Lake Rudd Partner, Sean Cota, is proud, yet a little embarrassed by the accolades given by CFTC Commissioner Bart Chilton at ICPA/OHIRI's Annual Conference. Commissioner Chilton's speech was very thought provoking with regard to futures and swap trading which effect the retail fuel industry. We thought you would benefit from reading what he had to say.
Speeches & Testimony
• “Twists and Turns in Tradium”
Introduction: Two Tents
Aquy (ah-quoy)! Or perhaps, háu, is a better known Native American greeting. Anyháu hi, hello, and good evening. Thanks for that kind introduction. I appreciate the invitation to spend some time with you. Thanks, also, to each of you for your participation in these organizations. As groups, you provide needed voices. Understandably, these organizations take time away from your families and your personal lives.
Spending a career making or helping to make decisions about policy issues, it has been invaluable to have organizations express opinions. You help government be more thoughtful, observant and attentive to what is actually going on in the countryside. So thanks to each of you—really, sincerely, thanks.
I also want to particularly thank Sean Cota who has been of great value to the Commission. He has served in advisory capacities for the Agency, but Sean has been a good sounding board for me, specifically. It is hard to adequately describe the overwhelming information we get from large companies and corporations. Finding smaller companies and individuals who are able to provide us with advice and counsel is rare. When you find a good one, like Sean, you hold onto them like a dog with a bone. Some days I actually feel like that, a dog getting, and holding onto, information. Other days, of course, I just feel like the tree. Either way, thank you, Sean.
Feeling like one day you are “this” and another day you are “that,” and being here on the Mashantucket Pequot Reservation brings to mind the fellow who visits the psychiatrist. He tells the doctor, “Doc, one day I wake up and feel like a wigwam, and the next day I feel like a teepee.” The Doctor looks to the ceiling and thinks, then leans forward and points his finger at the patient and says, “I know your problem. You’re two tents.” Ugh, I know. My point is, let’s not be too tense. Let’s relax for the next few minutes and have some fun and talk about some policy issues that are front and center.
Alternate Worlds
When one comes to a place like this, a hotel casino, it really sort of transports you to another world, doesn’t it? I’m not sure about that “altering the oxygen” in these places stuff. Maybe that’s an urban, suburban or rural legend or myth. I don’t know. Either way, there is unquestionably a dissimilar feeling, a different vision, vibe and sound, right? We look and sense things a little differently. It is, to some degree, an alternate world. Let me prove my point. In this world, right here and right now, they charge $5 to make an ATM withdrawal. It is a different world. More on bank fees after a bit here.
Another thing, in this world you can actually see some marvelous stuff most of us would never be able to come close to in our daily lives. Take the Hard Rock Cafe with that fabulous memorabilia. This one has Tony Iommi’s guitar. Tony, for those that don’t know, is a founding member of Black Sabbath. In fact, he’s the only constant band member. One of his guitars, a black Gibson SG is right here, in this world, at the Hard Rock. Tony used it at Ozzfest in 1997. It’s fantastic to see. There’s also a Bun E. Carlos, Cheap Trick Ludwig drum kit used on the 1979 Dream Police Tour. This place is another world, and it has one cool back beat soundtrack. “The dream police, they’re coming to arrest me, oh no.”
Tradium
There’s yet another world out there, too. I’m calling it Tradium. Times are rough and tough in Tradium. It seems most folks are in debt. Almost everybody lives on credit. And some of the biggest of the big firms are taking advantage of the Tradi-ites—that’s what they call themselves: Tradi-ites.
The other day in Tradium, what’s today? It was Monday. Monday in Tradium, a foreigner comes to visit. He stops at the Tradium Inn and Suites (formerly Howard’s Hotel—he was bought out by a syndicate) and lays down a $100 bill on the counter. But first, he says, he wants to inspect the rooms in order to pick one in which to spend the night. As soon as the foreigner leaves to do his inspection, Howard snatches the money and sprints next door to the Awful House where Butcher Bob is always having coffee and holding court. Howard pays his debt to Butcher Bob. Then, Bob takes the Benjamin. Oh yeah, in Tradium they call $100 bills “Benjamins,” too—weird, right? Butcher Bob takes the Benjamin and passes it across the table to hog farmer Phil, who dashes off to pay his bill at Freda’s Feed and Fuel. Freda races to the bank and pays her debt. The banker, Sterling, grabs the greenback. What? That’s his name: Sterling. It doesn’t have to be alliteration. That’s his name for crying out loud, and I’m not changing it for your amusement. So, Sterling rushes out the door and down the sidewalk. Looking both ways, he gives the 100 bucks to Vanessa Vixen (there ya go, back in the saddle, again)—Vanessa Vixen. Vanessa is Sterling’s for-hire love interest (not that it is really any of our business, but Tradi-ites know about Vanessa). So, right away Vanessa sheds her heels and hurries down the street as fast as she can (in that skirt—if that’s what you call it) to the Tradium Inn and Suites where, with a wink, she hands the $100 bill over to Howard to pay off her room bill. Howard then places the $100 back on the counter so the foreigner won’t suspect anything. Just then, the foreigner comes back, picks up the cash, and says the Tradium rooms aren’t acceptable. “I liked it better as Howard’s Hotel. You don’t even have in-room coffee! I won’t be staying here,” he says, as he pockets his Benjamin and makes like a tree and leaves.
Hang with me gang: during this entire chain of events, no one produced anything. No one earned anything—money for nothing. Nonetheless, all of Tradium is debt-free, (yay for the Tradi-ites!), and a few even envision a future with great optimism, expectation and anticipation . . . and a generation of kids with cooler names. Does some of that circumstance sound familiar? Is that how some systems in our world actually work?
Unfortunately, that’s not all that is going on in Tradium in these dark days. In this bizarre and inexplicable world, the population has suffered due to some of Tradium’s largest financial corporations. Regardless, the “geniuses” of these very firms have received behemoth bonuses—boatloads of those Benjamins. Many of them have put their needs above all else, even their own customers! Many, far too many, have engaged in fraud and even in market manipulation. Some have been involved in complex cons, others in dubious deceptions, and some in straightforward scams.
The Tradi-ites are getting awfully fed up with these dudes. They’ve had enough—and they’ve called them some not-so-nice names (even worse than Sterling). The Tradium Tribunal has gone so far as to pass some new laws and rules to stop the madness (they call them “traws” and “trules” in Tradium, but I don’t want to get lost in translation). The Tradium judges, or “trudges,” are fining the bad guys and even putting some behind bars at Tradium’s Iron City Correctional Facility. By the way, at Iron City, Tony Iommi and Black Sabbath: very popular. One inmate has a tat of Tony’s black Gibson SG. But, (keep hanging) the entire situation in Tradium is all very sad because nothing, not even putting nogoodniks in the Iron City slammer, has stopped the lunacy. In fact, many businesses and individuals have been devastated. The entire Tradium economy is even in precarious peril.
Regrettably, the circumstances in Tradium aren’t taking place once upon a time in a faraway land. You guys are smart. I bet you could see this coming. You! Nope, the things taking place in Tradium aren’t just “inside of my head,” oh no. They are all too real. They are here. It is, Dum - - - de DUM DUM: now.
The Here and Now
In fact, most of us are becoming numb to all of this, in all of the scandals and corruption. Most people can’t even keep track of all the junk going on in our Tradium-like financial sector.
I won’t get deep into the root causes of the 2008—and counting—economic calamity. I’ve spoken many times about it. Andrew Ross Sorkin’s Too Big to Fail is a must read for anyone who wants to know what actually happened. All I will say is that lax laws, rules and regulations led to many of the largest financial institutions in the world being involved in some irresponsible business practices. In turn, those business practices led to hundreds of trillions in a big bank bailout with no strings attached. There were no requirements that those banks make more loans (which was something sorely needed since folks were losing jobs by the millions, losing their homes and seeing their retirements devastated). Oh yeah, and as the economy suffered the worst frontal blow since the 1930’s and the government provided trillions of bail out buckaroos, firm executives received millions in bonuses. Is that something they teach at business school—tank the economy, get a bonus? Jeez Louise, that takes guts . . . or something Gordon Gekko-ish.
The List Goes On
But still today, even in the last year, it still seems like we are in an alternate world, like Tradium, yet it is here and now. I mentioned ATM fees earlier. Well last November, Bank of America agreed to settle for $410 million for charging excessive amounts on overdraft and debit card fees to over 13 million of their own customers. What BofA did was to program their computer systems to organize customer debit card and ATM transactions from high to low dollar amounts, as opposed to when the purchase was actually made. As a result, customers would enter into a negative balance circumstance quicker. Consequently, they’d bounce more times and incur more fees than they should. The bank collected all of these excess fees. Hence, they agreed to that $410 million settlement. As disconcerting as that was, it took place at roughly 13 different institutions! U.S. Bank settled, this summer, for $55 million for the same sort of thing.
We have also witnessed both Goldman Sachs and Citi establish these fake out funds (Goldman called it Abacus and Citi called it their Class V Funding III Securities) where they coaxed their customers to invest, then once the funds were populated with their own customers funds, the banks themselves took the opposite positions—psych! Did these guys go to school at Screw U and take that ethics class: Business OU812? Goldman paid $550 million in a settlement with the Securities and Exchange Commission (SEC) and Citi’s $285 million SEC settlement was tossed out by a judge as too lenient.
In July, Wells Fargo, the largest home mortgage lender in the country, reached a $175 million settlement (the second-largest residential fair lending settlement ever) with the Department of Justice (DoJ) related to brokers that charged higher fees and rates to more than 30,000 minority borrowers. From 2004-2009, Wells Fargo charged more to minorities than it did for white customers with the same credit ratings. DoJ’s Assistant Attorney General for Civil Rights (Tom Perez) said it amounted to a “racial surtax.”
We also have one of the largest banks in the world, Barclays, trying to manipulate the Libor rates—rates that impact just about everything anybody buys on credit.
Of course we have MF Global in which hundreds of billions in customer funds went missing, and there is Peregrine Financial Group that looks like a $200 million fraud.
And on top of all of that, JP Morgan, who seemed steady as all of this was going on announced a multi-billion trading loss due to a chap dubbed the London Whale. As Mr. Dimon said, “In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored. The portfolio has proven to be riskier, more volatile and less effective an economic hedge than we thought.” And, that was a firm some thought was rarely fallible.
Amazing, doncha think? This list of almost things goes on and on . . . unfortunately.
The New Normal—Not
Again, this may all seem like another world—some Tradium-type realm. It isn’t. It is here. Is it the new normal? It can’t be the new normal, right? We wouldn’t last. We’ve got to find a way back to healthier times, more stable times.
We unequivocally should ensure that there is an environment in which businesses can make money and that our rules and regulations aren’t so overly burdensome, costly or restrictive that we do damage to firms, markets or see market migration to other nations. It is all about balance. At the same time, customers, consumers and taxpayers need to be treated with dignity and respect. Given what has been going on, given some of what I’ve spoken about this evening, that hasn’t happened. There is a hefty weight upon us to ensure that rules and regulations are appropriate. We need important protections (some, by the way, we are just about to approve). However, it will require more than just what government can, or should, do. Government can’t mandate business morality and ethics. I’m convinced, however, that there needs to be better business values, standards and, yes, ethics. We need a culture shift, if you will, in the financial sector. I’ll be speaking about this at greater length next week.
From my perspective on the government side, the Dodd-Frank Wall Street Reform and Consumer Protection Act goes a long way toward establishing some important parameters. However, regulators are still working to implement the 2010 law. Of 398 total rules that government needs to finalize, as of the beginning of this month the government has only finalized 131—that’s 33 percent. For the CFTC alone, we do better than all other regulators, having completed 40 out of 59—67 percent.
I’m often asked if we are safer from a financial mess than we were prior to 2008. Sure we are, but until we get all of the Dodd-Frank provisions implemented, and a few more things done that have surfaced since then, we still have important work to do.
Volcker Rule
Let’s talk about just a few specific issues. The first one is the Volcker Rule, named after former Federal Reserve Chairman Paul Volcker. What the Rule says—and this is a law, part of Dodd-Frank—is that banks must not engage in proprietary trading. With some exceptions, they can only trade for their customers. Prior to the repeal of the Depression-Era Glass-Steagall Act in 1999, banks were what we traditionally think of as banks. They have customers and hold their money, perhaps making investments for their customers. But when Glass-Steagall was repealed, it allowed banks to trade for themselves as well as their customers. That’s how Goldman and Citi scammed their own customers because they—the banks—could trade for themselves. So, it created this troublesome duplexity. Were they trading to make money for themselves or for their customers? I suppose the two different motives could go in sync, but they don’t have to, and as it turns out they didn’t. Thus, the need for the Volcker Rule, which essentially reverts, to a large extent, to how banks operated prior to the Glass-Steagall repeal.
That may be all fine and good, although the banks really want to trade for their own accounts. Here is the problem, in my view: there is the possibility of a massive loophole. You see, there is a provision of Volcker that says regulators must allow banks to trade if they are merely hedging their own risk. So, under the law, under Volcker, the banks can’t speculate in the markets for themselves, but they will be allowed to trade in order to hedge their own business risk. However, the difference between hedging and speculating isn’t always so easy to distinguish. What is being urged would create a large loophole—an immense breach—in the Volcker Rule because it could allow almost any trades whatsoever to be considered as a hedge.
Say I work at one of these banks and I place a proprietary trade—a hedge—for some business concern that the bank holds. What happens if that hedge gets into the money? By that, I mean, what if it turns out that the hedging trade was something that did really well, something that looked pretty speculative? If I’m the bank and I get questioned by regulators, I simply say, “Hey, we are allowed to hedge our proprietary risk with trades and that is what we did.” Then, the government would be in the position of going to court arguing that the hedge was speculative and not simply a hedge.
I don’t see such cases going forward. The banks would hire an expert economist; the government would bring in its own—a stalemate whereby the government would have a very difficult time making its case. There would simply be too much litigation risk on the part of the government. You see, the “wide open spaces” that such a large loophole could create would leave a lot of room, as the Dixie Chicks sing, “to make the big mistakes.” We would be pretty much back to where we were without the Volcker Rule; banks speculating in the market and taking risks like they did leading up to the 2008 crash, and potentially taking advantage of their own customers.
Now, the Volcker Rule is a provision that amended the Bank Holding Act. The Federal Reserve has primary responsibility for that law. At the same time there are four other regulators who have something to say, or should have something to say, about how the Rule will be finalized. I’m concerned that our Agency—which has a lot of good, solid knowledge and experience about what the term “hedging” actually means and how it is used in markets—ya know risk-management markets—has been fairly inaudible on what the final Volcker Rule should look like. That is why in the morning, I’m sending a letter to Chairman Bernanke of the Federal Reserve Board suggesting that a clear, tailored, stick-to-the-law reading and interpretation of hedging is what should be incorporated in the final Volcker Rule.
In my letter, I write the following:
• The Volcker Rule should be interpreted and promulgated—promptly—so as to protect against the most basic conflicts of interest: that is, prohibiting banks from trading for their own interests ahead of their customers.
• Any exemptions from this prohibition should be considered in light of clear consumer protection objectives, and should be tailored to ensure that the exemptions do not create loopholes from regulation.
• Regulators should look to the CFTC for guidance regarding any exemption relating to "bona fide hedging."
• First, the Rule's definition of "hedging" should ensure that exempt transactions have and retain a risk-management purpose.
B. Second, entities claiming such exemptions should be required to disclose to regulators their risk modeling, to ensure that such calculations are appropriately calibrated.
C. Third, if "hedges" over time result in profits greater than losses on the underlying risk, then there is presumption that the exemption has been improperly claimed. Such willful evasion over time in avoidance of the prescribed oversight should be prosecuted with the full force and effect of applicable laws.
Position Limits
Speaking of speculation, let’s talk about excessive speculation for a bit, shall we? In 2008 we saw energy prices go through the roof. That’s when crude reached its highest point in history in July of 2008 when it touched $147. 27. In fact, through all the talk about gas and oil prices, July of 2008 still stands as the highest price for both. The average gas price then was $4.11. Had anything in the underlying supply issues changed much from earlier in the year when prices were in the low $90s? Nope. What about demand? Was there some big demand, or an expected increase that drove those prices? Nope.
So, what changed? Well, in a three-year period between 2005 and 2008 we saw a massive increase in dollars moving into the futures industry. In fact we saw $200 billion in managed money come in from the likes of pension funds, hedge funds, and exchange traded funds (or ETFs). There certainly isn’t anything wrong with folks putting their money in the futures industry. What we were seeing was an asset class shift. Folks not satisfied with their returns in the equities markets, or simply wanting to expand their portfolio thought, “Hey, why not invest in crude oil, or nat gas, or silver or gold or soybeans?” And, they did.
It wasn’t just the billions that came into the futures markets, though. It was what they (by and large) did with the money. They parked their money and went long. What I mean is that they put money into the futures markets like some of our parents put money into blue chip stocks. They bought and held. If things go right sonny boy, “when I go over yonder you will gets these” and they will be worth something. And folks invested in Motorola or IBM or RCA. Well, they were doing the same thing, but in futures. Their bet (and some don’t like it when people call making trades in the futures industry a “bet” but that is exactly what it is—perhaps an educated bet, but so is doubling down on 11 with a full deck), is that crude, or whatever, is going to be worth more in several years than it is today. They don’t care much if the price goes down today, tomorrow or after the summer driving season. Nope. They are betting, yes betting, on the price going up in several years. They keep their money in the market and unless something really unusual happens, they keep it there. So, they have a fairly passive trading strategy, and many of them are really massive. I’ve termed these traders “Massive Passives.”
I can tell you that in 2008 most of the staff at the CFTC, and all of the other Commissioners didn’t see a need to do anything to curb what I saw as excessive speculation that was leading to large price swings. Look, if prices go up or down based upon supply and demand, that is the market. Regulators are not price-setters, but we are charged with ensuring efficient, effective, and fair markets devoid of fraud, abuse and manipulation. When prices are moved because of excessive speculation, that’s a problem, and I have witnessed it in several markets. All our citizens experienced it to some degree in 2008 with oil and gas prices.
Dozens of studies confirmed exactly what was, and at times continues, going on. In fact, so many people denied that there was evidence of the impact of excessive speculation that I put a bunch of studies on the CFTC web site. They are still up there if folks are interested. Incidentally, there is one that does date back to 1990, by a fellow named Larry Summers. It appeared in the Journal of Finance. Mr. Summers (along with three other colleagues) repudiated the view offered by other economists that suggests speculators reduce volatility. Mr. Summers et al. suggested that excessive speculation could increase volatility and that speculators can do so by joining with other speculators—jumping on the Tradium bandwagon, as it were—of irrational price movements.
Calling for limits, position limits, to ensure that no single trader controlled such a large percent of any given market was something that did gain support. In fact, some key members of the U.S. House like Congressman Joe Courtney who represents this Congressional District, numerous Senators, and none other than President Obama called for limits on speculation.
Finally, a provision was included as part of Dodd-Frank. I should also stop for a moment here to thank Sean for his work in this regard. He was a vocal and firm advocate for limits and I thank him.
So, limits were included in Dodd-Frank. In fact, we were supposed to implement position limits on energy commodities in January of 2011. We missed that deadline. The good news (and my enthusiasm is tempered here, but I’ll explain later) is that on October 12 the first set of CFTC speculative position limits becomes effective. These limits on speculation apply to the spot month, which is generally the period right before trading in a contract expires and the obligation to make or take delivery on a physical delivery futures contract applies. Spot month limits are not new. There has been some form of these limits administered by the exchanges (and also by the Commission in the case of the enumerated agricultural commodities). What is new is that these limits will now apply to swaps, whether they're exchange-traded or over-the-counter.
There are three reasons why I temper my enthusiasm on position limits:
1. Limits on speculative positions outside of the spot month won’t become effective until sometime later, probably sometime early next year—once we get enough data on swap positions. These hard limits on speculation outside of the spot month will be something new for the energy, metals, and non-enumerated agricultural derivatives markets. They are important, but again, won’t be in place in October.
2. I’m also not sure that we have reached the correct limit levels. What I have always said is that we should err on the high side to ensure we aren’t doing damage to the markets by syphoning away liquidity. We need to get the levels correct. So, I’m not suggesting that these limits levels are all right on the mark. They may have to be adjusted as we go forward, and our rule allows for that. Under the rule, the position limits change as the size of the derivatives markets and the size of the underlying physical market change.
3. Finally, while position limits should ensure that no one trader holds a concentration so large that it could manipulate prices, that doesn’t mean that a group of traders acting in concert couldn’t impact prices—as Larry Summers and his colleagues suggested. I’m not even talking about something that would obviously be a violation of law if they did something in collusion. I’m saying, what if a bunch of the Massive Passives simply decided to invest in a market, say heating oil, and all go long? What if there was a herding mentality and once a few did it, a bunch of others followed—regardless of supply and demand?
Remember that glorious footage of the buffalo—the Native American’s tatanka—herds running through the South Dakota grassland in Dances With Wolves? When the herd shifted, it left a path of damage because hundreds followed hundreds of animals.
The fact that all of the Massive Passives—like the tatanka—have an identical herding-type trading strategy could, in and of itself, since they have size and weight, push prices around.
That reminds me of my favorite sign in South Dakota, which is where Dances with Wolves was filmed. There is a hand painted tourist sign that reads:
“EXIT HERE—SEE THE ONLY HORSE IN SOUTH
DAKOTA—Not Used In Dances with Wolves!”
So, on the massive passives and on herding of traders, I’ve spoken to a lot of people about how we might address this circumstance. To be honest, I haven’t figured out an appropriate method. The answer that folks usually give me is to simply prohibit them from participating in the market. I don’t like that idea at all, and I’ve said so.
The bottom line is that these position limits will not completely stop the influence of excessive speculation. However, they will help, a lot. More, however, needs to be done. The art in it will be figuring out a balanced way to do something—in our Tradium-like world—in a way that liquidity isn’t sacrificed.
Gas Pains and Energy Policy
One final thing on energy and gas prices, specifically. I wrote about this in an op-ed this week. If you’ve heard some of the folks on the campaign trail recently, you'd think President Obama was the filling station fella with the long pole—actually raising gas prices all by his lonesome. In actuality, presidents can’t do much to effect energy prices in the short term. But then again, that's not opportune to say in an election year talking point.
When President Bush was in office, in 2008, is when we saw the highest gas prices in history—a record that still holds today. Today’s nationwide average was $3.87 per gallon. (By the way, WTI crude settled at $98.31 today). However, in 2008 when candidate Obama delivered his convention speech, he correctly didn't complain about President Bush and high gas prices. Governor Romney admonished the President for allowing gas prices to increase. Oh well.
What can be done by any President in the short term amounts to only one item: the Strategic Petroleum Reserve (SPR). President Obama used it last year (in cooperation with 27 other countries and a total of 60 million barrels) and gas prices reduced—although only for a little time. The SPR, however, really is for the grimmest conditions. While using it is at the decision of presidents, traditionally they've been hesitant to do so.
Presidents can, and have, tried to address gas and other energy prices through longer-term strategies. President Obama, as I mentioned, sought to end excessive speculation in energy and other markets by limiting the large positions any trader may hold. That’s a feather in his hat, in my view. The President also called for increased penalties for manipulators. The President’s energy policy will—years after he is out of office—reduce by half the amount we all pay for fuel by requiring more efficient vehicles (54 miles-per-gallon by 2025). In addition, his energy policy promotes other fuel sources (wind, bio-based products, solar, hydro, nat gas and clean coal to name a few). To some degree, that's working now. We have become over 70 percent self-sufficient in energy in this country. For the first time since 1949 we have exported more oil and fuel products than we have imported. We have done that two years running.
The complex thing with gas prices is that the longer-view strategies take time to go forward, and reaching political settlement is evasive on something that doesn't have an immediate impact and that can’t be marketed in the next election. That's why it is a simpler proposition to blame a president . . . even when it is exceptionally inappropriate, in my view.
Cheetahs
The last issue area let’s visit has to do with technology. “What’s the frequency, Kenneth?”—the high frequency traders or guys I affectionately call “cheetah traders.” Let me be clear, not “cheaters” like Boston card cheaters, but cheetahs, like the speediest land mammal. These cheetah traders are fast, fast, fast. They are out there 24-7, 365 in Tradium-like markets trying to scoop up micro-dollars in milliseconds. Like the Massive Passives, they are fairly new to markets, certainly to the extent they are in markets today.
For years, I have questioned their value. I wrote an op-ed in the Financial Times almost two years ago called “Cyber Cowboys” where I questioned the value of the HFTs. I’m not suggesting that they don’t provide some liquidity, although I suggest that it is “fleeting liquidity” since they don’t typically hold positions for more than a few seconds. If you want someone to hedge your heating oil for a minute, I know just the cats for you. And at the end of the trading day—although for some it never ends—they are pretty much flat—holding level positions.
I’m impressed with the technology they use and in awe of some of the folks who are behind this sort of trading. They are big-time brainiacs doing innovative and important work, and it is really cutting edge stuff. I certainly don’t want to endanger them as a species.
However, I don’t (as some do) simply think they are the envy of the world. The exchanges like them because they are market makers and provide increased volume. That’s understandable. On the other hand, they were part and parcel to the Flash Crash in May of 2010. Furthermore, because of their speed, cheetahs can sometimes have an impact in markets far beyond their position size. Other traders may look to the cheetahs as early indicators of market movements. In fact, I have seen where this has also started a herding effect (tatanka) in markets and moved prices significantly and swiftly. I think there is a good case to be made that, contrary to what many suggest, they can increase volatility at times.
Another point here is about technology, generally. We all know that sometimes it doesn’t do what it shoulda, woulda or coulda. Just like I went through a partial list of all the problemos with the banks, I can (and have), done the same for multiple malfunctions with technology we’ve seen in markets in the past few years. We saw a major problem at the Tokyo Stock Exchange in August. We all know that NASDAQ had a big issue when Facebook went public. Heck, the CFTC computer system was compromised earlier this year. Just last Friday we saw a 56-minute trading halt in Globex nat gas complex trading. And, early Monday morning we saw another trading halt on CME Globex Volatility Quoted Options, Interest Rate Options, and TRAKRS futures and options. And in June of last year, the natural gas market crashed eight percent in 15 seconds in overnight trading. These are all problems with technology and my point is that we shouldn’t just accept technology as the best thing in the world. We need to realize that like many things, there will continue to be issues. Like that tee shirt, right, “I have issues.” Well, technology has issues.
Here is another problem, the third largest trader by volume at the CME used to be, perhaps still is, a cheetah trader out of Prague, Czechoslovakia. If regulators want to get books and records from that cheetah trader in Prague, forget about it. You see, the cheetahs aren’t even required to be registered with the CFTC. We should do at least four things, and soon:
1. (Registration) As a pedestrian first step, the cheetahs need to be registered;
2. (Testing) but, they should also be required to test their algorithms before they are deployed in the live market production environment; and
3. (Kill Switches) they should have kill switches in case one of these cheetah programs goes feral; and finally
4. (Wash Trading) many times these traders are trading so super-fast that they actually cross their own trades in the market. We call those “wash sales” and they are illegal. We need to get a handle on that and stop it. Wash blocker technology should be required on all cheetah programs and we should require a full accounting of when they happen, and why and what is being done to stop it. And by the way, the report to the CFTC should be signed by the head of the pride, by the leader of the cheetah to ensure that we are getting it from the top.
There are other technology-related things that should be done and I am hopeful that we will soon put forward a concept release on technology issues for the public to comment upon. In fact, I had hoped that we would issue the concept release this summer. We should do it soon pardner. We’re burnin’ daylight. (There, we got the cowboys and Indians in there).
The Destruction of Tradium
If we do these things I’ve spoken about in a responsible fashion—the Volcker Rule, speculative position limits, caging the financial cheetahs, a culture shift in the financial sector—and if we implement the rest of Dodd-Frank in a thoughtful and balanced manner, we will make the financial sector more competitive, provide greater transparency and cultivate increased confidence.
In Tradium, too, all of these things would help pave the way for a positive future. But, unfortunately, Tradium’s days are finished. They are ending as I speak. Sad, right? Twelve, eleven, ten . . . I’d better skedaddle.
It has been a “trasure” being with you. Sorry, “trasure” means “pleasure” in Tradium. It has been a pleasure, a pleasure, being with you…three, two, one—poof!
I know some of you might wonder, being the caring folks that you are, why Tradium had to simply go “poof” and disappear. You were getting to have some affinity for it, weren’t you? Was it the cold-blooded titans, the living on credit, excessive speculation or technology? Was it global warming? What did it in? Well, it only lived inside of my head, oh no (the dream police—police, police).
Thanks for your time and attention. Wakan Tankan Nici Un—May the Great Spirit walk with you.
http://www.cftc.gov/PressRoom/SpeechesTestimony/opachilton-68
Speeches & Testimony
• “Twists and Turns in Tradium”
Introduction: Two Tents
Aquy (ah-quoy)! Or perhaps, háu, is a better known Native American greeting. Anyháu hi, hello, and good evening. Thanks for that kind introduction. I appreciate the invitation to spend some time with you. Thanks, also, to each of you for your participation in these organizations. As groups, you provide needed voices. Understandably, these organizations take time away from your families and your personal lives.
Spending a career making or helping to make decisions about policy issues, it has been invaluable to have organizations express opinions. You help government be more thoughtful, observant and attentive to what is actually going on in the countryside. So thanks to each of you—really, sincerely, thanks.
I also want to particularly thank Sean Cota who has been of great value to the Commission. He has served in advisory capacities for the Agency, but Sean has been a good sounding board for me, specifically. It is hard to adequately describe the overwhelming information we get from large companies and corporations. Finding smaller companies and individuals who are able to provide us with advice and counsel is rare. When you find a good one, like Sean, you hold onto them like a dog with a bone. Some days I actually feel like that, a dog getting, and holding onto, information. Other days, of course, I just feel like the tree. Either way, thank you, Sean.
Feeling like one day you are “this” and another day you are “that,” and being here on the Mashantucket Pequot Reservation brings to mind the fellow who visits the psychiatrist. He tells the doctor, “Doc, one day I wake up and feel like a wigwam, and the next day I feel like a teepee.” The Doctor looks to the ceiling and thinks, then leans forward and points his finger at the patient and says, “I know your problem. You’re two tents.” Ugh, I know. My point is, let’s not be too tense. Let’s relax for the next few minutes and have some fun and talk about some policy issues that are front and center.
Alternate Worlds
When one comes to a place like this, a hotel casino, it really sort of transports you to another world, doesn’t it? I’m not sure about that “altering the oxygen” in these places stuff. Maybe that’s an urban, suburban or rural legend or myth. I don’t know. Either way, there is unquestionably a dissimilar feeling, a different vision, vibe and sound, right? We look and sense things a little differently. It is, to some degree, an alternate world. Let me prove my point. In this world, right here and right now, they charge $5 to make an ATM withdrawal. It is a different world. More on bank fees after a bit here.
Another thing, in this world you can actually see some marvelous stuff most of us would never be able to come close to in our daily lives. Take the Hard Rock Cafe with that fabulous memorabilia. This one has Tony Iommi’s guitar. Tony, for those that don’t know, is a founding member of Black Sabbath. In fact, he’s the only constant band member. One of his guitars, a black Gibson SG is right here, in this world, at the Hard Rock. Tony used it at Ozzfest in 1997. It’s fantastic to see. There’s also a Bun E. Carlos, Cheap Trick Ludwig drum kit used on the 1979 Dream Police Tour. This place is another world, and it has one cool back beat soundtrack. “The dream police, they’re coming to arrest me, oh no.”
Tradium
There’s yet another world out there, too. I’m calling it Tradium. Times are rough and tough in Tradium. It seems most folks are in debt. Almost everybody lives on credit. And some of the biggest of the big firms are taking advantage of the Tradi-ites—that’s what they call themselves: Tradi-ites.
The other day in Tradium, what’s today? It was Monday. Monday in Tradium, a foreigner comes to visit. He stops at the Tradium Inn and Suites (formerly Howard’s Hotel—he was bought out by a syndicate) and lays down a $100 bill on the counter. But first, he says, he wants to inspect the rooms in order to pick one in which to spend the night. As soon as the foreigner leaves to do his inspection, Howard snatches the money and sprints next door to the Awful House where Butcher Bob is always having coffee and holding court. Howard pays his debt to Butcher Bob. Then, Bob takes the Benjamin. Oh yeah, in Tradium they call $100 bills “Benjamins,” too—weird, right? Butcher Bob takes the Benjamin and passes it across the table to hog farmer Phil, who dashes off to pay his bill at Freda’s Feed and Fuel. Freda races to the bank and pays her debt. The banker, Sterling, grabs the greenback. What? That’s his name: Sterling. It doesn’t have to be alliteration. That’s his name for crying out loud, and I’m not changing it for your amusement. So, Sterling rushes out the door and down the sidewalk. Looking both ways, he gives the 100 bucks to Vanessa Vixen (there ya go, back in the saddle, again)—Vanessa Vixen. Vanessa is Sterling’s for-hire love interest (not that it is really any of our business, but Tradi-ites know about Vanessa). So, right away Vanessa sheds her heels and hurries down the street as fast as she can (in that skirt—if that’s what you call it) to the Tradium Inn and Suites where, with a wink, she hands the $100 bill over to Howard to pay off her room bill. Howard then places the $100 back on the counter so the foreigner won’t suspect anything. Just then, the foreigner comes back, picks up the cash, and says the Tradium rooms aren’t acceptable. “I liked it better as Howard’s Hotel. You don’t even have in-room coffee! I won’t be staying here,” he says, as he pockets his Benjamin and makes like a tree and leaves.
Hang with me gang: during this entire chain of events, no one produced anything. No one earned anything—money for nothing. Nonetheless, all of Tradium is debt-free, (yay for the Tradi-ites!), and a few even envision a future with great optimism, expectation and anticipation . . . and a generation of kids with cooler names. Does some of that circumstance sound familiar? Is that how some systems in our world actually work?
Unfortunately, that’s not all that is going on in Tradium in these dark days. In this bizarre and inexplicable world, the population has suffered due to some of Tradium’s largest financial corporations. Regardless, the “geniuses” of these very firms have received behemoth bonuses—boatloads of those Benjamins. Many of them have put their needs above all else, even their own customers! Many, far too many, have engaged in fraud and even in market manipulation. Some have been involved in complex cons, others in dubious deceptions, and some in straightforward scams.
The Tradi-ites are getting awfully fed up with these dudes. They’ve had enough—and they’ve called them some not-so-nice names (even worse than Sterling). The Tradium Tribunal has gone so far as to pass some new laws and rules to stop the madness (they call them “traws” and “trules” in Tradium, but I don’t want to get lost in translation). The Tradium judges, or “trudges,” are fining the bad guys and even putting some behind bars at Tradium’s Iron City Correctional Facility. By the way, at Iron City, Tony Iommi and Black Sabbath: very popular. One inmate has a tat of Tony’s black Gibson SG. But, (keep hanging) the entire situation in Tradium is all very sad because nothing, not even putting nogoodniks in the Iron City slammer, has stopped the lunacy. In fact, many businesses and individuals have been devastated. The entire Tradium economy is even in precarious peril.
Regrettably, the circumstances in Tradium aren’t taking place once upon a time in a faraway land. You guys are smart. I bet you could see this coming. You! Nope, the things taking place in Tradium aren’t just “inside of my head,” oh no. They are all too real. They are here. It is, Dum - - - de DUM DUM: now.
The Here and Now
In fact, most of us are becoming numb to all of this, in all of the scandals and corruption. Most people can’t even keep track of all the junk going on in our Tradium-like financial sector.
I won’t get deep into the root causes of the 2008—and counting—economic calamity. I’ve spoken many times about it. Andrew Ross Sorkin’s Too Big to Fail is a must read for anyone who wants to know what actually happened. All I will say is that lax laws, rules and regulations led to many of the largest financial institutions in the world being involved in some irresponsible business practices. In turn, those business practices led to hundreds of trillions in a big bank bailout with no strings attached. There were no requirements that those banks make more loans (which was something sorely needed since folks were losing jobs by the millions, losing their homes and seeing their retirements devastated). Oh yeah, and as the economy suffered the worst frontal blow since the 1930’s and the government provided trillions of bail out buckaroos, firm executives received millions in bonuses. Is that something they teach at business school—tank the economy, get a bonus? Jeez Louise, that takes guts . . . or something Gordon Gekko-ish.
The List Goes On
But still today, even in the last year, it still seems like we are in an alternate world, like Tradium, yet it is here and now. I mentioned ATM fees earlier. Well last November, Bank of America agreed to settle for $410 million for charging excessive amounts on overdraft and debit card fees to over 13 million of their own customers. What BofA did was to program their computer systems to organize customer debit card and ATM transactions from high to low dollar amounts, as opposed to when the purchase was actually made. As a result, customers would enter into a negative balance circumstance quicker. Consequently, they’d bounce more times and incur more fees than they should. The bank collected all of these excess fees. Hence, they agreed to that $410 million settlement. As disconcerting as that was, it took place at roughly 13 different institutions! U.S. Bank settled, this summer, for $55 million for the same sort of thing.
We have also witnessed both Goldman Sachs and Citi establish these fake out funds (Goldman called it Abacus and Citi called it their Class V Funding III Securities) where they coaxed their customers to invest, then once the funds were populated with their own customers funds, the banks themselves took the opposite positions—psych! Did these guys go to school at Screw U and take that ethics class: Business OU812? Goldman paid $550 million in a settlement with the Securities and Exchange Commission (SEC) and Citi’s $285 million SEC settlement was tossed out by a judge as too lenient.
In July, Wells Fargo, the largest home mortgage lender in the country, reached a $175 million settlement (the second-largest residential fair lending settlement ever) with the Department of Justice (DoJ) related to brokers that charged higher fees and rates to more than 30,000 minority borrowers. From 2004-2009, Wells Fargo charged more to minorities than it did for white customers with the same credit ratings. DoJ’s Assistant Attorney General for Civil Rights (Tom Perez) said it amounted to a “racial surtax.”
We also have one of the largest banks in the world, Barclays, trying to manipulate the Libor rates—rates that impact just about everything anybody buys on credit.
Of course we have MF Global in which hundreds of billions in customer funds went missing, and there is Peregrine Financial Group that looks like a $200 million fraud.
And on top of all of that, JP Morgan, who seemed steady as all of this was going on announced a multi-billion trading loss due to a chap dubbed the London Whale. As Mr. Dimon said, “In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored. The portfolio has proven to be riskier, more volatile and less effective an economic hedge than we thought.” And, that was a firm some thought was rarely fallible.
Amazing, doncha think? This list of almost things goes on and on . . . unfortunately.
The New Normal—Not
Again, this may all seem like another world—some Tradium-type realm. It isn’t. It is here. Is it the new normal? It can’t be the new normal, right? We wouldn’t last. We’ve got to find a way back to healthier times, more stable times.
We unequivocally should ensure that there is an environment in which businesses can make money and that our rules and regulations aren’t so overly burdensome, costly or restrictive that we do damage to firms, markets or see market migration to other nations. It is all about balance. At the same time, customers, consumers and taxpayers need to be treated with dignity and respect. Given what has been going on, given some of what I’ve spoken about this evening, that hasn’t happened. There is a hefty weight upon us to ensure that rules and regulations are appropriate. We need important protections (some, by the way, we are just about to approve). However, it will require more than just what government can, or should, do. Government can’t mandate business morality and ethics. I’m convinced, however, that there needs to be better business values, standards and, yes, ethics. We need a culture shift, if you will, in the financial sector. I’ll be speaking about this at greater length next week.
From my perspective on the government side, the Dodd-Frank Wall Street Reform and Consumer Protection Act goes a long way toward establishing some important parameters. However, regulators are still working to implement the 2010 law. Of 398 total rules that government needs to finalize, as of the beginning of this month the government has only finalized 131—that’s 33 percent. For the CFTC alone, we do better than all other regulators, having completed 40 out of 59—67 percent.
I’m often asked if we are safer from a financial mess than we were prior to 2008. Sure we are, but until we get all of the Dodd-Frank provisions implemented, and a few more things done that have surfaced since then, we still have important work to do.
Volcker Rule
Let’s talk about just a few specific issues. The first one is the Volcker Rule, named after former Federal Reserve Chairman Paul Volcker. What the Rule says—and this is a law, part of Dodd-Frank—is that banks must not engage in proprietary trading. With some exceptions, they can only trade for their customers. Prior to the repeal of the Depression-Era Glass-Steagall Act in 1999, banks were what we traditionally think of as banks. They have customers and hold their money, perhaps making investments for their customers. But when Glass-Steagall was repealed, it allowed banks to trade for themselves as well as their customers. That’s how Goldman and Citi scammed their own customers because they—the banks—could trade for themselves. So, it created this troublesome duplexity. Were they trading to make money for themselves or for their customers? I suppose the two different motives could go in sync, but they don’t have to, and as it turns out they didn’t. Thus, the need for the Volcker Rule, which essentially reverts, to a large extent, to how banks operated prior to the Glass-Steagall repeal.
That may be all fine and good, although the banks really want to trade for their own accounts. Here is the problem, in my view: there is the possibility of a massive loophole. You see, there is a provision of Volcker that says regulators must allow banks to trade if they are merely hedging their own risk. So, under the law, under Volcker, the banks can’t speculate in the markets for themselves, but they will be allowed to trade in order to hedge their own business risk. However, the difference between hedging and speculating isn’t always so easy to distinguish. What is being urged would create a large loophole—an immense breach—in the Volcker Rule because it could allow almost any trades whatsoever to be considered as a hedge.
Say I work at one of these banks and I place a proprietary trade—a hedge—for some business concern that the bank holds. What happens if that hedge gets into the money? By that, I mean, what if it turns out that the hedging trade was something that did really well, something that looked pretty speculative? If I’m the bank and I get questioned by regulators, I simply say, “Hey, we are allowed to hedge our proprietary risk with trades and that is what we did.” Then, the government would be in the position of going to court arguing that the hedge was speculative and not simply a hedge.
I don’t see such cases going forward. The banks would hire an expert economist; the government would bring in its own—a stalemate whereby the government would have a very difficult time making its case. There would simply be too much litigation risk on the part of the government. You see, the “wide open spaces” that such a large loophole could create would leave a lot of room, as the Dixie Chicks sing, “to make the big mistakes.” We would be pretty much back to where we were without the Volcker Rule; banks speculating in the market and taking risks like they did leading up to the 2008 crash, and potentially taking advantage of their own customers.
Now, the Volcker Rule is a provision that amended the Bank Holding Act. The Federal Reserve has primary responsibility for that law. At the same time there are four other regulators who have something to say, or should have something to say, about how the Rule will be finalized. I’m concerned that our Agency—which has a lot of good, solid knowledge and experience about what the term “hedging” actually means and how it is used in markets—ya know risk-management markets—has been fairly inaudible on what the final Volcker Rule should look like. That is why in the morning, I’m sending a letter to Chairman Bernanke of the Federal Reserve Board suggesting that a clear, tailored, stick-to-the-law reading and interpretation of hedging is what should be incorporated in the final Volcker Rule.
In my letter, I write the following:
• The Volcker Rule should be interpreted and promulgated—promptly—so as to protect against the most basic conflicts of interest: that is, prohibiting banks from trading for their own interests ahead of their customers.
• Any exemptions from this prohibition should be considered in light of clear consumer protection objectives, and should be tailored to ensure that the exemptions do not create loopholes from regulation.
• Regulators should look to the CFTC for guidance regarding any exemption relating to "bona fide hedging."
• First, the Rule's definition of "hedging" should ensure that exempt transactions have and retain a risk-management purpose.
B. Second, entities claiming such exemptions should be required to disclose to regulators their risk modeling, to ensure that such calculations are appropriately calibrated.
C. Third, if "hedges" over time result in profits greater than losses on the underlying risk, then there is presumption that the exemption has been improperly claimed. Such willful evasion over time in avoidance of the prescribed oversight should be prosecuted with the full force and effect of applicable laws.
Position Limits
Speaking of speculation, let’s talk about excessive speculation for a bit, shall we? In 2008 we saw energy prices go through the roof. That’s when crude reached its highest point in history in July of 2008 when it touched $147. 27. In fact, through all the talk about gas and oil prices, July of 2008 still stands as the highest price for both. The average gas price then was $4.11. Had anything in the underlying supply issues changed much from earlier in the year when prices were in the low $90s? Nope. What about demand? Was there some big demand, or an expected increase that drove those prices? Nope.
So, what changed? Well, in a three-year period between 2005 and 2008 we saw a massive increase in dollars moving into the futures industry. In fact we saw $200 billion in managed money come in from the likes of pension funds, hedge funds, and exchange traded funds (or ETFs). There certainly isn’t anything wrong with folks putting their money in the futures industry. What we were seeing was an asset class shift. Folks not satisfied with their returns in the equities markets, or simply wanting to expand their portfolio thought, “Hey, why not invest in crude oil, or nat gas, or silver or gold or soybeans?” And, they did.
It wasn’t just the billions that came into the futures markets, though. It was what they (by and large) did with the money. They parked their money and went long. What I mean is that they put money into the futures markets like some of our parents put money into blue chip stocks. They bought and held. If things go right sonny boy, “when I go over yonder you will gets these” and they will be worth something. And folks invested in Motorola or IBM or RCA. Well, they were doing the same thing, but in futures. Their bet (and some don’t like it when people call making trades in the futures industry a “bet” but that is exactly what it is—perhaps an educated bet, but so is doubling down on 11 with a full deck), is that crude, or whatever, is going to be worth more in several years than it is today. They don’t care much if the price goes down today, tomorrow or after the summer driving season. Nope. They are betting, yes betting, on the price going up in several years. They keep their money in the market and unless something really unusual happens, they keep it there. So, they have a fairly passive trading strategy, and many of them are really massive. I’ve termed these traders “Massive Passives.”
I can tell you that in 2008 most of the staff at the CFTC, and all of the other Commissioners didn’t see a need to do anything to curb what I saw as excessive speculation that was leading to large price swings. Look, if prices go up or down based upon supply and demand, that is the market. Regulators are not price-setters, but we are charged with ensuring efficient, effective, and fair markets devoid of fraud, abuse and manipulation. When prices are moved because of excessive speculation, that’s a problem, and I have witnessed it in several markets. All our citizens experienced it to some degree in 2008 with oil and gas prices.
Dozens of studies confirmed exactly what was, and at times continues, going on. In fact, so many people denied that there was evidence of the impact of excessive speculation that I put a bunch of studies on the CFTC web site. They are still up there if folks are interested. Incidentally, there is one that does date back to 1990, by a fellow named Larry Summers. It appeared in the Journal of Finance. Mr. Summers (along with three other colleagues) repudiated the view offered by other economists that suggests speculators reduce volatility. Mr. Summers et al. suggested that excessive speculation could increase volatility and that speculators can do so by joining with other speculators—jumping on the Tradium bandwagon, as it were—of irrational price movements.
Calling for limits, position limits, to ensure that no single trader controlled such a large percent of any given market was something that did gain support. In fact, some key members of the U.S. House like Congressman Joe Courtney who represents this Congressional District, numerous Senators, and none other than President Obama called for limits on speculation.
Finally, a provision was included as part of Dodd-Frank. I should also stop for a moment here to thank Sean for his work in this regard. He was a vocal and firm advocate for limits and I thank him.
So, limits were included in Dodd-Frank. In fact, we were supposed to implement position limits on energy commodities in January of 2011. We missed that deadline. The good news (and my enthusiasm is tempered here, but I’ll explain later) is that on October 12 the first set of CFTC speculative position limits becomes effective. These limits on speculation apply to the spot month, which is generally the period right before trading in a contract expires and the obligation to make or take delivery on a physical delivery futures contract applies. Spot month limits are not new. There has been some form of these limits administered by the exchanges (and also by the Commission in the case of the enumerated agricultural commodities). What is new is that these limits will now apply to swaps, whether they're exchange-traded or over-the-counter.
There are three reasons why I temper my enthusiasm on position limits:
1. Limits on speculative positions outside of the spot month won’t become effective until sometime later, probably sometime early next year—once we get enough data on swap positions. These hard limits on speculation outside of the spot month will be something new for the energy, metals, and non-enumerated agricultural derivatives markets. They are important, but again, won’t be in place in October.
2. I’m also not sure that we have reached the correct limit levels. What I have always said is that we should err on the high side to ensure we aren’t doing damage to the markets by syphoning away liquidity. We need to get the levels correct. So, I’m not suggesting that these limits levels are all right on the mark. They may have to be adjusted as we go forward, and our rule allows for that. Under the rule, the position limits change as the size of the derivatives markets and the size of the underlying physical market change.
3. Finally, while position limits should ensure that no one trader holds a concentration so large that it could manipulate prices, that doesn’t mean that a group of traders acting in concert couldn’t impact prices—as Larry Summers and his colleagues suggested. I’m not even talking about something that would obviously be a violation of law if they did something in collusion. I’m saying, what if a bunch of the Massive Passives simply decided to invest in a market, say heating oil, and all go long? What if there was a herding mentality and once a few did it, a bunch of others followed—regardless of supply and demand?
Remember that glorious footage of the buffalo—the Native American’s tatanka—herds running through the South Dakota grassland in Dances With Wolves? When the herd shifted, it left a path of damage because hundreds followed hundreds of animals.
The fact that all of the Massive Passives—like the tatanka—have an identical herding-type trading strategy could, in and of itself, since they have size and weight, push prices around.
That reminds me of my favorite sign in South Dakota, which is where Dances with Wolves was filmed. There is a hand painted tourist sign that reads:
“EXIT HERE—SEE THE ONLY HORSE IN SOUTH
DAKOTA—Not Used In Dances with Wolves!”
So, on the massive passives and on herding of traders, I’ve spoken to a lot of people about how we might address this circumstance. To be honest, I haven’t figured out an appropriate method. The answer that folks usually give me is to simply prohibit them from participating in the market. I don’t like that idea at all, and I’ve said so.
The bottom line is that these position limits will not completely stop the influence of excessive speculation. However, they will help, a lot. More, however, needs to be done. The art in it will be figuring out a balanced way to do something—in our Tradium-like world—in a way that liquidity isn’t sacrificed.
Gas Pains and Energy Policy
One final thing on energy and gas prices, specifically. I wrote about this in an op-ed this week. If you’ve heard some of the folks on the campaign trail recently, you'd think President Obama was the filling station fella with the long pole—actually raising gas prices all by his lonesome. In actuality, presidents can’t do much to effect energy prices in the short term. But then again, that's not opportune to say in an election year talking point.
When President Bush was in office, in 2008, is when we saw the highest gas prices in history—a record that still holds today. Today’s nationwide average was $3.87 per gallon. (By the way, WTI crude settled at $98.31 today). However, in 2008 when candidate Obama delivered his convention speech, he correctly didn't complain about President Bush and high gas prices. Governor Romney admonished the President for allowing gas prices to increase. Oh well.
What can be done by any President in the short term amounts to only one item: the Strategic Petroleum Reserve (SPR). President Obama used it last year (in cooperation with 27 other countries and a total of 60 million barrels) and gas prices reduced—although only for a little time. The SPR, however, really is for the grimmest conditions. While using it is at the decision of presidents, traditionally they've been hesitant to do so.
Presidents can, and have, tried to address gas and other energy prices through longer-term strategies. President Obama, as I mentioned, sought to end excessive speculation in energy and other markets by limiting the large positions any trader may hold. That’s a feather in his hat, in my view. The President also called for increased penalties for manipulators. The President’s energy policy will—years after he is out of office—reduce by half the amount we all pay for fuel by requiring more efficient vehicles (54 miles-per-gallon by 2025). In addition, his energy policy promotes other fuel sources (wind, bio-based products, solar, hydro, nat gas and clean coal to name a few). To some degree, that's working now. We have become over 70 percent self-sufficient in energy in this country. For the first time since 1949 we have exported more oil and fuel products than we have imported. We have done that two years running.
The complex thing with gas prices is that the longer-view strategies take time to go forward, and reaching political settlement is evasive on something that doesn't have an immediate impact and that can’t be marketed in the next election. That's why it is a simpler proposition to blame a president . . . even when it is exceptionally inappropriate, in my view.
Cheetahs
The last issue area let’s visit has to do with technology. “What’s the frequency, Kenneth?”—the high frequency traders or guys I affectionately call “cheetah traders.” Let me be clear, not “cheaters” like Boston card cheaters, but cheetahs, like the speediest land mammal. These cheetah traders are fast, fast, fast. They are out there 24-7, 365 in Tradium-like markets trying to scoop up micro-dollars in milliseconds. Like the Massive Passives, they are fairly new to markets, certainly to the extent they are in markets today.
For years, I have questioned their value. I wrote an op-ed in the Financial Times almost two years ago called “Cyber Cowboys” where I questioned the value of the HFTs. I’m not suggesting that they don’t provide some liquidity, although I suggest that it is “fleeting liquidity” since they don’t typically hold positions for more than a few seconds. If you want someone to hedge your heating oil for a minute, I know just the cats for you. And at the end of the trading day—although for some it never ends—they are pretty much flat—holding level positions.
I’m impressed with the technology they use and in awe of some of the folks who are behind this sort of trading. They are big-time brainiacs doing innovative and important work, and it is really cutting edge stuff. I certainly don’t want to endanger them as a species.
However, I don’t (as some do) simply think they are the envy of the world. The exchanges like them because they are market makers and provide increased volume. That’s understandable. On the other hand, they were part and parcel to the Flash Crash in May of 2010. Furthermore, because of their speed, cheetahs can sometimes have an impact in markets far beyond their position size. Other traders may look to the cheetahs as early indicators of market movements. In fact, I have seen where this has also started a herding effect (tatanka) in markets and moved prices significantly and swiftly. I think there is a good case to be made that, contrary to what many suggest, they can increase volatility at times.
Another point here is about technology, generally. We all know that sometimes it doesn’t do what it shoulda, woulda or coulda. Just like I went through a partial list of all the problemos with the banks, I can (and have), done the same for multiple malfunctions with technology we’ve seen in markets in the past few years. We saw a major problem at the Tokyo Stock Exchange in August. We all know that NASDAQ had a big issue when Facebook went public. Heck, the CFTC computer system was compromised earlier this year. Just last Friday we saw a 56-minute trading halt in Globex nat gas complex trading. And, early Monday morning we saw another trading halt on CME Globex Volatility Quoted Options, Interest Rate Options, and TRAKRS futures and options. And in June of last year, the natural gas market crashed eight percent in 15 seconds in overnight trading. These are all problems with technology and my point is that we shouldn’t just accept technology as the best thing in the world. We need to realize that like many things, there will continue to be issues. Like that tee shirt, right, “I have issues.” Well, technology has issues.
Here is another problem, the third largest trader by volume at the CME used to be, perhaps still is, a cheetah trader out of Prague, Czechoslovakia. If regulators want to get books and records from that cheetah trader in Prague, forget about it. You see, the cheetahs aren’t even required to be registered with the CFTC. We should do at least four things, and soon:
1. (Registration) As a pedestrian first step, the cheetahs need to be registered;
2. (Testing) but, they should also be required to test their algorithms before they are deployed in the live market production environment; and
3. (Kill Switches) they should have kill switches in case one of these cheetah programs goes feral; and finally
4. (Wash Trading) many times these traders are trading so super-fast that they actually cross their own trades in the market. We call those “wash sales” and they are illegal. We need to get a handle on that and stop it. Wash blocker technology should be required on all cheetah programs and we should require a full accounting of when they happen, and why and what is being done to stop it. And by the way, the report to the CFTC should be signed by the head of the pride, by the leader of the cheetah to ensure that we are getting it from the top.
There are other technology-related things that should be done and I am hopeful that we will soon put forward a concept release on technology issues for the public to comment upon. In fact, I had hoped that we would issue the concept release this summer. We should do it soon pardner. We’re burnin’ daylight. (There, we got the cowboys and Indians in there).
The Destruction of Tradium
If we do these things I’ve spoken about in a responsible fashion—the Volcker Rule, speculative position limits, caging the financial cheetahs, a culture shift in the financial sector—and if we implement the rest of Dodd-Frank in a thoughtful and balanced manner, we will make the financial sector more competitive, provide greater transparency and cultivate increased confidence.
In Tradium, too, all of these things would help pave the way for a positive future. But, unfortunately, Tradium’s days are finished. They are ending as I speak. Sad, right? Twelve, eleven, ten . . . I’d better skedaddle.
It has been a “trasure” being with you. Sorry, “trasure” means “pleasure” in Tradium. It has been a pleasure, a pleasure, being with you…three, two, one—poof!
I know some of you might wonder, being the caring folks that you are, why Tradium had to simply go “poof” and disappear. You were getting to have some affinity for it, weren’t you? Was it the cold-blooded titans, the living on credit, excessive speculation or technology? Was it global warming? What did it in? Well, it only lived inside of my head, oh no (the dream police—police, police).
Thanks for your time and attention. Wakan Tankan Nici Un—May the Great Spirit walk with you.
http://www.cftc.gov/PressRoom/SpeechesTestimony/opachilton-68
RSS Feed