Streetwise Professor

June 13, 2010

Still Way Too Short to Regulate

Filed under: Commodities,Derivatives,Economics,Energy,Politics — The Professor @ 2:40 pm

Last August, I wrote a post titled “Not Tall Enough to Regulate” in which I skewered CFTC Commissioner Bart Chilton.  He was very peeved.  He’s not going to be any happier about this post, because he hasn’t changed his mind, nor have I.

This weekend’s WSJ has a semi-fawning story on Chilton, focusing on his advocacy of position limits–and the endorsement thereof in the House and Senate bills currently in conference.  The article gives Chilton an opportunity to explain his position.  His utter failure to do so, which implicitly implicates the entire position limits initiative both at the CFTC and in Congress, speaks volumes about the intellectual bankruptcy of the pro-limits side.

Here’s what the article says (emphasis added):

The volatile summer of 2008, when $145-a-barrel oil led to $4-a-gallon prices at the pump, was the pivotal moment for the Midwesterner. Mr. Chilton says he largely ignores prices, but the surging cost of oil changed his mind. “I’ve seen nobody who can justify $147 [a barrel for crude oil]. It doesn’t mean the massive passives are the sole culprit. I think they’re having an impact. As regulators, it’s our job to be asking these questions,” he says. Mr. Chilton pushed the CFTC to propose position limits that would prevent traders from having a large concentration in energy contracts for four of the most highly traded commodities at the center of the global energy market.

“Position limits that are reasonable,” Mr. Chilton says, “would end the possibility of large concentrations in individual markets that could inordinately influence price.”

. . . .

In July 2008, the CFTC staff issued a report saying that financial traders weren’t driving oil prices higher. Mr. Chilton was infuriated and publicly called the report “deeply flawed.” Today, he charges the report was “political” and done to appease Republicans.

Mr. [Dr.] Harris says, “There was no political pressure from any party. We looked but we couldn’t find any smoking gun. There were a lot of people working hard to find out what was going on. We had dedicated economists and their reputation was more important than political pressure.”

Possibility.  Could.  I think.  A refusal to take seriously empirical evidence, or to critique it rigorously, and a complete failure to provide any of his own.  Ad hominem accusations of politicization when competent economists–which Chilton certainly is not–did not give the answer he wanted.  (This is particularly rich from a political lifer who owes his position to long service as a Senate staffer.)

This is the basis for major policy changes that could have serious effects on the market?

I have a piece on position limits coming out in Regulation titled “No Theory?  No Evidence?  No Problem!”  That’s Chilton (and to a large extent, Gensler, and most of the Senate) in a nutshell.  Any cogent–or even coherent–theory of how speculators are influencing prices?  No.  In particular, any cogent/coherent theory of how passive traders–buy and hold traders so beloved in securities markets–cause prices to increase 100 percent in a period of months?  Surely you jest.  Any empirical evidence to support the claims that speculation and/or passive traders have distorted prices?  See above slander of CFTC economists, along with the CFTC position limit NOPR, for illustrations of the “we don’t got to show you no steekin’ evidence” attitude of Chilton et al.  He just “thinks” it’s “possibly” true–that’s enough, dontcha know.

Here’s a guy who has never been in the markets, and who has never seriously studied markets (“he largely ignores prices”), declaring that prices are somehow wrong.  He wants to restrict the market in order protect against the theoretical possibility (and a theoretically ungrounded theoretical possibility at that), but does not give serious consideration to the far more realistic and likely deleterious effects of the limits on liquidity, hedging, and price discovery.  His justification for the “crowding out” provisions are particularly inane, and not based on any serious economics analysis.

As I point out in the Regulation piece, markets aggregate massive amounts of dispersed information, so it is impossible to explain–“justify”–exactly why prices are what they are.  If it were possible, we wouldn’t need markets to discover prices. That’s why debates over speculation never end: you can’t prove or disprove that the price was right.  Bob Barker doesn’t give you the answer just before going to commercial.

But we know that people spend tremendous time and resources to develop information about values–arguably too much time and resources–and that through trading decisions, this information is embedded in prices.  Moreover, since prices guide the allocation of resources, distortions in prices should result in distortions in quantities–something which (as I point out in the Regulation piece)  were not observed in the commodity price boom and bust.  Commodities are different than say, internet stocks: they are consumed and produced every minute of every day, and distortions in prices will distort those decisions–and such distortions are noticeable.  And if speculators are overpaying–they’ll end up owning the stuff.  None of that happened, and Chilton and others have failed even to acknowledge the issue, let alone confront it.

There should be a pretty high bar to overturn the operation of markets.  Any such action should be based on serious economic reasoning and sound empirical evidence.  And no, deep musings during guitar picking sessions or boat trips to restaurants don’t count.

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  1. agree. blogged about this same thing. Chilton makes normative economic statements. Instead they should be looking for positive economic statements.

    Comment by Jeffrey Carter — June 13, 2010 @ 7:09 pm

  2. […] over at, Craig Pirrong echoes my sentiments-with a more academic bent.  Professor Pirrong has a PhD in […]

    Pingback by Career Politician Makes Him Market Savant « Points and Figures — June 13, 2010 @ 7:14 pm

  3. What else can you expect of a politician so hell-bent on control that his chief economist is forced to resign in protest?

    Comment by Æternitatis — June 14, 2010 @ 11:05 am

  4. AEternitatis–You bet. And the whole story, which I have to keep to myself to protect confidences, is even more dispiriting. Who is that Pirrong guy, anyways? 🙂

    The ProfessorComment by The Professor — June 14, 2010 @ 12:34 pm

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