Streetwise Professor

January 9, 2011

Political Points

Filed under: Commodities,Derivatives,Economics,Exchanges,History,Politics — The Professor @ 10:21 am

My post on the “points” system under which the CFTC would monitor positions, and then intervene on a discretionary basis when any position breached pre-set levels (“points”) brought to mind a story about the famous–or notorious, depending on your perspective–speculator, Arthur Cutten. Cutten engaged in massive speculations in wheat during the 1920s.  In 1925, he made the largest income tax payment up to that time in the history of northern Illinois–over $500,000.  Importantly, as a result of his market activities, Cutten attracted the attention–and the ire–of the government.

The Grain Futures Act of 1922 required large speculators to report their positions to the government.  Speculation continued apace despite this requirement, and the authorities were impatient to do something to stop it.  Calvin Coolidge’s Secretary of Agriculture, W.M. Jardine, demanded that the Chicago Board of Trade do something to stop the “gambling” in grain. In response, the CBT created the Business Conduct Committee.

Even in the aftermath of the creation of the BCC, Cutten continued his speculations.  Cutten bought millions of bushels of May, 1926 wheat.  The Grain Futures Administration, the division of the Department of Agriculture responsible for enforcing the GFA, “suggested to the Board of Trade that Cutten’s holdings were too large for one person” (Ferris, The Grain Traders, p. 180).  The BCC swung into action and called in Cutten for a little chat.

When Cutten arrived for the meeting May wheat was selling at $1.65/bu.  (He had bought at around $1.50/bu).  His arrival at LaSalle and Jackson* was observed, and traders soon discerned its import: wheat began selling off as he ascended in the elevator to the conference room where the BCC was meeting.

The BCC told Cutten: “the Grain Futures Administration has made the complaint that you are carrying too much open stuff.”  Cutten resisted selling, but the committee persisted.  Finally, one of the committee members put his arm around Cutten, and told him: “You ought to sell some wheat for the sake of the Board of Trade.  You know, this committee is the device we settled upon to keep the government from taking fuller control of trading in futures.  They get the figures and watch the accounts from day to day.”

Cutten still resisted: “Why should I sell before I’m ready?”  The committee member responded: “For the sake of the Board of Trade.”

Cutten finally relented.  Prices fell further.  He later lamented that the elevator ride to the BCC meeting had cost him a million dollars.

The mechanism that forced Cutten to sell looks remarkably similar to that proposed under the point system.  The government monitored large positions, and exerted pressure on a particular trader–in this case, through the CBT–and that trader eventually capitulated.

What is worrisome about this story is that the intervention that forced Cutten to sell occurred in an overtly politicized environment.  The Secretary of Agriculture, in step with a long line of Senators and Representatives viewed commodity speculation as a social ill.  Jardine had demagogued the issue repeatedly: he had dragooned the CBT into creating not only the BCC, but to mandate clearing of all grain transactions as well.  A speculator who had gained considerable notoriety for his previous operations in the market was targeted for pressure.  At least insofar as the public record is concerned, there is no evidence that the GFA or its handmaiden BCC undertook any serious inquiry to determine whether the speculator’s actions had or threatened to distort prices.  Similarly, there is no evidence that less intrusive measures were considered or proposed: to mitigate concerns about a corner, for instance, the BCC could have limited Cutten’s ability to take deliveries of wheat in quantities necessary to effectuate a squeeze.

Thus, one reasonable interpretation of the events of 1926 is that the GFA–the great-grandfather of the CFTC–intervened in the market for political purposes, rather than on the basis of a well-reasoned and empirically supported concern that the market had in fact been distorted by the actions of a particular individual.

Having watched closely–and up close–the fevered battles over commodity speculation in the past several years, I have no confidence that the same thing wouldn’t happen under the points system.  In fact,  I would put that more strongly: I have every confidence that the same thing will happen again.   Discretionary authority is subject to political pressure, not to mention the whims of regulators.  Consequently, it is inevitable that such authority will be abused.

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