Unnecessary Systemic Risk: Banks' Price-Fixing and Racketeering in Side Businesses

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.

---

[1] Melanie Burton, “Glencore, JPMorgan Sued Over Warehouse Aluminium Prices,” Reuters, August 7, 2013.

[2] Ibid.

American Consumers Using Gas-Savings to Reduce Debt: Frugality or Responsibility?

The steep drop in the price of oil in July 2015 was a concern for traders. Drillers and other energy companies comprise a significant portion of the S&P 500 index. “The upside to falling oil is that all the money that drivers are saving at the gas pump should mean more spending by them at stores — and a faster-growing U.S. economy. But Americans are choosing to pay off debt instead of going shopping.”[1] Is this a bad thing? In reckoning it as such, Wall Street analysts are missing the big picture, even financially.

Gasoline at a station in January 2015. (ABC News)

To go on a shopping spree when in significant consumer debt is, I submit, foolish and perhaps even reckless. The mentality erroneously treats debt as permanent rather than something to be paid back. In this respect, the U.S. Government has been a terrible role model, as Bill Clinton dedicated only half of the surpluses in the late 1990s to paying down the debt. After his presidency, the wars and occupations in Iraq and Afghanistan added more than $4 trillion to the government’s debt.

To urge consumers in debt to spend what they save on gas implies the same mentality. Tim Courtney at Exencial Wealth Advisors, for example, says "Household finances are growing more healthy ... but you want to see a pick-up in spending, too."[2] I submit that such additional spending at the expense of reducing debt is detrimental to a person’s financial position. Not only is the debt not reduced, but also the habit of spending while ignoring the debt is reinforced. Consumers regaining their pre-debt position is good for Wall Street, moreover, because the financially solid position puts the consumers in a better position to spend beyond the short term.

Even so, using discretionary income to reduce household debt is said to be frugality. The following passage from The Associated Press is a case in point, and even makes explicit the interests behind the perspective. “The new frugality helps explain why the biggest long-term driver of stock prices — corporate earnings — have been so disappointing lately. In the second quarter [of 2015], companies in the S&P 500 grew earnings per share just 0.07 percent from a year ago, according to research firm S&P Capital IQ.”[3] That which is behind disappointment can be expected to be treated harshly rhetorically. Hence, responsible efforts to reduce debt is “frugality,” which has the negative connotation of cheapness.

I submit that debtless consumers are worth more societally than are continuously increasing corporate earnings (and consumer debt). The Associated Press could have reported that consumers were being responsible while over-reaching corporate expectations were taking a hit. How the media decide to report a story does indeed have an impact not only on consumers and company managers, but also the society as a whole—even in how it votes. In the case of the U.S., especially relative to the E.U., business interests can be said to have a disproportionate influence societally.

---

[1] Bernard Condon and Ken Sweet, “Why Stocks Are Tumbling 6 Years into the Bull Market,” The Associated Press, August 23, 2015.

[2] Ibid.

[3] Ibid.

Wall Street Banks in Commodities Businesses: An Inherently Unethical Conflict of Interest

Writing to the bank’s board of directors, an executive at Goldman Sachs wrote that the bank’s commodities division would achieve higher value “if the business was able to grow physical activities, unconstrained by regulation and integrated with the financial activities.”[1] According to Sen. Carl Levin, Goldman’s goal here is “to profit in its financial activities using the information it gains in the physical commodities business.”[2] The integration could be achieved in part by using the bank’s access to nonpublic information from the banking or trading operations to manipulate the price of a commodity by artificially restricting or adding to supplies through ownership at the production or storage stages. This structure contains a conflict of interest. Because resisting the temptation to exploit the conflict would put the Goldman bankers at odds with the bank’s financial interest, I contend that reliance by the public on intra-bank firewalls (i.e., policies) separating the commodity businesses from the bank’s trading operations is too weak to protect the public, including buyers of the commodity.

The full essay is at "Wall Street Banks in Commodities"

---

1. Sen. Carl Levin, “Opening Statement,” Wall Street Bank Involvement in Physical Commodities Hearing, Permanent Subcommittee on Investigations, U.S. Senate, November 20, 2014 (accessed November 21, 2014)

2. Ibid.

3. Ibid.