Streetwise Professor

A busy day at the CFTC today.  One big rule moved forward, another not.

The rule that moved forward implements the Frank-n-Dodd requirement that swaps be traded on “Swap Execution Facilities” or SEFs.  The proposed rule was released on a 4-1 vote, with Commissioner Jill Sommers the lone nay.

Specifically, the rule specifies:

* platforms that provide for a centralized limit order book available to all participants and/or;

* platforms based on transparent request for quote systems that provide requests for quotes that are visible to all participants on platform, allow liquidity providers to post bids and offers and provide time priority for market participants who originated a request for quote.

* Trading platforms are allowed to offer three tiers of transactions:

* Tier 1 transactions are not block trades and exhibit material transaction volume.

* Tier 2 transactions are not block trades and do not exhibit material transaction volume.

* Tier 3 transactions are not subject to clearing and execution requirements, are block trades or are illiquid or bespoke. These swaps could be executed through various methods including voice and limited request for quote systems.

I’m with Sommers on this one. The underlying presumption of the CLOB-or-Public RFQ is that the more pre-trade transparency and anonymous trading, the better for customers, and that lack of transparency is a means of enhancing dealer/market maker market power and profit.

This is not true as a general matter.  As has been seen from time immemorial in securities markets, many customers prefer to trade away from centralized markets as this reduces their trading costs.  It is possible that this “fragmentation” harms other market users more than it helps those that choose not to patronize the centralized, transparent, anonymous market.  That is a common argument, but it is not generally true.  That argument is premised on the (usually) implicit assumption that the CLOB market is perfectly competitive with free entry–which may well not be true, and in fact has been untrue in many markets.

Moreover, for many products, derivatives end-users have had the choice between trading on centralized markets (with clearing and the associated credit arrangements) and trading in decentralized dealing markets (without clearing).  Indeed, the latter combination has grown absolutely and relative to the former.  Although it is difficult to determine the contribution of each element of the transaction and post-trade bundle to traders’ decisions on where to trade, this fact raises serious doubts about the assertion that forcing trades onto centralized platforms will be overwhelmingly beneficial to derivatives end-users.

The rule that didn’t move forward, somewhat surprisingly, was that on position limits.  CFTC Chairman Gensler had already delayed voting on the proposed rule once, and did it again today.  He said that “I think it’s just appropriate to let this one ripen a bit more.”

Uhm, Gary.  It’s pretty ripe already.  As in rotten.

The new position limit proposal is less bad than the one from January.  It no longer has the silly crowd out provision, or the equally silly limited risk management exemption.  The crowd out provision essentially forced market participants to choose between being hedgers, market makers, or speculators.  That micromanagement of firm business models in contravention of the potential for synergies across these functions was an unnecessary constraint on market participants.

On the other hand, the new rule has a very restrictive definition of bona fide hedger.

Although some of the worst elements have been stripped away, the underlying problem with spec limits generally remains.  No one has yet to provide credible evidence showing that speculation has distorted prices in recent years, or even provided a credible theory to demonstrate how this can happen (other than in corners or squeezes, which are better deterred in other ways).

Although it is not quite clear as to why the rule has not garnered majority support in the Commission, anti-speculation crusader Bart Chilton indicated that he did not support the rule as written.  This is likely due in part that he was a big fan of the crowding out provision.  In his remarks after the meeting he also indicated that the two-step approach in the proposal, which would have delayed full-blown implementation of limits until the Commission had the ability to collect data from the swaps market so it would be able to base its choice of  limits on, you know, actual data.  In other words, Chilton is playing Jacobin on this issue.  Republican commissioners have expressed reservations about proceeding without such information.

Apparently, however, Gensler threw a sop to Chilton, by instructing staff to identify position levels that would trigger a Commission review that could result in an order for large traders to reduce their positions.

Position limits have proved to be an extremely contentious issue.  SEFs are very controversial as well.  Both represent attempts by the CFTC–acting at Congressional direction–to transform the ways of executing transactions, and the quantities of transactions, that consenting adults have freely chosen.  That inevitably generates opposition.  There can be justifications for doing this.  Unfortunately, neither Congress nor the CFTC have provided even remotely plausible ones.

Today’s NYT carries a breathless–and endless–expose on OTC derivatives clearing.  All of the issues it discusses have been discussed, at length, here on SWP.  I almost hesitate to say anything more, because it’s tedious to repeat myself because it’s tedious to repeat myself.  But the fact that stale arguments continue to dominate the conventional wisdom–as now officially endorsed by the New York Times–means that I must venture once more into the breach.

In a nutshell, the article repeats a familiar narrative about the OTC derivatives market.  You might call it the What’s the Frequency Kenneth Griffin Narrative.  (Indeed, Citadel and Griffin are cited throughout the article.)  An oligopoly, not to say cabal (though the NYT comes close to doing so, by referring to “a secretive elite”), of large banks operating in an opaque market earns outrageous profits.  It is now attempting to perpetuate its oligopoly through control of clearinghouses, ironically mandated by the Dodd-Frank Act.

Let’s focus on the clearing aspect for a moment.  First of all, as I’ve said repeatedly, there is definitely a double edged sword involved in clearing.  On the one hand, limiting access to clearing is a great way to exercise market power.  On the other hand, too liberal access to clearing can create systemic risks, and make the governance and management of clearinghouses far more complex and far less efficient (by increasing the heterogeneity of the membership).

Indeed, I gave a talk on clearing before the Columbia Program in the Law and Economics of Capital Markets Regulation on Thursday where I made this very point.   The audience (which consisted of a very distinguished group of law and finance scholars) was generally sympathetic to clearing, I think, and as a result there were a lot of skeptical questions.  One was right along the lines of the NYT article, suggesting that dealers were an oligopoly and that clearing would increase competition.  I responded that in fact, clearing could be a great way of cartelizing an oligopoly.  However, trying to mitigate this problem through regulating CCP admissions criteria could undermine the goal of reducing systemic risk.  As I put it in the slides for my talk, this was one of many Morton’s Forks in Dodd-Frank. (I’ll post a link to the slides and the video from my talk when they are available–probably just in time for Christmas!)

The NYT article describes the efforts of the dealer banks to exert control over CCP risk committees.  Well, duh.  It’s their capital at risk.  Which presents another problem here.  To reduce systemic risk, CCPs have to have a lot of capital backing trades.  That capital doesn’t fall from the sky.  Where is it going to come from?  Since clearing has begun, major market intermediaries have provided the capital.  And since it is their capital at risk, they have demanded and exercised control over the risks that they are taking on.  It’s not that complicated.

Attempts to regulate governance in ways that reduce the control that group X exerts means that you will simultaneously reduce the amount of capital that group X is going to supply.  So you need to get capital from someone else.  And if you don’t the CCP will be undercapitalized and then there are problems; indeed, in the event, CCPs will be the source of the very systemic risk legislators and regulators hoped that they would banish.

In other words, there are trade-offs here that are quite thorny, but the NYT–and too many other people who should know better–ignore altogether because they get in the way of a good morality play.  It is particularly ironic, and annoying, that many of those who were baying for clearing mandates are now just waking up to those trade-offs.

There are other issues in this article regarding clearing that need to be addressed.  One is ICE Trust.  The author of the piece, Louise Story, talks about the formation of the ICE Trust, which involved the combination of a dealer-run initiative Formerly Known as the Board of Trade Clearing Corporation and ICE.  As originally envisioned, and as currently operating, ICE Trust was an inter-dealer clearing system.  So who other than the dealers would you expect to dominate it?

In her attempts to make ICE Trust appear as sinister as possible, Story descends into self-parody:

The banks also refused to allow the deal with ICE to close until the clearinghouse’s rulebook was established, with provisions in the banks’ favor. Key among those were the membership rules, which required members to hold large amounts of capital in derivatives units, a condition that was prohibitive even for some large banks like the Bank of New York.

I read that to Mrs. SWP, who laughed out loud.  Mrs. SWP is an art major, but she is endowed with common sense.  Her response (post-laugh): “Like they were going to join an organization before they knew what the rules were?  And they were going to join an organization with rules that hurt them?”

More substantively, the quote makes the capital requirements seem like–and only like–a means for exclusion.  Yes, they can play that role, as I’ve written ad nauseum for years.  But high requirements can also be a crucial way of ensuring the safety of the institution, and reduced heterogeneity in the financial condition of members can make the difference between an effective organization and a dysfunctional one.

In other words, the NYT is printed in black and white, but the issues involve are anything but black and white.  Until people get real in grappling with the trade-offs, we are doomed to pointless arguments and counterproductive policies.

The other big issue in the article relates to transparency and trading, and its effect on profits.

The story begins with this tale:

This fall, many of Mr. Singer’s customers purchased fixed-rate plans to lock in winter heating oil at around $3 a gallon. While that price was above the prevailing $2.80 a gallon then, the contracts will protect homeowners if bitterly cold weather pushes the price higher.

But Mr. Singer wonders if his company, Robison Oil, should be getting a better deal. He uses derivatives like swaps and options to create his fixed plans. But he has no idea how much lower his prices — and his customers’ prices — could be, he says, because banks don’t disclose fees associated with the derivatives.

“At the end of the day, I don’t know if I got a fair price, or what they’re charging me,” Mr. Singer said.

It proceeds:

And the profits on most derivatives are masked. In most cases, buyers are told only what they have to pay for the derivative contract, say $25 million. That amount is more than the seller gets, but how much more — $5,000, $25,000 or $50,000 more — is unknown. That’s because the seller also is told only the amount he will receive. The difference between the two is the bank’s fee and profit. So, the bigger the difference, the better for the bank — and the worse for the customers.

It would be like a real estate agent selling a house, but the buyer knowing only what he paid and the seller knowing only what he received. The agent would pocket the difference as his fee, rather than disclose it. Moreover, only the real estate agent — and neither buyer nor seller — would have easy access to the prices paid recently for other homes on the same block.

Ask yourself: for what product that you buy do you know the markup or the seller’s profit?  Answer: probably none.  You rely on competition, comparison shopping, etc., to discipline sellers and ensure that you get a good price.  Presumably that, and soliciting multiple offers, are exactly what Mr. Singer does when buying the physical oil he sells (the markups on which and profits made by the seller he almost certainly does not know either).  (By the way, do Mr. Singer’s customers know his costs and markups?  Just asking.)

The usual retort is that the OTC derivatives market is an oligopoly and that a lack of price transparency limits competition.  By structural measures, OTC dealing is less concentrated than most industries.  With respect to transparency, many large market participants (end users) repeatedly stress that they have access to multiple bids and offers, and are perfectly capable of shopping for good deals.

Moreover, and this cannot be stressed enough, for many products–including Mr. Singer’s heating oil–there are exchange traded markets with great transparency pre- and post-trade.  Mr. Singer and others can utilize that information to evaluate the price offers being made by the dealers on OTC trades.  Moreover, they can trade on those markets if they are so convinced that the OTC dealers are hosing them. So why don’t they?

I am also annoyed that people, including Ms. Story, accept uncritically the proposition that OTC dealing is obscenely profitable.  Maybe it is–I would definitely like to see a more definitive study on this that goes beyond the mere quoting of revenue numbers from OTC trading and how it compares to overall bank revenues.

Indeed, there’s a fundamental tension between various criticisms of OTC derivatives markets.  On the one hand, they are supposedly extremely profitable.  On the other, they supposedly pose huge risks for the banks that are the major dealers.

Think that there could be a connection?  The counterparty risks that dealers face are a contingent liability.  If OTC derivatives dealing is indeed highly risky, as is often asserted, this contingent liability could be quite large.  Which means that in a competitive market prices–notably spreads between dealer bids and offers–must be wide enough to compensate for that risk.

This further means that looking at profits in “normal” times can be misleading.  These “profits” are in part, and arguably in large part, compensation for risk.  And given the nature of risk in these markets, where things can go along swimmingly for a long time and then go non-linear, the losses for which these “profits” are compensation can be extremely concentrated in time; the contingent liability becomes a real one, and particularly a real big one, relatively infrequently. So you can look at profits over years that look fat and say that they are supercompetitive.  But they can disappear in a trice.

This is arguably analogous to the equity premium puzzle.  That puzzle states that the returns to investing in stock appear to be very high given the risks.  That conclusion is dependent on how you measure the risk, and the compensation required (based on preferences) for these risks.  Legions of finance academics and practitioners have wrestled with those issues for decades now, and there has been no definitive resolution of the puzzle.  Very little–and arguably no–comparable research has been undertaken to study the risk-return trade-off in derivatives dealing.  That problem is, moreover, arguably far more complex than the equity premium puzzle.  It is a tail risk problem, and evaluating tail risks and the appropriate compensation for them is hard.  (Tail risk could be the source of some of the equity premium too.)  With free entry and exit, to a first approximation you would estimate that the prices charged compensate for risk.  You should certainly be very reluctant to draw strong conclusions to the contrary without a much deeper analysis than has been done until now.

(This is also analogous to a peso problem.)

Until the risks of OTC derivatives dealing, and the costs of those risks, are measured far more accurately than has been the case heretofore (and the analysis usually doesn’t go much beyond the kind of stuff that’s in the NYT article), I would be chary indeed about arguing that OTC dealers make supercompetitive profits.

And I would be especially careful about arguing about the huge risks of OTC dealing out of one side of my mouth, and the huge profits of OTC dealing out of the other.

This gets at the main problem with all of these jeremiads against OTC derivatives markets.  OTC dealing is supposedly hugely profitable.  Customers are supposedly exploited.  But OTC derivatives markets expanded dramatically absolutely and relative to the transparent, anonymous exchange markets that offer products that are close substitutes on many dimensions.

Huge profitability and supercompetitive prices should have encouraged entry by other potential OTC counterparties; the entry of new trading mechanisms (including, potentially, exchange-like mechanisms with clearing as well); and the movement of trading to existing futures and options exchanges.  But the reverse happened.

In other words, criticisms like Mr. Singer’s, and Kenneth Griffen’s, and Louise Story’s remind me of what Yogi Berra said about Ruggeri’s (a restaurant on The Hill in St. Louis): “Nobody goes there anymore. It’s too crowded.”   The OTC markets are big and crowded with customers.  If they’re such a bad deal for these customers, why is that true?  Why hasn’t entry, or the movement of customers to available substitutes, constrained market power and prevented exploitation of customers?  Not to say that such an outcome is inconceivable, just that Louise Story, Kenneth Griffin, and the cast of thousands who criticize OTC derivatives markets haven’t come close to answering these questions.

I long for the day when there will be serious consideration of these issues, rather than superficial black hat-white hat narratives.  There are so many thorny, thorny issues involved in derivatives market structure.  The trade-offs are not easy.  Let’s stop pretending that they are.  And most importantly, let’s stop legislating and regulating like they are.

The EU is proceeding with plans to take a much more aggressive regulatory approach in commodity markets.  The scheme will empower the to-be-established European Securities and Market Authority (ESMA) broad powers to intervene in commodity markets.  These powers would include the ability to impose “ex ante” position limits.  These proposals are included in a massive, sweeping proposal to regulate financial markets.  The new powers include:

— supervisors should have powers to intervene at any stage during the life of a derivative contract

— supervisors could require any holder of a contract to provide a full explanation for the position, provide all relevant documentation, reduce the size of the position in the interest of an orderly market and investor protection

— EU regulators to propose standards for setting position limits for derivative contracts traded on and off exchanges and define when such limits should be triggered

. . . .

— a separate “chapter” should be introduced into MiFID to “help ensure that sufficient clarity and regulatory focus are devoted to how commodity derivative markets function in the future”

— there is a need for a position-reporting obligation by categories for traders for contracts trade on all EU venues

— to avoid problems with convergence between futures and spot prices in commodity derivatives, a requirement could be added to the way commodity derivatives contracts are designed to ensure price convergence

— currently commodity trading for own account is exempt from MiFID rules but this waiver should be narrowed

— if an off-exchange, physically settled contract is like an exchange traded contract and standardised then it should also be centrally cleared

John Kemp of Reuters has more detail (sorry, no link: the story was emailed to me and I can’t find it on Reuters):

Under enhanced position management, position holders could be required to provide a full explanation for the position, including relevant documentation, to show whether the purpose is hedging or speculation. They could be required to reduce the position in the interest of an orderly market, investor protection or market integrity. The authorities could intervene at any time in the life of a derivative contract.

. . . .

But the consultation envisages that the future European Securities and Markets Authority (ESMA) would be given a powerful coordinating role and empowered “to propose technical standards to set ex-ante position limits both for derivative contracts traded on exchange and OTC [over-the-counter]” when necessary to address “risks to the overall stability or delivery and settlement arrangements of physical commodity markets”. That looks like a direct reference to preventing squeezes in the delivery mechanism.”New implementing measures could further define the details of when the powers to propose position limits may be triggered. For example, these could be triggered when conditions in a given market in terms of liquidity or market concentration jeopardise market efficiency or integrity,” according to the consultation document.

Decisions about when to invoke enhanced position management powers would be taken by the ESMA rather than left to exchanges. ESMA would set overall principles to be applied at national level. But it could also intervene directly when there is a threat to the orderly functioning and integrity of financial markets and national authorities have not taken sufficient measures to address the issue.

This implies a much bigger, more direct role for the regulator in handling the issue of dominant positions and market squeezes.

The Kemp piece, and some of the elements of the proposal (e.g., the focus on convergence) suggest that the focus of the new position control regime will be to prevent manipulation.  That focus is laudable, in contrast to the vague, obscure, untestable, theoretically and empirically unsupported goal of eliminating “excessive speculation” that underpins the CFTC’s authority to impose position limits (now vastly expanded).  (Give me a few minutes, and I’m sure I could come up with many more pejoratives.)  Manipulation (in its most important forms) is something, in theory and in practice, that can be defined, understood, and empirically identified.  In contrast, determining when speculation is “excessive” is a nebulous task, with no grounding in proper economics and impossible to implement in practice.  As a result, what happens in markets tends to be a Rohrschach Test, with some people (e.g., Bart Chilton, Michael Masters) seeing excessive speculation everywhere, and others not.

Kemp notes that the EC initiative is an implicit rebuke of Britain’s Financial Services Authority, which has argued that position limits are unnecessary. Kemp further notes that the FSA already has many of the powers outlined in the EC proposal, but delegates their implementation to exchanges.  As was seen in cocoa over the summer, and has been seen chronically in the metals markets for decades, that basically means in practice that “light touch” is a massive understatement, and that market participants can undertake some blatantly egregious–manipulative conduct–with little fear of hearing even a whispered “boo” from the exchange or the regulators.

Nor is it evidently much better on the Continent.  Although not related to commodities, the Porsche corner of VW shares, which I’ve written about extensively, was about as brazen and extreme as it gets, but the German regulators played Sergeant Schultz, and saw nothink.

So, in principle a manipulation-focused bolstering of regulatory powers is a good thing.  (See, I’m not an anarchist, despite what some think.)  That said, a highly discretionary system that relies on ex ante intervention is inefficient, compared to a realistic alternative.  I’ve written for what seems forever (although it’s only about 16 years or so) that an ex post regime that imposes sanctions on those that manipulate the market is highly preferable.  It economizes on resources committed to supervision.  Moreover, true corners and squeezes can be identified reliably ex post, and the perps are not judgment proof, and hence can be deterred by the prospect of severe sanctions imposed in the event of a determination that they have manipulated; a determination that can be made with considerable precision, and little likelihood of falsely convicting the innocent.

The EU/EC is in an excellent position here to do something constructive, because it starts with a blank slate.  Unlike the US, which is hamstrung by poorly crafted laws that provide little guidance to judges and regulators, thereby permitting the proliferation of economically deficient (and precedential) decisions, the EU has the ability to create an anti-manipulation statute that is grounded in economics, which provides specific guidance and tests to triers of fact.  My suggestions along these lines are here, amongst other places.  (Hint, hint, nudge, nudge.)

Permitting a private right of action would also be quite beneficial, because those harmed by squeezes are highly motivated to take action if they can be compensated for the damages that they suffered.  As the US experience shows, relying on regulators alone to punish manipulative conduct after the fact, even when they have the power, is all too often woefully inadequate.

Moreover, even if there is a focus on ex ante regulation, that regulation would be more effective, with lower probabilities of inappropriate intervention and inappropriate failures to intervene (cf. cocoa, July, 2010) if it were predicated on a firm economic understanding of manipulation, and if it were to set out in detail the indicia of manipulation and manipulative conduct that would attract regulatory scrutiny.  There is always a fear that a broad, vague grant of discretionary power to regulators can lead to a proliferation of both Type I and Type II errors.

Along these lines, although the descriptions of the EC consultation document suggests a focus on manipulation properly understood, the statements of the politicians in charge of the effort raise serious concerns that the regulation might be used to attack any form of conduct that doesn’t suit the person speaking at the moment.  For instance, EU commissioner Michel Barnier, who is driving the reform effort, has said:

If someone is doing something which affects the market then he or she must be held to account.  Hyper-speculation is scandalous.

“Affects the market” is pretty broad.  The broadside against “Hyper-speculation”–as opposed to manipulation–smells suspiciously like the pernicious “excessive speculation” language in the Commodity Exchange Act.  It doesn’t take too much of an imagination to picture that during some future energy or ag price spike, a regulator subject to political influence would intervene in a destructive way, chasing some chimera of hyper-speculation.  Politically influenced regulators (and there is no other kind) are great at killing the messenger.

Which all means that it is difficult to be too enthusiastic about the proposal.  Yes, a rule focused on manipulation, properly understood, would be an improvement.  But ex ante measures are inferior to ex post, and I strongly suspect that whatever emerges will give regulators a lot of discretion that can be abused–and will be abused, in the event, the next time developments in the commodity market leads to a popular and political hue and cry to “do something.”

Some weeks ago I opined that it was foolish for Poland to lock itself into a very long term contract with Gazprom (going out to 2037) given the prospects for shale gas.  I did a little digging (or should it be drilling?) for information on shale gas prospects in Poland, Ukraine, and elsewhere in Europe, but other things (e.g., life) intervened and I didn’t follow up.  Fortunately, Deutsche Welle recently ran a piece on the subject that contains some interesting data and commentary:

The largest deposits of shale gas in Europe are assumed to be located on Polish territory. New technology from the United States could make it possible to exploit these gas reserves. Test drillings are planned all across the country.

According to geologists, Poland could become the largest gas supplier in Europe after Norway and Russia. It would make the eastern European country rich – much richer than previously assumed, said energy expert Pawel Nierada from the Sobieski Institute in Warsaw.

“Conservative estimates already show that Poland could suddenly become a serious exporter on the European gas market,” Nierada said. “The reserves exceed our country’s consumption many times over. It’s hard to imagine what it would be like if the more optimistic estimates of the US government were to turn out to be true. Then, here in Poland, we would have more gas than Norway.”

Specifically, estimates are that Poland has 3 trillion cubic meters of recoverable gas.  This is a small quantity compared to Russian reserves, but (a) it’s relatively large compared to Polish consumption, and consumption in adjoining countries, (b) it’s close to market, rather than locked in forbidding locations in northern Russia, and (c) it’s not in the tentacles of the gas octopus, and hence not in the clutches of one of Poland’s historical enemies.

There are skeptics, of course:

But many people are skeptical about this procedure, Nierada said.

“There are also critical voices which say that the technology is still in its infancy – the experts from the Russian gas company Gazprom, for example,” he said.

Gazprom, expressing skepticism?  Go on.  Tell me another one.

In fact, the company has acknowledged in word and deed that the shale revolution in the US has already derailed some big plans, and the extension of that revolution could truly rock Gazprom’s world, and not in a good way.  So the company has every incentive to play skeptic in the hope that this will slow down the shale juggernaut–and every sentient being should discount its skepticism as heavily as the market discounts its stock price.  Indeed, Gazprom is actively looking to get into shale plays in the US.  At the very least, this indicates that it (quite sensibly) wants to learn more about the details of the technology and the performance of shale plays so that it can plan accordingly.  Alternatively, it could indicate that the company knows very well that shale is for real, and wants to get into the game.  Either way, it belies its skeptical public statements.

Yes, there are uncertainties about shale.  The environmental concerns, from what I have learned, seem over-hyped: and there are firms out there who have every incentive to try to hype fears in order to impede shale gas as a competitive force.  More substantial questions relate to the production profile of shale wells, specifically, that production tends to fall more rapidly from shale wells than traditional ones.  But this is an evolving technology, so the possibility that additional innovations will mitigate that problem.

But as I wrote in my earlier post, the very fact that there is considerable uncertainty with an appreciable upside potential means that it is wise to avoid locking into long term commitments until that uncertainty is resolved.  Poland specifically, and Europe generally, are in the very early days of the shale experiment.  There is some uncertainty about how the technology that has worked in the US will perform in European formations, in addition to the technological and production uncertainties just mentioned.  But the US experience, in which shale has completely demolished the conventional wisdom about the future of the North American gas market in a period of less than 4 years, and which has made earlier major investment plans based on this conventional wisdom costly failures (e.g., LNG import terminals in the US–shed a tear for Cheniere; Gazprom’s abortive plans to export LNG to the US), should make everybody everywhere extremely chary about entering into expensive long term commitments.  There is a real option value here–a value to waiting–and greater uncertainty actually makes that option to wait more valuable.

But I guess “everybody” doesn’t include the Poles, and “everywhere” doesn’t include Poland.  For they tweaked their deal with Gazprom to meet EU objections, and leapt into a long term commitment with Gazprom.  This was incredibly foolish.

The impression of foolishness is only reinforced by some of the rationales advanced by Polish officials:

Production in Poland could begin in ten years at the earliest, gas companies said. But experts think it could start earlier. Then, the country could fulfill a dream it has had for hundreds of years: to be economically – and therefore also politically – independent from Russia.

In spite of that, though, politicians across the spectrum have been slamming on the brakes, such as economics minister Waldemar Pawlak.

“Up till now, shale gas has been more of a media phenomenon,” Pawlak said. “We still don’t know how difficult it will be to produce in Poland. It will also be more expensive than gas from conventional sources, because more drilling is necessary for the same amount of output.”

Poland’s president Bronislaw Komorowski has been skeptical, too. He said that all those production towers across the country would be an eyesore.

Economic factors drive skepticism

Even if there are factual reasons for the skepticism, experts have long criticized Polish politicians for being too passive. For years, Poland has relied on imports from Russia without even considering the exploitation at least of conventional gas resources in the country. This was mainly due to the monopoly of the state-owned gas firm PGNiG.

“The company was never interested in producing gas itself,” Nierada said. “It earned its money very easily, after all, by buying gas from Russia and simply adding its margin. The company didn’t care about how high the final price was.”

An economics lesson for Economics Minister Pawlak (there’s a joke in there somewhere):  “We don’t know” is a reason to avoid long term commitments until you find out: that’s the implications of real options theory, in a nutshell.  Moreover, even if it takes more wells in Poland to produce the same gas that could be produced in the frozen wastes of Russia, costs (to Polish consumers) could well be lower because (a) it’s a damn site more expensive to explore, drill, and produce in many of the godforsaken places Gazprom will go to produce gas to meet its contractual obligations, (b) it’s expensive to transport gas from godforsaken places in the frozen north to Poland, and (c) Gazprom is likely to exercise considerable market power if unconstrained by competition from Polish or European sources.

And I would add, Mr. Pawlak: $4-$5 gas is not a media phenomenon.  It’s the real deal.  Yes, declining demand resulting from the financial crisis has had something to do with the cratering of the price of gas in the US.  But that’s not the whole story.  Increased production has had a very huge impact.

As for President Komorowski.  Please.  You’re embarrassing yourself.  Visit DFW some time.  Hell, I can see oil wells from my office in Houston.  And production towers go up, and then they come down, and producing wells are barely noticeable.  It’s no big deal.  Really.

Indeed these objections from Polish officials are so pathetic that it raises darker suspicions.  Such as: they have been, er, suborned by Gazprom/Russia.  The alternative explanation is cluelessness.  Not a happy choice.

But Poland has made its bed, and will have to lie in it.  Maybe shale gas will prove to be a flash in the pan.  But maybe not.  And the fact that the “maybes” are so divergent means that Poland’s hasty decision to betroth itself to Gazprom for the next decades was unwise, and extremely so.

This is one of those stories (h/t JRL) that can be read on many levels:

Meeting of the Security Council chaired by President Dmitry Medvedev will discuss energy security in late November. The necessity of a federal law “On energy security of the Russian Federation” and legislative and organizational measures will be considered at the meeting.

The state aspires to complete information on oil and to control over it. The Interior Ministry is supposed to combine  efforts with the Energy Ministry in prevention of oil thefts. By and large, the matter concerns establishment of Oil Control, a system that is supposed to shut down the black market of oil products. Work on this mechanism has been under way since earlier this year, when oil companies complained to the president against countless illegitimate mini-refineries that were making fuel of dubious quality and selling it domestically and abroad.

A source within the government announced that approximately 10% (about 50 million tons) of all oil made annually disappears without a trace. “As matter stand, oil companies do not want the state to know exactly what they have. The intended involvement of law enforcement agencies is not going to make them happy at all.”

Political Information Center Director General Aleksei Mukhin allowed for the possibility of a connection between the idea to establish a control mechanism and the notorious YUKOS affair. Mikhail Khodorkovsky and Platon Lebedev are facing charges of theft of 350 million tons of oil. The verdict will be passed in mid-December. “The state wants control over commercial activity of the fuel and energy complex,” said Mukhin. “The Interior Ministry
and Federal Security Service have some serious lobbyists working for them. With information on the movement of fuels in Russia and abroad available to them, these structures will be able to influence oil companies’ marketing policies… Reorganization of the Interior Ministry is about to put an end to police generals’ business ventures. They need something else… I suspect that losses of oil will only increase now.”

On the one hand, I would not put it past some Russian oil businesses to attempt to escape the country’s onerous tax burden on oil.  On the other hand, this gives the Interior Ministry access to extremely valuable commercial information that they can utilize for various nefarious purposes that just happens to line the pockets of Ministry personnel.

It seems that some firms in the oil industry were too clever by half, asking the state to intervene to crack down on some dodgy competitors, only to find that the Interior Ministry would take this as an invitation to get up close and personal with all of their businesses.  Proving yet again that it’s very dangerous to give the slightest opening to the operators of protection rackets, as they will take what you offer plus anything else that they feel like taking.  You give an inch, they’ll take miles.

Testifying before the Senate in 1928, Texas cotton broker William Clayton responded to an accusation that he had manipulated the market with this drily arch remark: “The word ‘manipulation’ . . . in its use is so broad as to include any operation of the cotton market that does not suit the gentleman who is speaking at the moment.”

I’m sure Mr. Clayton is long dead, but his spirit lives on in the CFTC’s just proposed manipulation rule.  It is broad, sweeping–and maddeningly vague.  It basically promulgates a we’ll-know-it-when-we-see-it-and-tell-you-when-we-do-(with-a-subpoena) “standard.”

The rule itself just regurgitates the language of Frank-n-Dodd.  The explanation of the rule contained in the Federal Register provides ample evidence that the Commission views the rule as a fishing license to catch pretty much anything that damn well strikes its fancy.  Some key quotes:

Likewise, the Commission proposes to interpret CEA section 6(c)(1) as a broad, catch-all provision reaching fraud in all its forms–that is, intentional or reckless conduct that deceives or defrauds market participants. [Emphasis added.]

. . . .

The Commission proposes to continue interpreting the prohibition on price manipulation and attempted price manipulation to encompass every effort to improperly [sic] influence the price of a swap, commodity, or commodity futures contract. [Emphasis added.]

. . . .

Consistent with judicial interpretations of the scope of SEC Rule 10b-5, the Commission proposes that subsection (c)(1) be given a broad, remedial reading, embracing the use or employment, or attempted use or employment, of any manipulative or deceptive contrivance for the purpose of impairing, obstructing, or defeating the integrity of the markets subject to the jurisdiction of the Commission. [Emphasis added.]

. . . .

The Commission proposes to continue interpreting the prohibition on price manipulation and attempted price manipulation to encompass every effort to influence the price of a swap, commodity, or commodity futures contract that is intended to interfere with the legitimate forces of supply and demand in the marketplace.   The Commission reaffirms this broad reading of the term “manipulation” with respect to new CEA section 6(c)(3), while also recognizing that manipulation cases are fact-intensive and that the law in this area will continue to evolve largely on a case-by-case basis.

It is quite clear from all this that the Commission wants broad authority, and the maximum discretion and flexibility, to reach any operation of the market that does not suit it at the moment.  Willie Clayton lives.

I’ve written before that by attempting to craft anti-manipulation rules that are so broad to catch everything, Congress and the Commission in fact make it very difficult to catch anything, including the most egregious manipulative conduct.  That is a real risk under the new rule, which just compounds the vagaries and definitional imprecision of the existing laws, regulations, and precedents by adding new ones.  What is a manipulative contrivance or device?  I have no clue–and the proposed rule provides none.

The Commission gives itself an out by saying that manipulation cases are fact intensive, and that “the law in this area will continue to evolve largely on a case-by-case basis.”

Well, that’s the problem, isn’t it?  Anti-manipulation laws have been on the books since 1922, and there have been quite a few cases brought under the laws.  But to characterize the result of this process as “evolution” would be far too charitable. “Chaos,” “confusion,” “muddle,” and/or “devolution” would be far more apposite.  And it got that way precisely, exactly, because Congress and the various regulators charged with enforcing the law did not provide any real structure or guidance, again acting under the misguided notion that a broader, less precise law would be a more effective one.  The problem is not that the CFTC has not possessed the powers to reach truly damaging manipulative conduct; it’s that it has employed these powers in a scatterbrained way.  And that has happened, in large part, because the relevant statutes are vague and provide no structure or guidance.

I’ve written ad nauseum for almost two decades on the problems in the law relating to market power manipulation.  Despite the fact that economics provides the logical and empirical basis to permit determination with considerable precision whether a market power manipulation has occurred; who committed it; and whether he intended to do so, the Commission has never succeeded in bringing a successful market power manipulation case.  (As the discussion in the Federal Register notice makes clear, the CFTC’s much ballyhooed victorious DiPlacido case was not a market power manipulation case.)  That is particularly disturbing because market power manipulation is likely to be the most damaging and socially costly type of manipulation that can occur in derivatives markets.

I’ve advanced recommendations as to how it would be possible to craft fairly specific rules that would make it easier to prosecute market power manipulations.  More specificity would make it more likely that the CFTC could actually crack down on truly damaging conduct.  Laying new broad, vague terms on top of old broad, vague terms won’t do that.

Just how, exactly, will the new rule address the problems that have stymied the Commission in cases like in re Indiana Farm Bureau? How does it correct the problems (most notably vagueness) that Judge Miller tellingly identified in Radley?  (It does address some of the issues relating to jurisdiction.)  Answer: not at all.  Meet the new rule, same as the old rule–at least in its defects.

Moreover, the vagaries of the new rule will inevitably create uncertainty in the minds of market participants about what conduct is and what conduct is not a “manipulative contrivance or device.”  More legal risk is not exactly what the markets need right now.

In other words, the new rule will raise the frequency of both Type I and Type II errors.  Truly manipulative conduct will continue to go unpunished, and perhaps aggressive but legitimate conduct will not suit some enforcement guy at some moment.  The new rule threatens to make all too real the old lawyer’s joke: “I won half the cases I should have lost, and lost half the cases I should have won, so justice was done.”  Not really.

In brief, the new rule doesn’t fix the well-known problems with the existing regulations, statutes, and decisions: it just repeats them, and arguably adds some more.  Since the reach of the new rule will be far greater than the old one–extending to every swap, for instance–the potential for damage is commensurately greater as well.

I found one part of the FR notice particularly amusing.  Specifically, there’s this “we don’t need no steekin’ economists” language:

The conclusion that prices were affected by a factor not consistent with normal forces of supply and demand will often follow inescapably from proof of the actions of the alleged manipulator.

. . . .

Cases of this nature, where distorted prices foreseeably follow from the device employed by the manipulator, do not require detailed economic analysis of the effect on prices.

Yeah.  And then there are all those other cases where conduct is not sufficient to infer price distortion.  Which happen to be the far most important ones.

I understand that a lot of lawyers don’t like to have to rely on economists.  I will pass over in silence why that’s true.  Suffice it to say that the lawyers would be more successful if the laws and regulations reaching economic conduct were based on coherent, precise economics, rather than gassy generalities about “devices” and “contrivances.”

CFTC Chairman Gary Gensler gave an extended interview with Reuters on Friday.  A good part of the discussion revolved around budgetary matters, but this gem caught my eye:

The agency likely will stagger deadlines for traders to become compliant with the new regulations — including speculative position limits, Gensler said, declining to give any details about a long-awaited proposal that the agency will unveil in the next month.

Investment funds, which make up as much as quarter of trade in markets like cattle, have already looked for alternative ways to buy commodities, with some buying physical products instead of futures and swaps.

That’s OK by Gensler.

“Congress asked us to do a job, we gotta do what Congress asked us to do,” he said, adding cash markets are not part of his mandate.

Wait just a cotton pickin’ minute.  The whole point about limiting speculation in derivatives markets is that such speculation allegedly distorts prices for the commodities that consumers actually buy and producers actually sell.  That is, that such speculation allegedly distorts cash prices.  Listen to all the crying and moaning and gnashing of teeth about the alleged effects of speculation, and the tales of woe focus on the impact of speculation on cash prices.

I remember distinctly when I testified before Congress on speculation in the summer of 2008: criticisms of speculation at the hearing focused on the impact of derivatives trading on physical commodity prices.  Battling Bob Etheridge of NC took time out from assaulting college students to bewail the plight of trucking companies in his district forced to pay higher fuel prices due to speculation.  The head of the Industrial Energy Consumers of America claimed that chemical producers and others had to pay higher prices for natural gas and crude feed stocks because of speculation in derivatives.

I could multiply these examples by the hundreds, and probably the thousands.  In the 1930s, speculative limits were rationalized as a way of bolstering the prices farmers received on the cash market for their grain.  Suffice it to say that it is beyond cavil that the drive to restrict speculation in derivatives is all about the cash markets.

For Gensler, at this late date, to claim that’s not part of his (or his agency’s) job description beggars belief.  Congress mandated the imposition of position limits for the express purpose of reducing the impact of speculation on cash market prices.  That’s what Congress “asked” CFTC to do.  To proceed with a plan to impose speculative position limits on derivatives, without regard to how said limits could have the unintended consequence of distorting cash market prices is both irresponsible, and at odds with the purpose of the regulation.

Now, obviously, I do not agree with the beliefs underlying the legislative mandate for speculative position limits.  But given that the mandate exists, and that Congress has delegated to the CFTC the authority to implement said limits to achieve a purpose set out in the statute, you’d think CFTC should devise those limits with an eye as to their real effect.  There is now substantial credible evidence that one effect of limits on derivatives will be to shift some activity into the physical markets directly in a way that has more potential for adverse effects on these markets.  It is therefore incumbent on CFTC to take that into account when designing its limits, as otherwise it would impose restrictions that would be directly contrary to the entire purpose of the limits in the first place .

I mentioned the JPM physical copper ETF.  BlackRock just announced another.  This is a growing trend.

Goldman and Standard Chartered argue that physical ETFs should have a limited effect on the market.  In most circumstances, I believe that’s true.  But we’ve seen in the Treasury markets that the limited “float” of some Treasury issues that results from bonds and notes being locked up in pension funds and other buy-and-hold investors can lead frictions that distort prices, and in particular can make it easier to squeeze the market.  Physical ETFs could have the same effect.  Moreover, as a general matter, and as I opined in my original piece on the subject, whereas with derivatives investors can get exposure to particular risks without holding the actual underlying, if physical ETFs are the only way to get exposure to particular commodity price risks, there is an additional constraint that can effect prices as operating under the constraint, to meet portfolio objectives investors may decide to hold inventories of copper that would be released for consumption had investors been able to achieve these objectives through the derivatives market.

At the very least, CFTC should investigate thoroughly the effect of speculative limits on the scale of physical ETFs, and the effect of physical ETFs on the cash markets.  But Gensler’s remark in the Reuters interview makes it evident that he, at least, considers the entire issue irrelevant to the entire position limit exercise.  That’s wrong, and just plain wrongheaded.

You might argue that this development was unintended by the drafters of Frank-n-Dodd.  You can no longer say that it is unanticipated.  Regulators should attempt to determine how market participants will react to their dictates, and plan accordingly.  Saying “it’s not my problem, man” doesn’t cut it.

The next brawl on the Frank-n-Dodd fight card is over segregation of customer funds in the clearing model.  From the FT:

The “risk” that is in the spotlight centres on how customer assets, such as margins required to cover potential losses on derivatives trades, are held.

Under the current futures model, “futures clearing merchants” (FCMs), which handle cleared derivatives hold these assets in pooled accounts. If one of the FCMs’ customers defaults, and causes the FCM to go under too, then the clearing house can tap into this pooled account – also called an “omnibus” account – to cover any losses that are not met by margin payments or the clearing house’s default fund.

For investors these accounts are an important safety net. And they want the pooled accounts to be replaced by a system of separate, or segregated, accounts. Then, if another investor defaults, their assets are safe.

“It is an extreme event, but it is not impossible,” said Richard Prager at BlackRock at the meeting organised by the CFTC.

. . . .

If regulators opt for segregated accounts, clearing houses won’t be able to tap into these in the event of a default. Instead, clearers say the current system of using omnibus accounts gives them an extra shield. The removal of this shield would mean they would have to find funds elsewhere, potentially driving up clearing costs for users.

Kim Taylor from CME Clearinghouse said the removal of omnibus accounts could require a 60 to 100 per cent rise in the default fund, the capital put up by the backers of clearing houses. Such a rise in capital costs could lead banks to “think twice” about being in the clearing business, she said.

Point number 1 (which everybody saying anything about clearing should repeat until they internalize it): a primary effect of any priority rule–and the difference between segregation vs. omnibus accounts is first and foremost a difference in who is in what loss position in default–is to shift risk around.  Under the omnibus model, the customers of an FCM are at risk to its other customers and the FCM itself.  If some customers default, and the FCM does not have the resources to cover this, under the omnibus system the clearinghouse can seize the entire customer margin held in the omnibus account to make whole those at other FCMs (including the other FCMs themselves) who are owed money.  This means that non-defaulting customer funds at the defaulting FCM can be used to cover the losses of the defaulting customers at that FCM (though not the losses on the FCM house account).  Under segregation, this can’t happen.  But that doesn’t mean the losses go away: they are borne by the other clearinghouse members who don’t default.  These firms are obligated to pay up to make those owed money whole.

In other words, with an omnibus account system, customer default losses are shared among FCM customers and members of the CCP.  Under segregation, they are shared only among members of the CCP.  The rule shifts losses around.

Note that this is somewhat ironic if the policy objective of a CCP mandate is to reduce the counterparty risk losses suffered by the large, systemically important financial institutions that are among the members of CCPs.  Segregation rules force said firms to bear larger default costs than omnibus rules: losses are shifted in their direction.  (And compared to bilateral markets, it can also be the case that large systemically important financial institutions will bear larger default losses under clearing than without it.)

In other words, just looking at the risk piece, the choice between segregation and omnibus is a choice between different sharing rules.  Default losses are actually spread more widely under the omnibus system, as non-defaulting customers are in a potential loss position.

But whenever you look at insurance arrangements, you have to consider the incentive effects, and most notably, the potential for moral hazard.  The crucial thing to understand here is that the segregation system is more vulnerable to moral hazard than the omnibus system.

This is true for at least a couple of reasons.

First, customer incentives to monitor FCMs are stronger with omnibus accounts.  A customer realizes that if the FCM doesn’t monitor its customers appropriately, or lets them assume excessively risky positions, he is at risk of loss from the FCM’s carelessness.  He therefore has an incentive to choose an FCM carefully, and to monitor that FCM, and potentially move to another FCM (“exit”)  or raise hell with his current one (“voice”) if he finds that FCM is slacking in watching its customers.

Second, under segregation, customers don’t care about the riskiness of the FCM’s trading or financing.  Remember a customer is in a loss position under an omnibus system when (a) there is a default in some customer accounts, and (b) the FCM can’t cover this loss.  Condition (b) is more likely to occur, the riskier the FCM’s own trading, financing, etc.  Therefore, a customer is more likely shy away from a high flying FCM that trades aggressively, or levers up to the max, or chooses fragile forms of leverage when under an omnibus system.  Under segregation, the customer channels Alfred E. Newman: “What, me worry?”  He will choose an FCM only on the basis of commissions, services, the quality of the Christmas party and golf outings, etc.  This means that under segregation, customer accounts will be at riskier FCMs, on average, than under omnibus accounts.

More moral hazard means that default losses will be greater on average under segregation.  And since non-defaulting CCP members are on the hook for the entire default loss with segregation, this means that CCP members have more capital at risk under segregation than with an omnibus system.  That’s why Kim Taylor concludes: “Such a rise in capital costs could lead banks to ‘think twice’ about being in the clearing business, she said.”  A bigger share of a bigger amount translates into a lot more capital.

Given this, it’s no surprise that the omnibus account system has had survival value.  It is a way of controlling moral hazard.  It reduces the insurance benefits of clearing (from the customers’ perspective), but it reduces the costs of providing this insurance.  As is the case with virtually every insurance system, including the most prosaic automobile policy, you need something like a deductible to mitigate moral hazard. Insurance is almost never complete due to the perverse effects of moral hazard. Omnibus accounts play the role of mitigating some moral hazards in clearing.

I would hope that regulators ask why the omnibus system evolved, survived, and dominated before prescribing the sharing rule that CCPs adopt.  (I’ve told one regulator exactly that.)  The survival principle tells you something.  Before changing what is, ask why it is.  Believe it or not, there is very likely to be a good reason for it.  And with omnibus accounts, that reason is control of risk.

I have to quote just one more thing from the FT article:

But the issue highlights the complexities – and costs – of reforms.

Well, no sh*t.  Some people (sounds of throat clearing) have been saying that for literally years.  If only the Sorcerers’ Apprentices had appreciated that before passing Frank-n-Dodd.

Unintended consequences, that is.

ETFs have been a big deal for several years now, including commodity ETFs.  Heretofore, the big commodity ETFs have been in energy, but now several firms have metals ETFs in the offing.

Most traditional ETFs have bought futures contracts.  So the US Oil Fund, for instance, buys NYMEX light crude futures.  As the contracts it holds near expiry, it rolls forward into deferred contracts, buying the deferred and selling the nearby.

But the new metals ETFs will invest in, and hold stocks of, physical metal rather than derivatives.  FT Alphaville, quoting from a JP Morgan prospectus for its new copper ETF, has the details:

Firstly, being physically backed and not futures-based — the trust will escape all regulatory restrictions governing the size and scope of its speculative commodity positions (since there’s no exchange presence). No USO or UNG implosion danger here.

As the documentation states:

The Trust will take delivery of Physical Copper in the form of LME Copper Cathodes. Because the Trust will not trade in copper futures contracts on any futures exchange, the Trust will not be regulated by the CFTC under the Commodity Exchange Act as a “commodity pool,” and will not be operated by a CFTC-regulated commodity pool operator. Investors in the Trust will not receive the regulatory protections afforded to investors in regulated commodity pools, nor may the COMEX or any futures exchange enforce its rules with respect to the Trust’s activities. In addition, investors in the Trust will not benefit from the protections afforded to investors in copper futures contracts on regulated futures exchanges.

Note, too, that as a result it is likely that the ETF will not be subject to position limits.  And I think this is a big part of the reason for going physical.

The construction of the fund to avoid regulation is clear as day.  The effects are not likely to be good.  The advantage of using derivatives (futures or swaps) to construct ETFs is that it makes it possible to achieve an arbitrarily large exposure to the price risk of the underlying (oil, or copper, or whatever) without ever handling the physical.  That is, derivatives allow the unbundling of the price risk and the holding of the physical product.  This lowers transactions costs, and crucially permits investors to achieve portfolio and risk objectives without being constrained by the size of the physical market.

In contrast, physical ETFs cannot exploit this unbundling.  But apparently, the benefits of avoiding position limits and other regulatory costs are sufficiently great to justify the loss of efficiencies associated with this unbundling.  (If the bundled risk-physical solution were better than the unbundled one, you would have seen physical ETFs when the regulatory constraint wasn’t a real threat.)

There is a perverse irony here.  The whole rationale (supposedly) for position limits is that speculation somehow distorts physical markets.  There is precious little evidence, outside of a few extreme examples (e.g., the Hunts) that this is a real problem.  But by driving those that want exposure to metals prices, either for speculative reasons, or for portfolio balancing reasons, regulations are making it more likely that speculation will distort prices and the physical markets.

I’m not saying this will happen, or will be chronic.  Only that distortions are more likely in the bundled world than the unbundled one in which ETFs trade in derivatives rather than the physical.  ETFs that roll aren’t in the physical market, rolling out of expiring positions before they can go physical.  This limits, and likely eliminates, their effect on prompt prices and consumption, production, and storage decisions.

In contrast, ETFs that hold the physical are by definition in the physical market, and there can be a conflict between the risk and profit objectives of physical ETF holders and the efficient allocation of physical supplies; those desiring exposure to metal price risk might hold onto stocks when it would be optimal to consume them instead.  Conversely, in an unbundled world, traders can maintain exposure to the price risk without having any influence on the use of the metal.

I can also imagine some manipulation strategies that exploit the physical ETF.  For instance, somebody could obtain a big physical position via the ETF, and use that to create or enhance market power in the derivatives market.  That is, the ETF can be a way of “locking up” metal that would otherwise be available for delivery, thereby enhancing market power in the derivatives market.

I said this was a perverse irony.  It’s actually more perverse than ironic.  A policy intended to reduce (probably chimerical) distortions in the physical market actually increases the likelihood that such distortions will occur.  That’s the kind of havoc that Sorcerers’ Apprentices wreak.  Get used to a lot of that going around.

I would have to say that this is unprecedented, at least I hope so:

Commodity Futures Trading Commission (CFTC) Administrative Law Judge George H. Painter made serious allegations regarding fellow CFTC judge Bruce Levine in announcing his retirement.In a notice sent to complainants and their attorneys, Judge Painter claims that Levine  told him that he had promised former CFTC Chair Wendy Gramm “that he would never rule in a complainants favor”. Painter’s notice goes on to say, “A review of his rulings will confirm that he has fulfilled his vow.”

In the notice Painter recommends the CFTC request the services of an administrative law judge to be detailed to the Commission from another regulatory agency to handle the remain cases on his docket. Painter writes, “If I simply announced my intention to retire, the seven reparation cases on my docket would be reassigned to the only other administrative law judge at the Commission, Judge Levine. This I could not do in good conscience.”

Yes, I’d say those charges are pretty serious, and disturbing.  Judges don’t, as a rule, criticize one another.  Things must have been pretty bad for Painter to break that rule.  But it doesn’t seem that in the end it will have a real effect.

Painter’s criticisms are limited to reparations cases (basically cases where customers of brokerage firms claim their brokers have failed in their duties towards them, and cost them money).  But he raises questions about the possibility of an ideological bias that could have affected decisions in other cases too.

I have been involved in a couple of Levine’s cases.  I’ve heard stories, but this is neither the time nor the place.  I would hope that there is some mechanism for investigating Painter’s allegations, and either clearing Judge Levine’s name if they are baseless, or holding him accountable if they are not.