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January 29, 2010

Looking at Davos through the Enron loophole

This week the bankers are throwing down the gauntlet to President Barack Obama at the World Economic Forum in Davos, Switzerland: don’t break up the “Too Big to Fail” (TBTF) banks or there will be “unforeseen consequences” beyond the past week’s flight of investors from financial markets. The bankers propose to defeat the anti-TBTF initiative—not under the bright lights of the coming U.S. electoral season, but in the negotiating rooms of the Bank of International Settlements in Basel, Switzerland and in preparations for the Group of 20 meeting in June in Canada. There, bankers can coordinate policy to ensure that TBTF Business As Usual may continue.

It is not clear what triggered President Obama’s decision to begin heeding the advice of his adviser, former Federal Reserve Bank chairman Paul Volcker. However, one of the targets of the “Volker Rule,” which would break up and rein in the TBTF banks, concerns a trading practice that resulted in the bank-induced commodity price volatility, which has damaged global food and energy security since 2007.

In proprietary trading (trading the bank’s own, largely borrowed, money), the banks, which have received a total $12.2 trillion of taxpayer bailouts as of December 2009, create and market financial products. Then armed with the knowledge of their own products’ vulnerabilities, they trade against their own clients’ investments, as detailed in a stunning article by Gretchen Morgenson in the New York Times. Short selling against commodities—e.g., in Goldman Sach’s commodity index funds—was among Goldman’s proprietary trading targets.

However, not all needed reforms are initiated at the presidential or intergovernmental level. On January 14, the Commodity Futures Trading Commission (CFTC) announced a rule to begin to close the nearly decade-old "Enron loophole," named for the company that had most ardently lobbied for it and than ruthlessly exploited it. The loophole exempts investment banks, hedge funds and energy futures traders from regulations that limit the number of futures contracts that can be held by any one entity at any one time. Trading without limits allowed oil-dominant commodity index funds to induce volatility in wheat futures prices (according to a June 2009 U.S. Senate investigation) as the index speculator “weight of money” overwhelmed the resources of traditional commodity traders.

Two of the five CFTC commissioners who voted for the futures contract limits acknowledged U.S. financial industry warnings that even the generous position limit rule would drive energy trades overseas, especially to their London branches. It almost goes without saying that proposals to regulate European markets are met with industry threats that trades will be executed in U.S. markets.

IATP, as a member of the Commodity Market Oversight Coalition (CMOC), commended the CFTC for beginning to close one of the most damaging loopholes to food and energy security of the past decade. On January 15, the CMOC and Americans for Financial Reform released joint principles for new legislation to regulate the over-the-counter (off-exchange) derivatives market of both commodity futures contracts and such notorious financial instruments of mass destruction as credit default swaps.

The U.S. Senate will hold hearings in February on OTC derivatives legislation to complement the The Wall Street Reform and Consumer Protection Act of 2009, passed by the House of Representatives on December 11. IATP will be working with the CMOC and AFR to close loopholes in the House bill that could continue to exempt nearly half of all OTC trades from regulation and leave them in “dark markets.”

The CFTC rule was published in the Federal Register on January 26. The comment period on the rule is open until April 26. IATP hopes both national and international allies will comment on this rule, which can be implemented without new legislation. Closing the Enron loophole will not only reduce runaway energy prices but also reduce agricultural price volatility, whether or not agricultural contracts are bundled into oil dominant commodity index funds.

For the bankers in Davos, a look through the Enron loophole would be instructive. The capacity of taxpayers, governments and workers to go into debt to pay for the damage caused by financial services industry deregulation is not infinite. Closing the Enron loophole, together with the implementation of the "Volker Rule" in legislation, cannot repair the damage already done, but can help prevent further pillaging of the real economy and its people.

Steve Suppan


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