It’s not inflation that will drive the price higher, nor the bungling policies of the Federal Reserve. It’s regulatory inflation. Or, an artificial constraint being put on the market that will increase the cost of your food and fuel.
The actual price of the commodity may not increase. But the risk and cost associated with putting a hedge on it will. Already, a small percentage of commodity hedging has left the transparent public marketplace and gone to the unregulated private market. Volume is down. That’s not an optimum event for price discovery and transfer of risk.
The CFTC has gone down the path of enacting a really stupid rule to take care of statistical outliers. If you have followed the news in futures markets, you know Jon Corzine committed fraud with customer funds. On the heels of that, a twenty year Ponzi scheme was uncovered at PFG Best.
Instead of responding by bringing Corzine to trial, the Obama administration stonewalled and swept it under the rug. I don’t see Elizabeth Warren sporting false outrage toward people that were defrauded at Senate hearings. Instead, she grandstands against government lawyers towards banks that responded to misaligned government incentives. Good photo op, bad thought process. James Koutoulas has done more to expose Corzine than any other individual, elected or other.
Both Craig Pirrong and Jon Lothian have excellent analysis on this issue. Craig worked on the exchange floors, and has a PhD in economics. He understands opportunity costs, and the exchange clearing mechanism better than 99% of the people out there today. Jon has participated in the marketplace for his entire career, and understands back office operations at a Futures Commission Merchant. They know what they are doing, and writing.
It’s also hard to see how these rules, if they had been in place, would have prevented either the Peregrine or MFG situations. Furthermore, there are other ways of attacking the exceptional-and MFG and Peregrine were exceptional-without imposing crushing burdens on the ordinary day-to-day operation of the markets, FCMs and their customers. For instance, the Peregrine fraud could not have continued if Peregrines regulator (the NFA) had direct electronic access to the firm’s accounts, thereby preventing Wasendorf from altering the paper statements he sent on to regulators to cover up his fraud. Hell, in the MFG case, having more excess margin in customer accounts would have just increased the money that Corzine could have tapped to cover the company’s losses and own margin calls: it is just that excess margin that disappeared somewhere, somehow. I would further note that since an FCM is most likely to be tempted to get at customer funds when it is in financial jeopardy (which is what happened with MF), adding to its financial burdens could create more problems than it solves.
The cost-benefit analysis the CFTC advanced in support of the rule is just the kind of joke I’ve come to expect. This is actually a problem that is amenable to calculation. Collect data on the distribution of customer margin deficits under current rules. Figure out the 99.9th percentile of this distribution. (Importantly, condition this distribution on market conditions-find out what that percentile is during very volatile periods.) Given the rigor of the rule, it is plausible to assume that additional funds equal to this 99.9th percentile will have to be held by customers, FCMs, or both will be held to ensure compliance. Calculate the return on this sum lost because customers and FCMs are required to hold low-yielding assets in order to comply with the rule. That’s one component of the cost.
Maybe if Corzine had made an anti-Muslim brotherhood movie that no one watched on YouTube we could have put him in jail. But then, he wouldn’t have been able to be out on the trail fundraising for the Regime.