The Goldman Sachs Guide To Manipulating Commodities

How big Wall Street banks are gaming commodities markets.

By SHARE
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Americans have learned a lot in recent years about how our largest financial institutions make their money. But few would have imagined that a million and a half tons of aluminum – a quarter of the national supply at any given moment – typically sits in a network of 27 Detroit warehouses owned by Goldman Sachs. And hardly anyone would have thought that manufacturers seeking to purchase that aluminum might wait 18 months or more for delivery, while warehouse owners like Goldman Sachs collect additional rent, paid for by consumers of aluminum products ranging from beer cans to home siding.

In an important hearing yesterday before the Senate Banking Committee, Tim Weiner of MillerCoors described the operation and how it boosts prices for real-economy companies. The witnesses at yesterday's hearing explained how the largest Wall Street banks have accumulated massive amounts of physical commodity infrastructure, ranging from warehouses to oil tankers to power generation plants.

Supply bottlenecks in bank-owned warehouses are only one part of the story. Banks are central players in the financialization of commodity markets, the treatment of physical commodities as purely financial assets to be manipulated for trading and investment purposes, rather than inputs for the real economy.

The original purpose of markets in commodities and commodity derivatives was to ensure steady prices and consistent availability for real-economy users of commodities. But the selling of commodities as an inflation hedge and a retirement asset (over $440 billion in investor money has poured into commodity investment funds since 2004, as opposed to just $25 billion into equity funds) has transformed these markets, increasing price levels and price volatility, and opening up many opportunities for manipulation.

[See a collection of political cartoons on the economy.]

Some of the richest opportunities for such manipulation lie in combining control of physical commodities with dominance of commodity derivatives and futures markets. The major banks are, of course, key dealers in these derivatives markets. Control of physical commodities allows them to both forecast and influence the spot commodity prices that can determine derivatives pricing. Indeed, some observers have pointed out that bank involvement in warehousing has allowed them to conceal information from the markets on the true supply of physical commodities, creating market squeezes and artificially fueling investor appetite for commodity futures.

Big financial players are constantly seeking new ways to take advantage of this nexus. For example, the Securities and Exchange Commission recently approved the applications of JP Morgan and BlackRock for exchange traded funds (ETFs) that will be backed by physical copper. These funds will store physical copper in bank-owned warehouses to back investor shares in the ETF – potentially creating an investor-funded squeeze in the physical copper markets that would raise commodity prices and make market manipulation easier. 

The potential conflicts of interest and opportunities for manipulation created by the combination of a dominant position in derivatives markets and a dominant position in actual commodity infrastructure are one reason why the traditional division between banking and commerce makes sense. Banks have a central role in the economy, thanks to their key position in the financial markets, their enormous balance sheet resources supported by leverage levels available to no other industry and their privileged access to liquidity. Unless the scope of their activities is restricted, they have too many opportunities for abuse of market power. As law professor Saule Omarova testified yesterday, Americans have traditionally viewed "large aggregations of financial power in the hands of a few money trusts with great suspicion." Such aggregation of power is the inevitable result of a failure to separate banking and commerce.

[Read the U.S. News debate: Are Banks Becoming Too Big to Jail?]

Regulators and legislators can and should take action to limit bank involvement in physical commodities:

  • With increased public scrutiny of the issue, the Federal Reserve announced last Friday that it will review and reconsider its 2003 decision on the scope of commodity activities that it defines as "complementary" to banking and therefore permissible for banks. Reconsideration should lead the Fed to place stricter limits on bank commodity activities.
    • Both regulators and Congress need to reexamine the interpretation and impact of the "grandfathering" provision in the 1999 Gramm-Leach-Bliley Act. Goldman Sachs and Morgan Stanley, who only converted to financial holding companies in 2008, will likely try to rely on this provision to argue that they should be allowed to continue commodity activities.
    • Regulators and Congress also need to establish clear responsibilities for preventing manipulation of physical commodity markets. Right now, it's not clear who has this job. The prudential banking regulators do not see the integrity of commodity markets as part of their mandate, even though the institutions they regulate have enormous capacity to manipulate these markets. The Commodity Futures Trading Commission regulates commodity derivatives markets, but not the markets for physical commodities. The Federal Energy Regulatory Commission does regulate spot markets in energy, but not in other physical commodities. The Securities and Exchange Commission regulates securities markets but not commodity markets. And the Justice Department has generalized anti-trust authority to prevent abuse of market power, but lacks the depth of experience and resources to provide a consistent presence policing commodity markets. It's crucial to get a cop on this beat.

      Marcus Stanley is policy director of Americans for Financial Reform, a coalition of more than 250 civil rights, consumer, labor, business, investor and other groups working for a strong, stable and ethical financial system.

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