By ANN HINCH
Assistant Editor

WASHINGTON, D.C. — A bill is now moving through the U.S. House that, if made law, could give the Commodity Futures Trading Commission (CFTC) broader oversight of non-commodities stock trading.

Instruments such as credit default swaps used in over-the-counter (OTC) trading are unregulated. A Congressional Research Service document defines credit default swaps as “contracts that provide protection against default by third parties, similar to insurance.” Among the most notorious of these have been credit defaults for subprime mortgages.

One criticism has been that because credit defaults are easier to trade than insurance, some parties involved that gained from such swaps never experienced actual risk, yet still profited even if the original credit holder suffered a loss. Another has been lack of transparency – even to regulatory agencies – of just who is trading these swaps.

Shawn Hackett of Hackett Financial Advisors, Inc. said OTC is also called “the dark market” because it has no oversight, no margin calls and no accountability. This market is legal; Hackett said it has been around for some time, but really started being used more in the past few years.

“People just got so carried away,” he said of its usage, describing it as “no one watching the store” and the trading being done with a “casino-type mentality.” Those responsible for creation of the OTC market, he said, convinced politicians oversight wouldn’t be necessary.

“I’m not saying it does happen,” Hackett said of unsavory OTC trading of commodities, “but I think what (those in Congress favoring more oversight are) saying is any OTC market has the potential to go astray.” (A House Ag Committee staffer who asked not to be named explained by law, ag commodities cannot be traded off the exchange – but there are more commodities than just food, such as energy and metal.)

Ranking Minority Member Frank Lucas (R-Okla.) of the House Ag Committee said House Bill 977 passed by voice vote out of committee almost two weeks ago and is awaiting changes in the House Financial Services Committee, of which he is also a member. It could pass through others – such as Energy and Commerce, for example – before it goes to the full House for debate.

“This is not the bill, necessarily, that will go to the floor of the United States House,” he explained of what came out of the Ag Committee, adding there may be similar legislation in the Senate. “You have to classify this as a work in progress.”

Last year, a House bill out of committee never made it across the floor because September’s financial disasters took precedence. Lucas said it also called for more oversight, but so far, HB 977 is broader in scope.

Background

National Farmers Union (NFU) President Tom Buis said early last year, the NFU was getting calls from growers frustrated about wild fluctuations in wheat futures. Because of widening basis and skyrocketing margin fees, grain elevators and local farmer co-ops stopped buying future delivery contracts from growers.

This meant many growers couldn’t get the high wheat prices trading on commodities exchanges, despite the fact they controlled the grain delivery. Buis said the NFU went to the CFTC, but was told such price discovery was “nothing out of the ordinary” and that there was nothing the CFTC could do to narrow basis.

Much of this futures market activity was coming from non-commodities speculators, through hedge and index funds. Buis said a lot of it was on OTC swaps from investors who never intended to take delivery of grain or livestock – they just wanted to profit on paper. And commodities were increasingly popular.
“There weren’t too many moneymaking opportunities on Wall Street,” Buis pointed out. “They went to the hot market, which were commodities” – which were rising on a weak U.S. dollar (which meant higher overseas demand for American exports) and inflationary fears.

The House Ag staffer said HB 977 would apply to all commodities, not just food. It would institute trading limits so no one person can amass too much stock to corner the market and drive up prices on that commodity, such as the Hunt brothers attempted to do with silver in the late 1970s.

More power to CFTC

HB 977 would extend CFTC oversight to any kind of trading that directly affects commodities trading. It would do this by giving the commission more information on investors and allowing it to hire more staff, which the House Ag staffer said is now at historically low levels.

Lucas said much of the market activity that has led to such financial grief now “couldn’t have even been imagined 20 years ago.” Speculation in energy commodities that drove crude oil to record highs last year, for example, showed him recent oil prices weren’t a simple function of supply and demand. “Clearly there was outside money, speculation money, coming into the process,” he said.
Buis said to add insult to injury, it was speculation in the energy market that drove up oil prices and, by extension, food prices – but as oil prices have come down and ag futures have dropped, prices on food at the store have stayed the same. Yet, much blame was laid at the feet of the American farmer last year for those food prices.

While Lucas doesn’t like rampant speculation, he did say a market needs enough resources to create price discovery. He likened it to a farm auction with only one bidder, as opposed to a dozen: Only one price offered isn’t as fair an indication of value of the farm as 12 offers.

“I understand enlightened self interest,” Lucas said. “Greed doesn’t make sense.”

Some lawmakers want HB 977 to unify oversight entities – including the CFTC and the Securities and Exchange Commission (SEC) – into a “super regulator” for all markets, which does not seem a good idea to him.

He did vote to approve the bill out of the Ag Committee, as giving more oversight to the CFTC. He added lawmakers split on this bill are doing so not along party lines, but other philosophy. Views seem to vary depending if a representative is from a big farm state, or from an exchange area such as Chicago, which favors fewer regulations.

Buis, who testified before the Ag Committee on behalf of the NFU, said HB 977 as it stands would make OTC trading more transparent to the CFTC and give it some prosecutorial power.

“You can’t say (what’s) happening if you can’t see everything that is happening,” he said. For example, he said he could invest in something through a bank, but he might not show up as the investor under current practice. “You’ve got to have some regulations and some teeth in there, and some transparency.”

“You can write all the legislation you want,” Hackett agreed. “But if you’re not going to enforce it, it really does very little good.”
To read the bill, go to http://thomas.loc.gov and enter HB 977 in the “Search Bill Summary and Status” box. All text after Section 12 are additions to last year’s bill.