Senate Report Finds Strong Wall Street Influence on Commodities Markets

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Legislators urge the Fed to increase oversight of large banks.

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A Senate report recently highlighted the growing influence of Wall Street banks on commodities markets. In a review of three major financial institutions, the Senate Permanent Subcommittee on Investigations claimed that some banks profit from their outsized influence over commodities markets by engaging in certain strategic acquisition and trading activities. The Committee argued that this poses risks both to the banks and the broader economy, and it urged the Federal Reserve to strengthen its oversight of commodities trading.

In its report, the Committee warned that the “long tradition of separating banks from commerce . . . is eroding.” To assess the influence of banking behavior on commodities markets, the Committee developed case studies involving three banks: Goldman Sachs, JP Morgan Chase, and Morgan Stanley. These three banks are the holding companies with the largest levels of involvement with physical commodities. The report explained how these banks have expanded their commodities-related trading beyond buying and selling stock to include owning not only commodities themselves, but also the plants and storage facilities that enable commodities trading.

Products are often differentiated from each other based on factors like branding, design, or serviceability. However, because commodities are often raw materials, they generally are not differentiated in ways that other products can be. Thus, commodities prices can be influenced by the entity that controls the supply of the commodity more than other products’ prices can be so affected. The Committee argued that the banks in the case studies have gained disproportionate power to influence commodities prices by controlling the supply of commodities as well as securing inside information about the items they would be trading.

The Committee stated that the banks’ power presents at least four major problems. First, banks may speculate too aggressively or simply acquire too much of a risky asset. In addition, banks may gain unfair trading advantages because they can afford to own mass facilities. Banks also may start to commingle banking with other commerce activities, which may produce prices that do not reflect the true value of commodities. Finally, the Fed may be unable to regulate bank behavior.

To illustrate these problems, the Committee explained how Goldman Sachs purchased a company that manages most of the exchange-traded aluminum in the U.S. Following that acquisition, Goldman Sachs increased its trading in aluminum to its highest historic level. The Committee posited that the bank then profited by manipulating the flow of aluminum in and out of the facility and by gaining access to information through its subsidiary about the aluminum industry that was not available to other traders.

The report also examined JP Morgan Chase’s acquisitions of metals and power plants. It alleged that the bank took advantage of lax oversight from the Fed in order to increase its metals purchases to 12% of its total holdings—more than double the current 5% limit. The Committee also stated that JP Morgan Chase has recently acquired over 30 power plants and argued that it has been manipulating electricity payments and blocking power plant modifications in order to maintain an advantage in trading.

The Committee made similar claims about Morgan Stanley, alleging that its efforts to construct a new natural gas facility, dealings with a natural gas pipeline company, and involvement with oil storage and transport activities all showcase the bank’s outsized influence over oil and gas trading.

The Committee urged the Fed—the agency with sole authority over bank holding companies in the U.S.—to separate banking and commodities activities and to clarify limits on commodities holdings. It argued that owning commodities (and their related ventures) presents risks that could threaten the stability of financial institutions that are essential to the functioning of the U.S. economy. Some of the entities held by these banks engage in risky behavior for which a bank could be subject to liability. Senator Carl Levin (D-MI) characterized this risk by positing, “imagine if BP had been a bank.”

The report also cited a 2012 study the Fed completed that found that banks had not put aside enough capital or purchased enough insurance to protect themselves from catastrophic scenarios that could arise in a commodities downturn. The Committee argued that the Fed has failed to address this known issue.

Most physical commodity transactions are not regulated by the U.S. Commodity Futures Trading Commission, U.S. Securities and Exchange Commission, or any other bank regulator; therefore, banks can currently make relatively outsized trades with little oversight. A downturn in commodities values could thus have an outsized impact on a bank that has made excess purchases. Excessive commodities holdings pose risks to the banks themselves and pose a future bailout threat to the economy. Commodities markets make up a large portion of financial trading in the U.S. and, as the report pointed out, banks have historically not been allowed to hold commodities.

It is possible the Fed will decide to take action on commodities trading. The Senate Committee released its report at a time when the Fed is facing heightened scrutiny—both from within and from other federal authorities—over its relationship with banks. Indeed, Fed Governor Daniel Tarullo recently testified before the Committee about the Fed’s oversight of commodities activities. After criticism that regulators became too close to banks in order to regulate them effectively, the Fed announced its intent to perform a comprehensive internal review of its oversight procedures, which may result in stronger regulation of commodities trading.