from Commentaries:
CFTC prepares to recant speculators’ influence
-- John Kemp is a Reuters columnist. The views expressed are his own --
Like Archbishop Thomas Cranmer before he was burned at the stake for heresy, the U.S. Commodity Futures Trading Commission (CFTC) seems about to make a dramatic recantation.
Later today, the Commission will hold the first of three public hearings to discuss whether to impose tougher position limits in energy markets and restrict the availability of hedging exemptions. But it is already preparing to release a report that will accuse speculators of playing a significant role in last year's oil price spike, according to a report in the Wall Street Journal.
While it might seem a minor shift in emphasis, it is a radical reversal of the Commission's previously stated view that there was "no evidence" that investment flows had a material impact on prices. Commission staff have doggedly maintained that physical supply and demand factors could explain all the observed volatility in oil and other commodity prices over the past two years.
The position was stated most forcefully by CFTC Chief Economist Jeffrey Harris in testimony to the House of Representatives' Agriculture Committee in May 2008 (http://www.cftc.gov/stellent/groups/public/@newsroom/documents/speechandtestimony/harris-fenton051508.pdf).
It was repeated in September 2008 in the CFTC's "Staff Report on Swap Dealers and Index Traders" and again this year in a joint report with the United Kingdom's Financial Services Authority (FSA) on commodity regulation for the International Organisation of Securities Organisations (IOSCO).
The Commission's view has come under pressure from sceptical legislators as the scale of speculative positions in commodity markets and the number of exemptions the Commission and exchanges have granted have been revealed. Congressional anger threatened to derail Gensler's confirmation. The price of allowing him to take office seems to have been a promise to take a tougher approach.
Credit control will be much more intrusive in future
– John Kemp is a Reuters columnist. The views expressed are his own –
The international system of bank regulation, epitomised by the Basle II process and the light-touch principles-based regulation of Britain’s Financial Services Authority (FSA) has comprehensively failed.
In too many instances, light-touch principles-based regulation with an emphasis on banks’ internal risk controls turned out to be no effective regulation at all.
Former Fed Chairman Alan Greenspan was the most prominent proponent of this approach, which relied on the profit-maximising self interest of financial institutions to limit risk-taking to prudent levels.
In this view, bank leaders themselves could be relied upon to manage their institutions prudently — after all bankruptcy is not in the interest of shareholders. Previous bank failures (such as Barings) were the result of failure to measure risks properly, or failures of internal communication and control.
So the job of regulators was to set out principles and ensure banking institutions had adequate internal systems and controls, then allow senior management to ensure the overall level of risk was prudent.
This reliance on internal risk-management systems has proved to be a huge error. As Greenspan himself noted recently, bank leaders had not acted in the careful manner he had expected when he pushed for them to be freed from the old, more restrictive regime.
Why this backlash against Basel II?
The first lesson I learned 15 years back when I joined an Indian Bank (incidentally by name Indian Bank) as Probationary Officer was to never ever get in to the Real estate lending. The Real estate lending was seen, is seen and will be seen by the public sector banks in India that cautiously. It’s a kind of taboo for public sector banks in India. Over a period, they have also liberalized their policies but still with a lot of caution. Indian public sector banks have largely survived the present turmoil. I am not blaming the banks who are bullish on the real estate funding. But, it reflects the underlying risks involved in this exposure.
Let’s visit American market for once:
1. Banks knowingly take exposures on sub-prime borrowers.
2. They are nicely wrapped under CDSs
3. CDSs are rated high in the market.
4. Banks buy nicely packed CDSs at high premiums without knowing the crap under the wrap.
5. Sub-prime borrowers default.
6. Banks collapse.
7. Basel II has failed.
Why can’t the so called John Kemps and Alan Greenspans say for once CDSs failed? The high bonus driven profit maximization strategies of the banks with least sympathy to the public funds are prime reasons for the market turmoil.
Let us now get in to a story mode:
I earn 100 bucks a month, I can invest a maximum of 100 bucks in stock market or take an exposure for 5 times of that which is 500 bucks if I do day-trading (depending upon the margin requirements, assuming 20 per cent). I invest in good scrips based on the market research and some kind of tips from my broker. (This is similar to the Standardized Approach for credit risk suggested by Basel II wherein banks take external ratings supplied by Moodys, S&P, Fitch etc. into consideration). Once I get some sort of maturity as a player in the market I develop my own mechanisms to identify which company is good and which company is bad etc. (This can be correlated to the Internal Ratings based approach suggested by Basel II wherein you rate your own customers based on various risk parameters and risk profiling). I make all my sincere efforts to understand the market dynamics before taking any exposure. I leave no stone unturned to dig out the risks involved. After all, it is my hard earned money. I don’t require any Basel II here.
Let us suppose, my stock market exposures are regulated by Basel II, then Basel II has given me ample room to initially understand the market over a period (The Standardized Approach) and then move on to my own developed mechanisms (The Advanced Approach). Do I still expect Basel II suggest me to restrict my exposure to only 500 bucks, as this is the maximum I can leverage? Can’t the so called best brains of the world (Harvards, London BSs, IIMs) working with Lehmans with fab bonus driven packages understand the basic risk management principle in any walk of life, in this case the LEVERAGE (Mind you, there is a leverage point in dealing with spouse also). When Lehmans were collapsed, their leverage was well above 25 times.
Further extension to the above story, If I am greedy enough, I start borrowing from my next door neighbor and invest in the market and when market collapses, I sit pretty and blame my wife (Banks blame Basel II) as I was never told by my wife not to borrow from others. I apply for an IP and there ends my liability to my next door neighbor.
Basel II is aimed at improving the risk management practices, not policing against deeds and misdeeds of the banks. If the Banks’ management chose to be dishonest, Basel 20 or 200 also can not help.
Could you please post your article “Peak Oil is right answer to wrong question” on this blog so that I may pull it to pieces. However, I suggest that you have a look at the energy costs in extracting non-conventional oil or CTL. The production costs (mostly natural gas) are absolutely linked to the oil price, so as oil prices rise, so do production costs, which in turn cause the price to rise some more. A sustainable level of production in the Canadan Tar Sands, even if nuclear is used, would be no more than a paltry 5 million barrels a day (in 20 years) this is because of the water (& other environmental) constraints. The IEA predict peak beyond 2020, but this is only because of a growth in production in “Fields yet to find”. These fields are however unlikely to be developed as the bulk of them are in OPEC and OPEC won’t want to develop them even if they are found.