Senate investigators found that banks including Goldman Sachs, Morgan Stanley and JPMorgan bought metals warehouses, crude oil tankers and other prospects in the physical commodities world, then used these businesses to gain unfair advantages and influence markets.
“It’s time to restore the separation between banking and commerce and to prevent Wall Street from using nonpublic information to profit at the expense of industry and consumers,” said retiring Sen. Carl Levin, who runs the committee.
The banks have objected to the report’s findings.
The report marks the end of a two-year bipartisan investigation into how the nation’s largest banks behaved in the commodities markets. The findings suggest that the answer is “not very well,” -- but it was the Federal Reserve, rather than the banks, which earned the bulk of the Senate’s scorn.
The Senate report faulted the Fed, the nation’s largest bank regulator, for not knowing how many commodities these banks owned and for allowing the banks to violate their regulatory limits. The report cited J.P. Morgan’s physical commodities business, for instance, for holding the equivalent of 12% of its regulatory capital in physical commodities - more than twice the regulatory limit.
The Senate said that because commodities are mercurial in price, the excess holdings by banks posed potential risks to firms and the financial system.
The report pointed to BP’s Deepwater Horizon explosion in the Gulf of Mexico as an example of a risk that could have taken down a bank.
Many in the commodities markets scoffed, however. The Senate’s report shows little evidence that the banks did anything illegal like manipulating prices, experts said.
“If they find stark evidence of collusion or price-fixing or something like that, then all bets are off. Then they can go after them, like they’ve gone after them for the other scandals, such Libor,” said Edward Meir, commodities consultant at INTL FCStone. “From what I’ve read, there’s no smoking gun, just circumstantial evidence.”
The report could pressure the Federal Reserve to reconsider its 12-year-old decision to allow big banks to own commodities.
Hearings about the report’s findings start on Capitol Hill on Thursday and Friday. Under the eye of retiring Sen. Carl Levin (D., Mich), executives from Goldman, Morgan Stanley and JPMorgan are slated to speak, along with other speakers who are expected to say the banks weren’t playing fair.
Traders, consultants and other commodities experts, however, said that the Senate’s findings are thin and that two days of Capitol Hill hearings are likely to be no more than “good theater” with little lasting impact, said Meir.
The reason: While thorough, the Senate’s report may come too late to change the working of the commodities markets. Commodities traders, consultants and other experts said too much has changed in the commodities markets, rendering the report’s findings moot.
In other words, while the Senate’s censure cannot be ignored, that ship -- or rather, that tanker -- may have sailed.
Several banks knew of the Senate’s probe some time ago as regulators made their dissatisfaction known.
In July 2013, the Commodity Futures Trading Commission and the Justice Department opened investigations of banks who own metals warehouses, looking for collusion or price-fixing.
The Federal Reserve followed by signalling a year ago that it was considering imposing bigger surcharges on banks that maintained physical commodities operations like metals warehouses and power plants.
With such broad signaling from authorities that trouble loomed, the banks decided the headache of being in this tiny section of the global markets just wasn’t worth it.
As a result, the banks have been planning their exits.
Credit Suisse and Deutsche Bank are packing their bags, JPMorgan shed much of its business in a series of sales adding up to roughly $3.5bn, and Morgan Stanley is paring back its operations. The metals warehouses owned by Goldman Sachs -- the properties at the heart of the Senate’s review - are currently on the auction block. New rules from commodity exchanges supervising warehouses have also drastically cut the wait time for car manufacturers, aluminum can makers and other users.
As a result, the two-day Senate hearing on banks’ role in commodity markets is more likely to be “good theater” than to have any lasting influence or impact on the markets, say experts.
“The hearings are looking at a market environment from 12-18 months ago that doesn’t exist now,” said Nic Brown, head of commodity research, at Natixis.
So a lot of this “is a bit after the fact,” Meir said. “They’re going to raise a stink, call people up and ask questions. They’re going to fish for is to see if anything illegal transpired.”
Why were banks even allowed to own physical commodities in the first place? It comes back to that Fed decision a dozen years ago to allow Wall Street firms to own physical commodities.
A big part of the Senate report focuses around the warehouse system run by the London Metal Exchange.
The banks took advantage of the rules the LME had on warehouse management, and it caused huge backlogs of metal being delivered to buyers in two key regions: Detroit and Vlissingen, the Netherlands.
Buyers who wanted metal, like a car company, at times had to wait up to two years to get aluminum delivered, versus a couple of months previously. The Senate report said Goldman would give some companies an incentive to keep their metal in the warehouse, which benefitted the bank.
“(The banks) were gaming the system. The rules the LME had were very reasonable seven, 10 years ago. But the situation changed,” Brown said.
This went on for years, until companies like MillerCoors -- who needed their aluminum -- became fed up and complained to regulators.
In July 2013 these companies took part in Senate subcommittee hearing, which made the probes and investigations visible to the public.
Soon after that July 2013 hearing, the LME started to explore a change to its rules and wait times fell drastically. Meir said they should have made those changes long before.
“What I fault the LME for is that they are supervisors of the warehouses, they write the rules, they should tell them (warehouse owners) how to play the game so that consumers who had legitimate physical needs would not be disadvantaged by queues (wait times) generated by shuffling metal,” Meir said.
Meir said when the biggest concerns over the warehouse rules were voiced, actual aluminum prices were falling.
Premiums, however, were rising. Premiums are the added costs buyers must pay to get goods delivered.
“The banks could argue that aluminum prices were actually falling when all of this was going on. It’s not like they were engineering a spike. The premiums were going up, but it wasn’t a ‘squeeze’ in the traditional sense of the word,” Meir said. “What they did was not illegal, although it certainly did not look that good to the marketplace, to consumers and to the regulators.”
The committee, under Carl Levin, has earned a reputation for disciplining Wall Street wrongdoing. The committee has previously issued blockbuster reports that criticized Goldman Sachs on its mortgage trading and JP Morgan for its London Whale trade.
This article was written by Debbie Carlson, for theguardian.com on Thursday 20th November 2014 20.37 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010