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Prepared by:

Thomas O. Gorman,
Dorsey and Whitney LLP
1801 K St. N.W.
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Gorman.tom@Dorsey.com

 
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    Policy


    Do the Markets Work for You? Position Limits, Massive-Passives, Cheetahs and Culture

    CFTC Commissioner Bart Chilton addressed the Arkansas State University Agribusiness Conference (Feb. 13, 2013) in remarks titled “Red” – perhaps because the school is known as the “Red Wolfs” and it is valentines day this week. The Commissioner’s remarks – aside from numerous references to “red” – focused on the question: “Are these markets working for you?” To examine this point Commissioner Chilton focused on four interrelated points: 1) the origins and purpose of the markets; 2) position limits; 3) high speed trading; and 4) culture.

    First, the commodity and futures markets are rooted in agriculture and evolved as a place for produces, processors and consumers. Those markets permitted produces to hedge their crops and facilitated price discovery for them as well as consumers. Speculators benefited the markets and the participants by adding liquidity which helped narrow the spreads.

    Then came the market crisis which the Commissioner described this way: “The high-flyers were taking speculative risks beyond anything we’d ever witnessed. Many times these were wild, casino like financial instruments – derivatives, on say bundles of mortgages – that wrecked our economy when they crashed. Nine million people lost their jobs – millions more their homes.”

    This lead to the second point, position limits. Now in the commodity markets there are what Commission Chilton calls the “Massive-Passives.” These are huge index funds, hedge funds or other types of managed money that simply take a position and park. Query whether these types of huge speculative interests in the markets are influencing prices. Stated differently, do the markets still work for producers and consumers? A “myriad” of studies such as those by Goldman Sachs, Rice University, MIT and the Federal Reserve Bank of St. Louis have documented the fact that speculation and the Massive-Passives are influencing prices. That impacts everyone from Wall Street to Main Street. For this reason Commissioner Chilton favors position limits. The CFTC’s position limits rule was, however, recently invalidated in a case that is on appeal to the D.C. Circuit.

    High speed traders, or “cheetahs” as Commissioner Chilton calls them because of their speed, were the third point. High speed traders move in milliseconds or one-one thousandth of a second. They move far faster than other market participants. While they have benefits for the markets, there are also costs. A recent study done in conjunction with the CFTC concluded that high seed trading imposes quantifiable costs on small investors. This does not mean they should be banned but suggests that some sensible rules be put in place. Commissioner Chilton has previously detailed a proposal for such rules.

    Finally, the critical question is culture. Although the market crisis and its excesses have passed the scandals and wrong doing have not. MF Global and Peregrine are two recent examples where investors lost substantial sums. There are others. Wells Fargo discriminated against mortgage customers. Bank of America cheated thousands of others with “crooked debt and overdraft fees.” And, the Libor debacle impacted anyone with a loan and debt While agencies like the CFTC bring case after case essentially it is not enough. Rather, the critical point was recently summed up by Barkleys new CEO, Anthony Jenkins who bemoaned the fact that his bank had gone after short-term profits at the expense of values and the firm’s reputation Commissioner Chilton noted. Mr. Jenkins put it this way: “We must never again be in a position of rewarding people for making the bank money in a way which is unethical or inconsistent with our values.” In the end rules and enforcement cases can help make the markets work for everyone but it takes good culture to achieve that result.

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