The Federal Reserve, in a surprise move, set the ball rolling late Tuesday for possible new limits on ownership of physical commodities by the large financial holding companies on Wall Street that it regulates.
The Feds advance notice of a proposed rulemaking came after months of pressure, following news reports that showed that Goldman Sachs & Co. and JP Morgan Chase & Co. were involved not just in the trading of financial contracts for delivery of commodities but actually had their feet in the physical markets where aluminum and copper are stored and delivered in the real economy.
Buyers of these products complained of market distortions, and the Fed said last summer that it was looking into the issue. On Tuesday it sought comment on greater regulation of this activity, giving interested parties until March 15 to provide a written response.
In making its case for the possible additional regulation, the Fed cited recent explosions of railroad tank cars carrying crude oil from North Dakota and BPs disastrous oil spill in the Gulf of Mexico.
While the Board has placed limitations on physical commodities activities that were designed to reduce safety and soundness risks, recent incidents suggest that review of these limits is prudent to determine their adequacy in protecting safety and soundness and financial stability, the Fed said. In addition, ownership of physical commodities that are part of a catastrophic event could suddenly and severely undermine public confidence in the FHC (financial holding company) or its insured depository institution and undermine their access to funding markets until the extent of the liability of the FHC can be assessed by the market.
From a consumer standpoint, the concern with big banks owning or storing physical commodities such as barrels of oil or bushels of wheat is that they can artificially affect the supply of products, thus the final price, while potentially benefiting from the bets theyve made in the futures market, where contracts for future delivery of commodities trade. Wall Street banks also could affect activity in the so-called dark markets, where huge private two-party bets are made about the future movement of commodity prices.
McClatchy in recent years has reported on how Wall Streets recent and outsized involvement in the commodities markets may have raised the price of everything from gasoline to cotton and coffee.
Coming on the heels of numerous settlements with regulators tied to the housing crisis, Wall Street banks appear to be shying away from new controversy. JP Morgan Chase said last July in a surprise statement that it was exiting the physical commodities market. Morgan Stanley and Goldman Sachs have both said theyre trying to sell off some of their physical commodities business, too.
The Fed notice got a thumbs-up from Sen. Carl Levin, D-Mich. His Permanent Subcommittee on Investigation has been investigating Wall Street wrongdoing during the financial crisis and has been looking at bank ownership of commodities.
Citing oil spills, railway crashes, nuclear power plant meltdowns and natural gas explosions, the Federal Reserve describes how a low probability but high cost catastrophic event could shake public confidence in a major financial institution, triggering problems for the bank holding company, its federally insured bank, and even the U.S. financial system, Levin said. The Fed is absolutely right when it says we need to consider strengthening the limits on bank participation in physical commodity activities.
By Kevin G. Hall
McClatchy Washington Bureau