Some of the major Wall Street banks have become the owners of aluminum, natural gas and several other physical commodities, thereby putting more risk on the financial stability of the U.S. economy. This was the basic finding of the Senate Permanent Subcommittee on Investigations that began probe around two years ago.
The Senate report specifically mentions JPMorgan Chase & Co. (JPM), Morgan Stanley (MS) and The Goldman Sachs Group, Inc. (GS) as the companies which amassed huge stakes in commodity market, thereby changing its dynamics. This allowed the banks to trade in uranium, operate coal mines and metal ware houses, run oil and gas pipelines, and hoard copper and other metals.
The primary reason for the Senate probe was to examine whether increased participation of banks in physical commodity business would trigger any additional risk. Further, the probe was supposed to identify if increased oversight and regulations are necessary.
The 396-page report offered several new details, previously unknown to the public. As per the report, ever since Goldman acquired Detroit-area metal warehouses run by Metro Trade Services International in 2010, the warehouse have amassed 85% of the U.S. aluminum storage market. Further, warehouse management paid incentives to metal owners to participate in ‘merry-go-round’ deals that transferred metal from one building to another but not shipping it out of the warehouse, thus creating an artificial supply shortage and leading to rising prices.
Moreover, the Senate probe revealed that JPMorgan had accumulated physical commodities in the tune of 12% of its Tier 1 capital, while disclosing a lesser amount to regulators. Also, Morgan Stanley was the owner of 55 million barrels of oil storage capacity, 100 oil tankers and 6,000 miles of pipeline. Further, Morgan Stanley had intended to build its own compressed natural gas facility to supply jet fuel to major airlines.
All these new information is expected to further intensify the on-going debate regarding the collapse of barrier between the core banking activities and other commercial activities of banks. The new details raise questions as to whether such commercial activities could harm businesses and consumers.
The findings also stated that banks abused the information available to them as the owner of physical commodities, to gain through unfair trading practices. Further, the banks may have possibly manipulated prices in the commodity market.
Changes Recommended
The Senate report has suggested several recommendations that would likely usher more transparency in the banks’ involvement in the physical commodity market. The Federal Reserve is responsible for ensuring that banking and commercial activities remain separate and that the banks strictly follow this rule.
The regulator is also required to strengthen banking disclosures pertaining to the physical commodities and ancillary businesses. This would aid in effective regulatory oversight and public disclosures.
The report also suggested that the Fed should establish minimum capital and insurance requirements to avoid claustrophobic events in physical commodity activities. Further, the regulator should ensure that banks are prohibited from utilizing non-public information gathered from physical commodities businesses to benefit their trading businesses.
Additionally, the Office of Financial Research should further investigate and offer more recommendations on the issues related to detection, prevention and enforcement actions against banks that use physical commodities businesses to influence commodity prices.
Road Ahead
Despite criticizing the Fed for not properly regulating banks in their physical commodity activities, the report revealed that since 2010, the Fed has been quelling the requests of certain banks to further increase their physical commodity businesses. Notably, some banks are also trying to move away from this business, which has recently lost some of its shine and become less profitable.
Over the past few years, there have been aggressive efforts by banks to shed their physical commodity businesses. JPMorgan, Morgan Stanley, Bank of America Corp. (BAC) and Goldman, among others, are trying to move away from this business to focus on their core banking operations.
With banking executives, experts and regulators about to testify before the Senate Committee, we await further insight into the banks’ physical commodity businesses. These testimonies could aid in the development of stringent regulations and prevent risky activities that would undermine the U.S. economic growth.
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