I've been having a running debate with a friend about the central role that the lack of government oversight has played in the current financial crisis. He (a good Republican) has argued that we have sufficient laws in place, and that the problem is really about criminality--we just have to enforce the laws on the books. I have argued that it's not about lawbreaking, it's about a lack of laws altogether.
Two remarkable recent events (the collapse of oil prices and the bailout of AIG) have shown just why regulation is so important, and why the Republican approach of minimizing or eliminating regulation of the financial markets is so dangerous (see AndreNeil's excellent diary for more on McCain financial advisor Phil Gramm's role in deregulation legislation).
Follow me below the fold for more on Why Regulation Matters . . .
Let's start first with the collapsing price of oil (down to $92 a barrel today, from a high of $150 just two months ago).
Commodity index investors, blamed for record oil prices, sold $39 billion worth of oil futures between a July record and Sept. 2, causing crude to plunge, according to a report released today.
The work by Michael Masters, president of the Masters Capital Management hedge fund, blames investors who buy and hold an index of commodities for driving prices to records and for their subsequent drop . . . Congressional pressure on the CFTC to step up enforcement and restrict anonymous trades has pushed index traders out of their positions, Masters said.
http://www.ibtimes.com/...
The really funny (and by funny I mean "in violently absurd contradiction to anything resembling rational thought") part of this whole situation is that there are people trying to argue this (emphasis mine):
That view was challenged by the Smart Energy Policy Coalition, a group that represents the futures industry and commodities dealer trade associations.
"The findings of the new 'report' ... run counter to the analysis and judgment of the vast majority of economists, as well as Federal Reserve Chairman [Ben] Bernanke, Treasury Secretary [Henry] Paulson, the International Energy Agency and the Commodity Futures Trading Commission," the group said in a statement.
It noted that those authorities had concluded that rising oil prices were "the result of global economic conditions, the changing strength of the dollar and supply-demand fundamentals, not speculative trading activity."
http://www.newsobserver.com/...
So according to these representatives of the organizations at the heart of this entire ‘crisis’, the fact that prices skyrocketed overnight two months ago and are now falling back to earth faster than the disappearing value of Lehman shares is entirely attributable to shifting economics and ‘supply-demand fundamentals’ and not the abuse of an unregulated system by their clients. Unfortunately for them, the truth is not so benevolent to their argument:
But unregulated markets account for about two-thirds of oil trading on financial markets, and they could be used to manipulate oil prices on the regulated exchanges that account for the remaining oil trading.
The finding that some speculators exceeded positions in regulated markets is sure to spark debate about how much the CFTC knows about the markets it regulates, whether more stringent reporting requirements are needed, and whether the government should require more disclosure from speculators and investment banks.
http://www.newsobserver.com/...
In 2007, speculators owned just 37 percent of the contracts to buy West Texas Intermediate Crude on the New York Mercantile Exchange. The remaining 63 percent was controlled by oil refiners, wholesalers, trucking companies and other end users of petroleum products.
By April of this year, the proportion had almost reversed itself. Speculators controlled 71 percent of the contracts while oil users held only 29 percent.
http://www.consumeraffairs.com/...
The speculators, uncontrolled by any type of regulatory oversight, grossly distorted the market through their activity, creating a giant price bubble. Once they left, prices crashed back to earth.
But wait, there's more. My friend responded by saying, ok, even if that's true, so what? If we impose regulation here, they'll just move to trading in London or Frankfurt. I pointed out that the evidence to argue against that is in the above News and Observer story: "Congressional pressure on the CFTC to step up enforcement and restrict anonymous trades has pushed index traders out of their positions". When oversight (or event the threat of it) manifested, the speculators folded up their tents.
But it turns out that my answer was too simplistic. The truth is actually a bit more complex than that--they were already trading on the London Exchange, and that was a big part of the problem:
Then, apparently to make sure the way was opened really wide to potential market oil price manipulation, in January 2006, the Bush Administration’s CFTC permitted the Intercontinental Exchange (ICE), the leading operator of electronic energy exchanges, to use its trading terminals in the United States for the trading of US crude oil futures on the ICE futures exchange in London – called "ICE Futures."
Previously, the ICE Futures exchange in London had traded only in European energy commodities – Brent crude oil and United Kingdom natural gas. As a United Kingdom futures market, the ICE Futures exchange is regulated solely by the UK Financial Services Authority. In 1999, the London exchange obtained the CFTC’s permission to install computer terminals in the United States to permit traders in New York and other US cities to trade European energy commodities through the ICE exchange.
Then, in January 2006, ICE Futures in London began trading a futures contract for West Texas Intermediate (WTI) crude oil, a type of crude oil that is produced and delivered in the United States. ICE Futures also notified the CFTC that it would be permitting traders in the United States to use ICE terminals in the United States to trade its new WTI contract on the ICE Futures London exchange. ICE Futures as well allowed traders in the United States to trade US gasoline and heating oil futures on the ICE Futures exchange in London.
Despite the use by US traders of trading terminals within the United States to trade US oil, gasoline, and heating oil futures contracts, the CFTC has until today refused to assert any jurisdiction over the trading of these contracts.
http://www.globalresearch.ca/...
Unregulated markets in oil futures created the gas 'crisis' of this past summer, not supply and demand. Consumers are paying $4+ a gallon and higher prices for nearly everything else because of the increased cost of fuel, and we're twisting ourselves in knots debating whether and where to drill. And all of this happened because of unchecked greed and a lack of regulation.
That story makes a pretty clear case for the need for greater oversight in the oil futures market. But I hear you saying, "Yeah, but that's a commodities business--they're Wild West gunslingers anyway, and anything goes. Everyone expects that to be a mess, but nothing like that would happen in the button-down insurance business. The AIG problem must surely be the result of crooks and law-breaking!" Sadly, my friends, it is not:
But AIG's downfall involved a new kind of insurance its financial products unit offered investors in complex debt securities.
Its stock tumbled faster this year as first the debt securities lost value, and then the derivatives-based insurance contracts came under a cloud.
The Fed's extraordinary rescue of AIG underscores how much fear remains about the destructive potential of the complex financial instruments, like credit default swaps, that brought AIG to its knees. The market for such instruments has exploded in recent years, but it is almost entirely unregulated. When AIG began to teeter in the last few days, it became clear that if it defaulted on its commitments under the swaps, it could set off a devastating chain reaction through the financial system.
. . .
Most of AIG's subsidiaries are considered healthy and stable, and there is little question about who regulates them. AIG's crisis grew primarily out of its financial products unit, which dealt in complex debt securities and credit default swaps.
The swaps are not securities and are not regulated by the SEC And while they perform the same function as an insurance policy they are not insurance in the conventional sense, so insurance regulators do not monitor them either.
http://www.iht.com/...
Both of these situations occurred because market actors were doing their jobs of attempting to maximize the return to their investors. They aren't responsible to the rest of us for the consequences of their actions, but as recent events have shown, we pay the price when things go out of control. The necessary role of government in these situations is to make sure that someone is looking out for the rest of us, and policing the playground.
Without true government oversight by watchdogs that are committed to reining in the excesses (and competent enough to know what they're supposed to be looking for), these crises will continue to occur. We've seen this story before in the S&L crisis of the '80s, and we're seeing it again now in the mortgage crisis, both of which were also brought about by a failure to constrain the market forces that are driven to maximize short-term gain with little regard for external consequences.
It's no coincidence that these problems occur under Republican administrations, because the Republican philosophy is that no regulation is good regulation. And while McCain today called for greater oversight, he has consistently favored deregulation while in the Senate.
This crisis is crying out for a coherent and comprehensive policy to monitor the activities of the markets, and do so on a long-term basis, which can only be accomplished if we have leadership that believes that regulation matters. Barack Obama has been promoting just such a plan since March. I encourage you to let other people know about this--share the news with your friends. I did, and in the end he was finally persuaded to believe that it's worth coming over to our side (if only this one time . . . :).