocracy, or the rule of wealth, at a governmental level means that such companies can not only continue acting unethically but also extract monopoly or oligarchic rents. In the case of the defense industry, the increasing power of the major contractors can even result in pressure on lawmakers to go to war when diplomacy would have been a better route. Indeed, a government’s spending can become loop-sided in favor of defense because the major contractors are powerful enough to demand it because it is good business. Hence U.S. President Lyndon Johnson kept the Vietnam conflict going in large part because he was getting kick-backs from certain contractors. In short, from being able to evade anti-trust enforcement to being able to pressure or pay off presidents in favor of military engagements, consolidated defense contractors can be said to have too much power. 

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[1] Cara Lombardo and Doug Cameron, “Merger to Create Aerospace Giant,” The New York Times, June 10, 2019.

[2] Ibid.

[3] Ibid.

[4] Tony Davis, “South-side Tucsonans Mobilize for Another Water-Pollution Struggle,” Arizona Daily Star, April 16, 2017.

Hong Kong’s Chief Executive Capitulates on a Proposed Extradition Law

Facing huge violent protests, Carrie Lam, the chief executive of Hong Kong, a semi-autonomous region of China, decided on June 15, to indefinitely suspend her proposal to open extradition to mainland China and Taiwan. As the Chinese government demonstrated during the protests at Tiananmen Square decades earlier, holding a mass protest in China was not among the ways to impeded proposed legislation. Why, then, did Lam seem to cave into the popular protests in Hong Kong?

Perhaps it is naïve to claim that even in China, when popular protests are so large government officials cannot but conclude that enough of the people are advocating that Rousseau’s general will has spoken. Of course, a highly visible protest need not be from a majority of citizens. Often the political extremes show up to protest while the centrist majority stays home. In fact, the regularization or ubiquity of political protests in the E.U. and U.S. may dilute the ability to stand out in such a way that the intended change will happen. The Arab Spring’s mass protests in the Middle East demonstrate that even huge protests can be “regularized” within the control of a government. So I think the efficacy of protests has diminished as they have become increasingly hackneyed. It follows that the large, violent protests in Hong Kong in 2019 against the extradition bill were not decisive in the legislation’s untimely demise.

Alternatively, that local business leaders turned away from Lam on the issue could be said to be the decisive change that led to Lam’s decision to indefinitely shelve the bill. In the U.S. especially, the loss of support of corporate leaders could indeed stop legislation from progressing. The power by which corporations can use campaign contributions and lobbying in Washington, D.C. had indeed become formidable by 2019. In contrast, however, the Chinese government was relatively strong against the power of amassed private capital (i.e., large companies). With the support of the Chinese government, Lam could have handled the errant business elite, but did she have the central government’s support?

Government officials in Beijing “were starting to question her judgment in picking a fight on an issue that they [regarded] as a distraction from their real priority: the passage of stringent national security legislation in Hong Kong.”[1] So rather than yielding to the streets or the business sector, Lam yielded to the central government. The implication is that Hong Kong’s semi-autonomous status within a dictatorship could be questioned. In fact, semi-autonomous is an oxymoron in a dictatorship—that is to say, a façade.

---

1. Keith Bradsher, “In Hong Kong, Leader Yields to the Streets,” The New York Times, June 16, 2019.

The Impact of Federalism on Corporate Power in American Legislatures: The Case of Health-Insurance Reform

Florida, like about a dozen other states, debated in 2009 a proposed amendment to its state constitution that would have blocked, at least symbolically, much of the federal health-care insurance overhaul on the grounds that it tramples individual liberty. Behind the amendments was an industry with a vested interest—an industry that made substantial campaign contributions to the supporters of the amendment. I contend that there is an ethical conflict of interest lurking here, even if it is constitutional (assuming that wealth constitutes free speech, which itself is a problematic assumption), but the main issue here is how the blockage of federal law applying in Florida (and other states) would have affected federalism. What would have been better for the American federal system: federal or state legislation, or perhaps a combination? 

It was not just ideology that united the proposal’s legislative backers in Florida. The amendment's 42 co-sponsors, all Republicans, were almost all recipients of out-sized campaign contributions from major health care interests, a total of about $765,000 in 2008 alone. Around the 2008 election, moreover, the groups that provided health care contributed about $102 million to state political campaigns across the U.S., surpassing the $89 million the same donors spent at the federal level. 

The conflict of interest for the 42 co-sponsors in the Florida legislature opened them and their health-insurance backers to attack by those who wanted the federal government to be involved in health-insurance. Indeed, those federalists argued that the magnitude of the health-care industry’s contributions demonstrated the dangers of leaving such a question up to individual states, where campaign finance and ethics rules varied at the time from strict to negligible. The industry had enormous power at the state level, those federalists contended, and very few states had state-level consumer groups that were able to lobby effectively against the industry-legislator nexus. 

On the other hand, federalizing health-insurance law contributed to the consolidation-tendency of the "extended republic" at the expense of its member republics, or states. Indeed, the matter of the U.S. Government’s enumerated (i.e. limited) powers was not lost on the state legislators of several states who  were opposed to a federal health-care law. “We are trying to prepare, and trying to send a message that there is no reason for those decisions to get made at the federal level,” said Representative Linda L. Upmeyer, a Republican who was leading efforts in Iowa's legislature to prevent the anticipated federalization by the federal president, Barak Obama.[1] Upmeyer and anti-federalists knew that without “opt-in” or “opt-out” provisions in the federal legislation, state constitutional amendments would be preempted even should Congress refuse to reform health insurance. 

To be sure, states opting out of the eventual Affordable Care Act could have compromised the economies of scale assumed by the federal cost-saving measures. However, not even the cost-efficiency of proposed federal legislation should always overrule the contribution of the bill on the system of federalism. This focus had been a factor in the trend since the 1860's toward the consolidation of power at the federal level at the expense of the diversity-expressive power of the states. Too much "one size fits all" with not enough taking into account the differences between the member-states in an empire-level political union leads to an unbalanced system of federalism and thus eventual demise of the union itself. This point is lost when the focus is on particular pieces of legislation, and more specifically on their respective redeeming cost-efficiencies. 

What if industry power over legislation is strongest at the state level? Would not another incremental movement towards political consolidation at the expense of federalism have the virtue of protecting democracy from the encroachment of plutocracy, the rule by wealth? Yet leading up to Obama's Affordable Care Act of 2010, the president dropped his public-option for health insurance when the lobbyist for the private health-insurance industry threatened to withdraw its support. Obama's political calculus was doubtless that the vote would be so close that he would need the industry's support--hence, as often is the case in American legislation--incrementalism is the rule and large packages like FDR's New Deal are the exception. 

Therefore, even though the member-state legislatures are perhaps more easily dominated by big business, the federal head is also capable of being controlled or steered. Perhaps part of the solution to the problem of industry dominance over government lies in enabling the state governments to be able to check the federal government, and vice versa. In other words, the worst enemy of corporate corruption of public officials at either government may be balanced federalism.

1.  David D. Kirkpatrick, “Health Lobby Takes Fight to the States,” The New York Times, December 28, 2009.