Stacking the Deck
It’s well known that if you want to cheat at cards, you stack the deck. Marked cards, card readers, card counting are all ways to try and take gambling odds and turn them on their ear.

The investment banks in New York do a similar thing. There is a revolving door between Wall Street, K Street and the committee rooms of Washington DC where the actual business of government gets done. Senators and Congressman vote, and give broad policy statements. But the actual business is done by committee staffers and congressional staffers. They read all the bills, write the legalese for policy, and mark up the bills before a vote. Elected officials certainly have a wary eye, but the devilish details are usually out of their purview.

Committee staffers from DC regularly go to work for someone like Morgan Stanley, JP Morgan, Citibank, or Goldman, then back into a different government role and back and forth throughout their career. It’s a revolving door that never stops turning. The reason I point this out is to draw attention to CFTC Chairperson Gary Gensler. Currently, if you have been following previous posts on Fungibility, Conspiracy Theory, and The Banking System, you know there is a lot of controversy brewing between commodity exchanges. This is not unlike the fight that happened in the early 1990’s among options exchanges before full fungibility and payment for order flow was authorized by then SEC chairman Arthur Levitt, now partner at Goldman Sachs. This practice is not a statistical outlier, but a normal practice.

Now, if you are a DC staffer, and you see a lucrative job on Wall Street awaiting you if you have the right contacts and perform in an advantageous manner for Wall Street, what do you think you would do? It is human nature to maximize your own opportunity. As a matter of fact, that is one of the basic assumed characteristics of the rational investor. Gary Gensler is no different. Politically, he has donated exclusively to Democrats, but that is not important. What is important is that he is the first CFTC chair to come out of Wall Street. Generally they have been career lawyers, litigators, bureaucrats, industry people, academics or fund managers. It is interesting and ironic that at a crucial time in our nations’ financial history, the CFTC would have the first chairperson ever from Wall Street.

Wall Street would like to change the futures industry into looking just like the cash equity industry. Fragmentation, market dislocation, dark pools, and other nefarious anti-competitive practices would benefit the fat cats of investment banking. They would be able to increase profit margins in futures trading significantly were they able to successfully change the industry. Paul Volcker has proposed some short reaching reforms, and that effort has stalled in committee. There are significant differences between cash equities and futures, and thus the industry functions a lot differently.

Futures pre-1965 was the wild west of trading. It was unregulated, and as a result, lots of bad fraudulent practices sometimes took place. Hearing stories about cornering the market are not uncommon. With the advent of bigger more liquid markets, financial markets, structures like the CFTC, and NFA were set up to monitor these types of activities. Exchanges themselves had active self regulatory organizations within the exchange and relentlessly rooted out illegal activity. Members policed other members as well. It behooved the entire industry to police itself since the integrity of the marketplace was paramount for success. As a result, regulated futures markets are the flattest most highly competitive markets in the world. Virtually every order hits the marketplace, and transparency with lightening fast clearing and risk management are industry standards. Gensler and Wall Street would like to change that.

What does that mean for you? Higher prices in everything as markets fragment and have wider bid/ask spreads. Bigger, volatile market moves, as markets become thinner and less liquid. With fragmented markets, the oil rally that you witnessed in 2007 might have been even greater since only the favored few would have been able to take advantage of arbitrage opportunities. Markets also would make lower lows, putting farmers and producers at risk. Boom/bust commodity cycles could result. The cost to auction Treasury debt would increase dramatically. Changing futures markets to the whim of Wall Street would be a shadow tax on the entire economy of America.

This also discounts the economic impact on the City of Chicago. Futures business in Chicago conservatively contributes 150,000 jobs to the area. The changes that are being proposed would be devastating to Chicago, ruining the tax base of the city and causing massive unemployment. It wouldn’t affect simply traders, but accountants, bankers, lawyers, bartenders, waitresses, and many service personnel. Hopefully, Mayor Daley is aware and letting his Chicago connected White House know what is going on. Changing policy would be one of the bigger eggs ever laid on the American people by a well connected special interest group.

Chris Doering in an article today outlined Gensler’s testimony. It is a bit cryptic, but I think the gist of it says that he wants the government to make the call on how clearing operates-not allow them to continue on as self regulatory organizations. Interestingly, in the financial meltdown-independent self regulating clearing houses were the only thing solvent and propping up the failed system. Everyone knew their money was safe at CME Group, and ICE-but in the unregulated OTC world, they were panicked.

Gensler making the move for Goldman. Wall Street doesn’t want OTC derivatives to be dominated by a SRO Clearing operation. They would actually have to put up capital, and have a transparent market and position. Even Warren Buffett remarked in his 2009 letter to shareholders how Berkshire didn’t have to put up much in the form of cash to have derivative positions, and that the market wasn’t very transparent. Everyone knows the game, no one wants it to end. Gensler is running interference for them.

Here is a link to a Bloomberg article on the issue. “As the legislation turns” could be a good way to sum up what is going on!

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