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UPDATE August 8: In his New York Times column, Professor Simon Johnson discusses the extensive debate triggered by the Senate Banking Committee's recent hearing into Goldman's alleged manipulation of aluminum prices. Here is an excerpt from "Getting Big Banks Out of the Commodities Business."
"This may be the strangest debate we have had about banking in the United States in the last five years, because the answer is completely obvious: it is a new and very bad idea to allow big banks to also dominate any dimension of the commodities business. It is also not sustainable politically, and the big banks will soon have to divest themselves of these activities. [...] When you allow any companies both cheap government-backed financing and carte blanche to take over other sectors, what would you expect to happen? And if you allow any kind of unfair market power to develop, surely it would be a shock if this did not result in higher prices or less good service – or even some kind of manipulation."
ORIGINAL POST: What's raising the price of beer and soda? Hint: It's not the cost of hops or sugar. If complaints to regulators and Congress are accurate, it's the manipulation of aluminum markets by mega-bank Goldman Sachs.
Many of the failed, once-high-flying super-corporation Enron's alleged schemes to manipulate markets and defraud small investors and pension funds involved sham transactions with itself that the SEC alleged had "no economic substance." These "artifices" enabled Enron to falsely inflate its profits and unjustly enrich its insiders.
Now comes Goldman Sachs, updating a page from Enron's book. According to a major Sunday New York Times investigation called "A Shuffle of Aluminum, but to Banks, Pure Gold," by reporter David Kocieniewski, workers driving trucks and forklifts move tons of aluminum around and around its Detroit warehouses for what appears to be no reason at all.
"Two or three times a day, sometimes more, the drivers make the same circuits. They load in one warehouse. They unload in another. And then they do it again. This industrial dance has been choreographed by Goldman to exploit pricing regulations set up by an overseas commodities exchange, an investigation by The New York Times has found. The back-and-forth lengthens the storage time. And that adds many millions a year to the coffers of Goldman, which owns the warehouses and charges rent to store the metal. It also increases prices paid by manufacturers and consumers across the country. Tyler Clay, a forklift driver who worked at the Goldman warehouses until early this year, called the process 'a merry-go-round of metal.'"
At a U.S. Senate Banking subcommittee hearing yesterday chaired by Sherrod Brown (OH), an expert, Professor Saule T. Omarova of the University of North Carolina School of Law, confirmed the New York Times' analysis and testified that Goldman "has caused serious turbulence in the global market for aluminum, the second most widely used metal in the world after steel." She also explained that all the biggest mega-banks are branching out into the physical commodities markets.
That "turbulence" Professor Omarova highlighted was brought home by a witness for a beer company hampered and frustrated by Goldman's alleged actions. From a followup by Edward Wyatt in today's New York Times:
"Major beverage companies have complained about the maneuvers. Tim Weiner, a MillerCoors executive, told the panel on Tuesday that while consumers might not think they have much at stake from tons of aluminum bars stored in a warehouse near Detroit, the actions of Goldman and others have raised prices, cost jobs and hindered innovation. [...] Imagine going to a liquor store to buy a case of beer, and taking it up to the cash register to pay, Mr. Weiner said. Then instead of taking the case of beer to your car, the clerk told you to visit the store’s warehouse, where you can retrieve the beer in 16 months."
Professor Omarova points out in her encyclopedic testimony (32 pages) that while the big banks have pushed the envelope between the letter and spirit of the law, that the practices, while not at all transparent, are not necessarily illegal.
She explains how the big banks have exploited loopholes created by both the Federal Reserve and Congress, including those established by the infamous and PIRG-opposed 1999 repeal of Depression-era legislation separating banking and commerce, which also helped trigger the 2008 economic collapse. She explains how cracks in that once solid wall between banking and commerce have been substantially widened into full-fledged breaches large enought to drive trucks, or oil tankers, through. She explains how the historic events of September 2008, when the surviving giant investment banks -- Goldman and Morgan Stanley -- were brought under the Federal safety net (because they were too big to fail), were actually a boon to the firms' efforts to expand their physical commodities activities.
She goes on to point out how in 2008 and 2009 JP Morgan Chase took advantage of "once-in -a-lifetime" opportunities to acquire the commodities assets of two failing investing banks, Bear Stearns and UBS, which essentially grandfathered JPMC into the business, too.
She explains that these big banks are involved not only in aluminum, but other physical commodities markets, including other metals, oil, asphalt, chemicals, oil tankers, mines, refineries, electricity production "and other things." She explains how the fuzzy language of the laws aids mega-bank efforts to expand their footprint and how the banks actively and successfully sought language to give them an "open-ended source of legal authority for banking organizations to engage in any commercial activities that may become feasible or potentially profitable in the future."
So if the banks are making more money, what's the problem? She further explains that not only do the physical commodities trading practices pose both reputational risk to an individual firm's safety and the risk of "contagion" to the entire financial system, they also raise important questions related to the principal policy arguments that led to the separation of banking and commerce: conflicts of interest that could lead to credit mis-allocation, the potential for market manipulation and higher consumer prices and the risk of an even greater concentration of economic and political power than the big banks already enjoy.
Professor Omarova's concerns were echoed by another witness, Joshua Rosner, a managing partner at Graham Fisher and Company, who argued that these and other mega-bank tactics are part of their strategy to increase revenue through "control of nonfinancial infrastructure assets."
The committee's hearing certainly drilled deeply into a variety of complex and technical issues. But, as is often the case, Senator Elizabeth Warren (MA) provided a clear summary, according to today's New York Times:
“The notion that two of largest financial companies are adopting a business method pioneered by Enron,” she said, “suggests that this movie will not end well.”
In a separate followup in the New York Times today, Gretchen Morgenson and David Kocieniewski point out that:
"The Commodity Futures Trading Commission has taken the first step in an examination of warehouse operations that are controlled by Goldman Sachs, Glencore Xstrata, the Noble Group and others and used to store vast amounts of aluminum."
The banks may claim that "it's all legal." Certainly their phalanx of lobbyists and PR firms and their various political patrons will try to dismiss the significance of these important inquiries by Congress, major media and the CFTC. Yet, as Subcommittee Chairman Sherrod Brown (OH) explained yesterday:
“Ohio manufacturers and consumers should not have the price of their gas, beer, soft drinks, or electricity driven up by Wall Street speculators,” Brown said. “When Wall Street banks control the supply of both commodities and financial products, there's a potential for anti-competitive behavior and manipulation. It also exposes these megabanks - and the entire financial system - to undue risk from mine collapses, oil spills, and refinery explosions.”
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