A Futures Industry Insurance Policy

Posted by Jeff Carter
on August 10th, 2012

Yesterday, Democratic CFTC commissioner Bart Chilton went on CNBC to call for an insurance policy for futures trading accounts. In the last six months, two separate firms dipped into client capital to pay for either expenses or trading losses. PFG Best and MF Global both went across the ethical line and stole clients funds.

Deep damage has been done to confidence in the futures industry. Volume has been hurt. Exchanges look bad. It’s not a pretty picture for anyone.

As the debate over insuring accounts begins, there are some backstories you need to know about. First, there is no love lost between Wall Street and LaSalle Street. They compete for capital. ETFs compete head to head with futures. Hot money that flows into and out of markets flows to and from both arenas. Wall Street is regulated by the SEC, and LaSalle Street is regulated by the CFTC. Over the years, there have been consistent turf wars between the two over who will rule over what. Government bureaucracies are all about seizing as much power as they can. This ethical lapse has given them a crack to wiggle through and grab more power.

What’s the reality around the whole MF and PFG situation?

Customers were hurt. People’s hard earned money was stolen. One man, Russell Wasendorf is in jail. One man, Jon Corzine runs free. But take a step back. Since futures trading started at the CBOT in 1849, we have had only two instances where this happened. Whenever a firm has gone bankrupt before, and there have been plenty over the years, positions were transferred and customers were not hurt. Whenever a trader has gone bankrupt, there wasn’t a ripple in the market. Are these two ethical lapses really within the bell curve and +/- 3 standard deviations from the mean?

Continental Bank went under in 1984, no problem. In 2008, Lehman, Merrill, Bear Stearns all went under, no problems. I am for protecting customers. But we have to know what the cost/benefit analysis looks like before we take off into some hair brained scheme to fix a problem that might not actually exist.

Chilton wants a government program that will cover losses up to $2.5 billion. How did he arrive at that number? Why not $10 billion? Why not $100 billion? The futures industry is bigger than that. The costs of a $2.5 billion dollar government program lardered on to the heavily regulated futures industry would likely have a big negative impact on volume.

Suppose there was a program in place for the Bernie Madoff situation. The insurance policy Chilton proposes doesn’t even make a dent in the losses.

Already, State Street has come out in favor of some sort of insurance policy. This ought to get your nose sniffing in the wind. State Street is a Wall Street firm. The only reason they want an insurance policy is for competitive advantage. They see a chance to add extra expenses to competitors costs-which will be passed onto end users. That makes their product line more appealing-and State Street might even be able to increase its own fees without anyone noticing.

No doubt, the rest of Wall Street will come clamoring for insurance.

The best deterrent to unethical action is swift prosecution. I don’t hear a clarion cry from people like Bart Chilton for speedy justice for the clients of MF Global. When bureaucrats begin to tout new government programs, you ought to run for the hills.

I say, give this idea time. Let the private sector sort it out. What ever solution they arrive at will be cheaper and more efficient than any government solution.

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