Stop Gambling On Hunger

A good article that explains some of the problems that Senator Wyden’s STOP Commodity Speculation Act will remedy can be found here.

The author points out that earnings on commodity futures speculation is only taxed at a 23 percent rate, while earnings from equities is taxed at 35 percent, creating an incentive to drive investors into commodity markets. If we are to gain control over the commodity markets again, this tax incentive will have to go.

Luckily, Senator Wyden’s STOP Commodity Speculation Act (soon to be introduced) will make all commodity market users pay the 35 percent tax rate. Please write or call your Senators and ask them to cosponsor Senator Wyden’s bill.

The Institute for Agriculture and Trade Policy (IATP) describes how the financial reform bill being signed into law today by President Obama will benefit farmers and consumers around the world. See their press release here.

“This bill will help markets work for agriculture and all Americans, not just for Wall Street and the transnational corporations that hide their deals in private markets”

“Countries dependent on agriculture imports for food security will be able to forward contract at fairer and more predictable prices. Developing countries that rely on agricultural exports will similarly benefit from greater price predictability and stability as they forward contract sales.”

The Senate passed a cloture vote on the financial reform bill yesterday, another step toward getting the bill signed into law, hopefully within a few weeks. Members of the Commodity Markets Oversight Coalition created a list of the parts of the bill that will improve the functioning of commodity markets. These changes should help avoid future breakdowns like we experienced in 2008 and help diminish volatility in commodity prices.

The financial reform bill will:

• Fully close the “Enron Loophole” by empowering the Commodity Futures Trading Commission (CFTC) with authority over off-exchange (over-the-counter) derivatives markets, and by requiring across-the-board transparency for all derivatives.
• Require that derivatives be exchange-traded or cleared with real-time reporting, reducing systemic risk and market instability and uncertainty.  The final bill, unlike previous iterations, would also give the CFTC additional tools to enforce this requirement.
• Provide a narrowly-defined hedge exemption for legitimate commercial end-users to clearing and capital requirements for derivatives.
• Close the “Foreign Markets Loophole” by requiring that foreign boards of trade register with the CFTC if they plan on doing business in our markets.
• Provide the CFTC with additional authority to prosecute fraud and manipulation when it occurs. Since its inception, the CFTC has been handicapped by a less-than-adequate legal standard to prove manipulation, especially when compared to the authority provided other agencies and commissions such as the SEC. As a result, the CFTC has only successfully prosecuted one case over the last 35 years. The new measure will remedy this.
• Protects commodity trading “whistleblowers” who cry foul when they see fraud, manipulation or other violations of the law occurring.
• Require banks to “spin-off” their energy swaps trading operations into a separately capitalized entity that cannot access federally insured deposits. Other swaps in commodities (except gold and silver), equities and risky credit default swaps are included as well. This is expected to dampen the willingness of Wall Street speculators to take excessively leveraged positions in commodities, including energy.
• Empower the CFTC to set speculation limits in all markets, and requires them to set aggregate speculation limits across all markets.
• Prohibit “insider trading” in commodity futures, options and swaps on government information that is not yet public or otherwise made available to the trading community.
• Make permanent the CFTC Energy Markets Advisory Committee, which was established in early 2008 at the urging of NEFI and its coalition allies to provide an environment for energy end-users and industry groups to express concerns to regulators.  It further states that hedgers and consumers must be represented on the advisory committee.  Sean Cota (Cota & Cota, Bellows Falls, VT) currently represents our industry on the existing committee.
• Require a study into existing and prospective carbon trading markets.  There has been concern that if government sets a price on carbon through a cap-and-trade scheme or some other method, that such a market could become subject to excessive speculation and volatility, and could become more of an investment opportunity for Wall Street than a tool for reigning in greenhouse gas emissions.  This concern created skepticism among even the most liberal Senators and helped kill an economy-wide cap-and-trade program, at least for now.
• Give regulators one year to enact new rules and regulations, and require them to cooperate and coordinate here there is overlap between multiple agencies.

A number of articles have been published recently erroneously saying that the derivatives reforms in the financial reform bill will cost small and medium businesses millions in added costs. This is not true as commercial end users will be exempt from the new requirements.

The Commodity Markets Oversight Coalition has sent out a letter that spells out what is really in the bill as well as provides a good background to the use of derivatives:

DERIVATIVES REFORM WILL BENEFIT – NOT BURDEN – END USERS

In the course of the two-year long debate on how best to reform the derivatives markets, much attention has been given to the concerns of so-called “end-users,” or businesses that use derivatives to hedge against various forms of risk, including not only airlines, utilities and manufacturers, but also small business farmers, gasoline stations and home heating companies.

However, end-users have had growing concerns about the state of the derivatives markets that predate the 2008 financial collapse. Many have argued that these concerns are addressed, not exacerbated, by proposed reforms included in Wall Street reform package.

For more than a century, derivatives have been used by producers, processors, transporters and marketers of commodities – such as gasoline, home heating oil, wheat and livestock – to insulate their businesses and consumers from price risk. And for much of their history, they were a stable, reliable and transparent means of doing so.

However, if you speak to anyone who has used derivatives products for more than a decade, they will tell you that everything changed in 2000. The financial industry successfully secured blanket exemptions from Congress and federal regulators that led to a transformation of derivatives markets from simple commodity exchanges to the opaque and unregulated, multi-trillion dollar markets we know today.

To remain competitive, regulated exchanges weakened their own prohibitions on speculation, and allowed traders in the U.S. to access new subsidiaries in countries with weaker oversight. Over-the-counter and foreign derivative trading markets boomed, to the detriment of the traditionally stable domestic environments.

These changes lead to a “Wild West”-like environment. Excess volatility became the norm. Price spikes in commodities, most especially those experienced in 2007-2008, seemed to be dislocated from supply and demand fundamentals. Speculators were diving head-long into derivatives, and by 2008, came to dominate commercial hedgers four-to-one.

As commodity speculation swelled, retail gasoline and home heating oil prices surged beyond $4 per gallon. Trade associations attributed as much as $1 or more of these prices to speculation, despite the more than adequate inventories and a decline in demand. Global food prices were similarly rocked and the UN estimates that an additional 130 million people were driven to hunger as a result.

Derivatives reform will address many of these issues. Mandatory reporting, clearing and capital requirements for all derivatives would create transparency and much needed confidence in these markets, while a hedge exemption for bona-fide end-users would protect commercial businesses. It would also require that foreign exchanges doing business in the U.S. register with our regulators and encourage new cooperation with overseas agencies.

The bill also contains new tools that will help the Commodity Futures Trading Commission or CFTC, the principal regulator of derivatives, police against fraud and manipulation. It would also protect end-users from excessive speculation by expanding a 1936 statute requiring the CFTC to limit the size of speculators’ positions to over-the-counter markets and, importantly, in the aggregate across all markets.

Still, news coverage and op-eds have suggested that end-users are unified in opposition to reform due to fears that it will result in new government regulation and capital requirements, despite the well articulated hedge exemption and support for the legislation from airline, trucking, gasoline, home heating, and various agricultural industry groups.

If the “Wild West” was tamed by law and order, then the derivatives markets will be tamed by increased transparency, stability and confidence that legislative reform will bring. An important and reliable tool that hedgers have relied on for years will be returned to them and for this reason, end-users will benefit – not be burdened by – long overdue and comprehensive reform.

The only derivatives users that need worry about this reform are those that have exploited the status quo recklessly and irresponsibly, driving up costs for all Americans and threatening our nation’s economic stability and competitiveness. They fear it, and rightly so.

Jim Collura is a spokesman for the Commodity Markets Oversight Coalition, an alliance of derivatives end-users and consumer advocates in support of derivatives reform. Reach Jim at jimcollura@nefi.com

The Congressional conference committee voted to pass a version of the financial reform with fairly strong derivatives reform. One financial analyst estimates that 80 to 90 percent of the opaque over-the-counter (OTC) will be required to clear through clearinghouses. These unregulated derivatives were a large part of the overall financial meltdown and had a significant effect on global food and energy prices.

Hedge fund manager Mike Masters gives a great interview to CNBC here. He explains clearly why central clearing is important and how speculation has had undue influence on food and energy prices.

Johann Hari also has an excellent article that explains well what happened with excessive speculation in the commodity markets.

The Center for Media and Democracy also has a good article showing how the financial reform bill will help farmers and agriculture markets.

The conference committee charged with combining the House and Senate financial reform bills into one bill announced that they will leave debates about derivative reforms to the end of their scheduled time. They should address derivatives around June 24th or so.

This gives us time to place as many calls and send as many letters as possible to the conference members demanding strong derivatives reform.

Even if you have already sent a letter to your legislators, please go to the TAKE ACTION page and send a letter. It is now set up to be sent to each of the 43 members of the conference committee (12 Senators, 31 Representatives.)

Eighteen members of the Economists’ Committee for Stable, Accountable, Fair and Efficient Financial Reform (SAFER) sent an excellent letter to members of the conference committee who are debating the final language of the financial reform bill. They ask for the strongest regulations on commodity markets possible. The letter also gives a good background to the problem of excessive speculation in commodities, which will be helpful with many legislators who still do not fully understand what they are voting on.
They write in support of a strengthened version of the Senate bill, saying it “goes further than the House bill to promote stable derivatives markets that can effectively promote the well-being of consumers, farmers and other producers in the U.S. and throughout the globe.”
They trace the beginning of the problem to “deregulation that began in 2000 with the so-called “Enron loophole” [that] encouraged hyper-speculative activities by market players who had no interest in the underlying physical commodities being traded.”

They urge the legislators to go deeper than simply repairing the broken system that existed before: “…the first issue at hand for your Committee must be: what regulations of the derivative markets are needed to prevent a repeat of the 2008-09 financial market disaster? But we believe that your Committee also needs to give careful attention to the question of how to return the commodities futures market to its proper role of promoting price stability for consumers, farmers, and other producers.”

They go on to describe the various ways that the Senate bill is stronger. “The CFTC estimates that 90 percent of the derivatives market would be covered under the Senate version of the bill but only 60 percent under the House bill.”

Yet they also warn of the loophole that Senator Cantwell tried to plug with an amendment. The economists urge members of the conference committee to close that loophole.

A number of good materials have come out explaining the process of the conference committee that is working out the details between the House and Senate’s financial reform bills. A member of the Derivative Reform Alliance, who is closely following the fine print in each bill, created a Conference comparison chart Comparison of House and Senate bills(.doc) showing that the Senate bill is much stronger in the area of derivatives reform (the area that would have the most direct impact on stabilizing food prices). The bottom line? The Senate bill is superior in almost every way, though could also be strengthened with some language from the House bill.

Robert Pollin does a good job explaining the issues in the reform bill that will affect food price volatility in an article on Huffington Post.

Michael Lewis wrote a tongue-in-cheek memo from an imaginary Wall Street executive spelling out the strategy for bankers to undermine the reforms being considered. One part of his piece does a good job of summing up Wall Street’s arguments against making derivatives more transparent:

“To the mere mention of open, public exchanges for derivatives, you should always respond, ‘That will destroy liquidity in these fragile and complex markets.’ Most people don’t even know what ‘liquidity’ means, or what causes it or why they actually need to have more rather than less of it — or what, even, the point is of a market that requires privacy to operate. They will assume that you must understand it better than they do. For that reason alone it is useful.”

Unfortunately, many analysts agree that the area of derivatives reform is the area where Wall Street is working hard to weaken the bill, and is also the area where legislators are likely to be willing to give up the most. So it is essential that members of the conference committee hear from their constituents as to how important strong derivatives reform is to them. If you are represented by any of the legislators below, please call/write them and tell them to keep the strong derivatives reform language from the Senate bill.

Senate Conferees

• Leahy
• Harkin
• Dodd
• Lincoln
• Schumer
• Reed
• Johnson
• Shelby
• Gregg
• Corker
• Crapo
• Chambliss

House Conferees – a partial list of those members we think are likely

• Frank – CHAIR
• Maloney
• Kanjorski
• Gutierrez
• Waters
• Watt
• Meeks
• Moore
• Peterson
• Waxman
• Bachus
• Miller
• Biggert
• Paul?
• Garrett
• Hensarling
• Moore Capito

The financial reform bill continues to move ahead in Congress. One of the key things to look for in relation to gambling on hunger is whether Senator Cantwell will be able to get the language from her amendment, that was never voted on in the Senate, into the derivatives reform section of the bill.

If that language is not added, the derivatives reforms will
be practically toothless. Investors will be required to clear their trades through clearinghouses, but suffer no consequences if they choose not to.

Two articles sum up the issue and the political struggle around Cantwell’s amendment here and here.

A number of articles have been published summing up the Senate’s financial reform bill. Some of the better ones are here (NY Times), here (Business Week) and here (WSJ).

The Huffington Post and FireDogLake point out key things to look for as the House and Senate bills get worked out in conference committee. As we have stated before, the section that is most important for those concerned about excessive speculation in commodity markets is derivatives reform. This part of the bill will be intensely debated with some wanting to weaken it by widening the current exemptions for commercial end users, who actually buy and sell physical commodities, to include hedge funds and other financial businesses.

One effect of the financial reform bill in Congress is that it requires the Commodity Futures Trading Commission (CFTC) to set position limits instead of it being an option. This has emboldened the CFTC to go forward with its plans to place speculation limits on energy commodities like crude oil, natural gas, gasoline and heating oil. For more details on the CFTC, go here.

Keep looking on this website for updates on the financial reform bill.

The Senate continues to consider some final amendments to the financial reform bill offered by Senators Dodd (Banking committee) and Lincoln (Agriculture committee). Senate leadership has announced that it would like to vote on the bill by the end of the week (May 21).

The Commodity Markets Oversight Coalition sent a letter to the Senate today calling on Senators to pass the bill, including two important amendments that would help diminish commodity speculation:

Senator Feinstein’s amendment #4113 would close the “London loophole” for foreign boards of trade (FBOT) by giving U.S. regulators oversight of U.S. derivatives passing through FBOT.

Senator Cantwell’s amendment #4086 tightens the language requiring derivatives to clear through an exchange or clearinghouse, in order to avoid opening other loopholes.

After the possible Senate vote on Friday, the House and Senate have to work out differences between their financial reform bills. Representative Frank, chair of the House financial services committee, has announced that he wants the conference to be televised on C-Span. Most expect the final bill to be ready for President Obama’s signature before the end of June.