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  • “The High Test”

    Speech of CFTC Commissioner Bart Chilton to the Society of Independent Gasoline Marketers of America Annual Meeting, JW Marriott, Washington, DC

    November 4, 2011

    Introduction—I’ve Been Clean

    Hi, I'm Bart and I'm a . . . I’m a regulator. I've been clean from doing regulation for 13 days now—fingers crossed! Thank you. Thank you very much. That's nice of you to applaud.

    I've been getting my life together, but I couldn't do it alone. I've had a lot of help from my family and friends, my staff, and of course my sponsor: Willie, Willie Makit—Willie is here today. Thank you Willie.

    Now that I've been clean for a few weeks, since we had our last public meeting that is, I’ve been reassessing things. I mean regulation, government, politicians, and regulators like me: ugh, is it a waste? Is it all worth it?

    Think about it. Is government just about the worst? I hate the DMV. I hate standing in line only to be told to go someplace else. I'd like to tell them to go someplace else. And I keep hearing the news reports from Iowa and New Hampshire about all these awful job killing regulations of different colors and stripes. Those guys really dislike the Wall Street Reform Act. Are all regulations evil, I mean pretty much at their core, are they evil? Do we have an irresponsible government, senseless rules, ditzy politicians, and unaccountable regulators? Is it all enough to make you sick?

    And while we are at it, don’t some of you ask yourselves why you have to leave your families and leave your businesses and visit the belly of the beast? Why do you have to pay an association, lobby the Hill or talk to guys like me? Don't some of you just want to be left alone? Let the free market rule. Have free and fair competition.


    Don’t people long for the good ol' days when men were men and businesses could operate freely? And think back with nostalgia to years ago in the oil and gas industry—not Daniel Day Lewis way back, but to the 40s, 50s, and 60s. Ah, the wonderful age of the automobile, those days when people traveled by car, and enjoyed it. They drove all across the country. Families played games—like alphabet—on their trips. They made picnics—picnics for gosh sakes. How fun! They stayed in camp sites or motor lodges. Yes, motor lodges, and some of them had pools.

    Going to a service station was part and parcel to the automobile experience. It was fun and exciting. You could pull up to the pump and say, “filler-up with high test.” You'd get the premier grade petrol, your oil checked, your windows—plural—washed and a tip of a hat from those service station folks who wore uniforms. I even have a collection of presidential campaign buttons that were given away by the American Oil Company as premiums. They were given to me by Mille, my mother-in-law, and since I have the complete set, from 1896 (William Jennings Bryan) to 1968, they are probably worth a lot. As a gift, they are priceless to me.

    As a kid, I liked going to Sinclair because the brontosaurus mascot reminded me of Dino on the Flintstones. If you went to Esso, you'd put the tiger in your tank. Remember those tiger tails folks would hang out of their gas tanks? Or, you could get one of those orange Styrofoam Union 76 balls for your antenna—when folks actually had metal antennas. Boy, they were swell. And lastly, I had not only a toy Texaco tractor trailer, but I had the Texaco Fire Chief helmet. It had a microphone and a speaker on it. The speaker was behind the Texaco star on the front shield of the helmet. Boy was that neat.

    Ah, the good ol' days. It was a simpler time, a good time, and a fine time.


    But let's snap out of it a bit. Let's think back not to 40, 50, 60 or 70 years ago, let's go back to lunch: yes, lunch. Chicken, I believe it was. As was said in the introduction, I worked at the U.S. Department of Agriculture for several years. I had the occasion to visit many places that deal with various stages of food production, from the farm to the factory to our tables. If you have thought that some of what I've said today might not ring true, let me say this: if there is only one thing that you take away from my remarks this afternoon, believe this—you want food safety regulations. You want inspectors, you want quality controls.

    Actually, I guess we all want those airline safety regulations too, right? You guys came on planes, trains and automobiles, so I suppose we want the transportation industry to be safe. Oh, and kids' toys, I guess we want those to not have toxins in or on them. Okay that's it. Well, and no lead in paint. And not pesticides, herbicides, chemicals in our drinking water. Yeah, we want those regulations. We want those. Do we want clean air? I do, but I guess there might be a few here who don't. So, I suppose we actually do want some regulations. See, it won't kill ya’ to admit it.

    Try some of this. I promise you won't become an addict. We also need regulation in the financial sector.

    We don't live in simple times. We don’t live decades ago. Things aren't like the bygone days of yesteryear. We live complex lives, with new and emerging technologies, intricate and inter-related global financial markets of enormous size and breadth. We have banks that were so large that when they were toppling, or about to topple, we—all of us—had to fork over hundreds of billions of dollars in a hideous bail out. Those that took the bailout, by and large, are doing just fine thank you. They have done so well that they've paid their senior executives millions in bonuses. I mean individuals have received millions in bonuses. And why did that all happen again?

    Well, there isn't much doubt about the causes of the economic crash. The Financial Crisis Inquiry Commission (FCIC) established in the wake of the bailout law—the Troubled Asset Relief Program or TARP—concluded that there were two culprits to the crisis. One culprit: regulators. You see, in 1999, Congress and the president deregulated banks. They were no longer bound by the pesky Glass-Steagall Act that cramped their style and limited what they could do with the money in their institutions. After that, regulators got the message to let the free market roll. And, roll it did. It rolled right over the American people.

    The second culprits, according to FCIC, were the captains of Wall Street. Since they were allowed to do so much more without those rules and regulations, they came up with all sorts of creative and exotic financial products. Credit Default Swaps (CDSs)—bizarre deals on mortgages for potential homeowners and bets upon bets upon bets that were sold and resold to their contemporaries on the Street—became the norm. And it helped create an entire market out of the view of regulators. Hundreds of trillions of dollars of trading took place completely, utterly off regulators' radar screens. The value of these things was in the eye of the beholder. Folks were over-leveraged if their books called for it to be so: think Lehman Brothers who were leveraged 40 to 1. And then, in 2008, it all started to unravel.

    Those really aren't the good ol' days, are they? If we have forgotten about that time, shame on us. The economy is still crawling out of the economic hole. Folks are still in distress. We are still paying the price for those choices made back in 1999, and many more poor choices since that time.

    MF Global

    We don’t need to recall the events of 2008, however, to have a fresh whack-in-the-face reminder that we need appropriate regulations in place now. MF Global is the new poster child for why thoughtful financial regulation is needed, now more than ever.

    For several days, beginning last week, the CFTC, the SEC and other regulators closely monitored developments at the company. Since this issue has come to light, we have had staff camped out in their New York and Chicago offices looking at books and records and investigating precisely what happened. For us, job one is always—no excuses—to ensure that customer funds are held sacrosanct in what are called “segregated accounts,” and that they are safe and secure. In this case, as the Stones sing, we “got no satisfaction.” We still haven't and we won’t stop until we do. We need to ensure that customers—and markets—are protected to the fullest extent of the law. I can tell you that we are using any and all of our myriad authorities under the Commodity Exchange Act (CEA) in this endeavor.

    There had been lots of press reports about a potential sale of assets or another kind of transaction that might occur, and that would have perhaps cured MFG’s problems—but that just didn’t happen. At the same time regulators weren't getting satisfaction, apparently, neither were the potential new owners of MFG. So we have worked aggressively, with exchanges and through the court system, to ensure that customer funds are protected to the maximum extent possible, and that market disruption is kept to a minimum. We have also worked with the parties involved to allow the transfer back of some funds to MFG customers.

    This is a rough road, but we’ve moved into four-wheel drive, put on the tire chains, put some high test in the tank and we’re going to ride this through. We’ve got expert staff that have been and will continue to argue aggressively in U.S. Bankruptcy Court to protect investors, and we will continue, with whatever develops in this matter, to keep customers our first priority.

    Segregated Accounts—Show Me The Money

    Why is MF Global the new poster child for regulation? Well, it isn’t a generic claim I’m making. We have proposed to disallow a practice that MF Global was involved in. Specifically, MFG used internal repo transfers. These transfers are currently allowed, using segregated funds—customer funds. Our new proposed rule would have disallowed these repo transfers. Many firms, including MF Global and Senator Corzine specifically, have asked us to hold back on tightening up our regulations. They didn’t want that rule to go into effect. In fact, they made a good case that we needed to re-open our comment period to accept additional comments—something we have done on many rules. At this point, however, I think we have seen and heard quite enough on this rule and I have urged that we move forward on it at the very earliest opportunity.

    I do, however, believe that we need to do something additional. Today, I’m calling on our Agency to instruct our staff and our exchanges to ensure that we conduct routine and robust deep data dives on segregated accounts in conjunction with the tightening of the 1.25 rule. Firms no longer should be able to simply produce bottom line totals of segregated funds, but we should also get to see the actual statements and supporting materials to ensure that the funds are really there. They need to do a Tom Cruise and show us the money when it involves segregated accounts. And we also need to ensure that customer monies are actually where they are purported to be, 24/7/365, so that even intra-day transfers that could negatively affect customer funds are detected and prohibited. And let me be clear: if we catch someone doing that, we will use our prosecutorial authorities aggressively.

    So now, I think it’s time to move ahead—expeditiously—and make that rule tighter, cleaner, and—ultimately—safer, for customers and for American financial markets.

    Expect the Unexpected

    Now, it is appropriate and expected that some are crazy skeptical about unbridled regulation, but most average people probably understand that some of this makes common sense in our complicated world. The challenge is to be better than we have been in government about how we go forward on regulation. We need to be careful not to create an overly burdensome regulatory environment. We’re trying to get it right and, in some cases, that’s why the rules are taking longer than some of us wanted. But remember, we don’t want regular regulation. We need premium regulation—the high test stuff—to stave off another financial meltdown.

    Oscar Wilde had a great quote – “To expect the unexpected shows a thoroughly modern intellect.” He made this statement about the “modern intellect” in the late 1800’s, when people rode around in buggies and didn’t have electricity. There was still, however an increasingly complicated world emerging. The industrial revolution with the numerous inventions and gizmos was taking hold. Typewriters, escalators, contact lenses, dishwashers, washing machines, cash registers, seismographs, radar and metal detectors —all invented in the last half of the 19th century. It was an exciting time. And think about radar and metal detectors. A lot of these inventions might have even seemed spooky or demonic to some. However, not if you thought as Wilde suggested. If you expected the unexpected, it would demonstrate your modern intellect.

    So, my point—and I do have one, is this: we’re at a similarly exciting time right now with regard to financial reform regulations. I’m going to invite you to do something—to expect the unexpected with regard to financial regulation.

    I believe these new rules will actually create jobs. They will create new sectors within sectors. They will create new opportunities for economic growth on American soil. Let me explain why.

    For the first time, we are not writing rules and regulations for an exchange-trading market that is already in existence—like the securities and commodities markets. This new exchange-trading marketplace is being built from the ground up. To be sure, there is a vibrant over-the-counter swaps market in this country, and as I’ve said many times, we don’t want to do anything to hurt legitimate business but at the same time we need to fix what got us into the mess in 2008. We’ve got real, tangible and extremely important reasons to continue to move forward to implement financial reform. Folks who are upside-down on their mortgages will tell you that. Again, let me get back to my original point: why these regulations will be a positive good for the American economy.

    As I said, this industry, this exchange-trading of swaps, will be built from the ground up. The Dodd-Frank law instituted clearing requirements for swaps—the fundamental provisions to address transparency and systemic risk issues. Along with those statutory dictates are new requirements for “swaps execution facilities”—platforms on which to trade swaps. And yes, there are currently vibrant platforms trading OTC swaps, but now they will be registered entities operating under a set of uniform core principles and overseen by a federal financial regulator. In addition, there will be “swaps data repositories,” to warehouse swaps data. All of these entities—and the participants—will be registered with the Commission and will require staff to ensure compliance with federal mandates. As this new industry develops, I am fully confident that “better mousetraps” will be developed. People will devise new and innovative—and better—ways of doing business, and we as regulators are going to need to be nimble and responsive to ensure that we accommodate that growth and at the same time protect markets and consumers. I have no doubt that these new regulations—instituting new types of clearing, trading, and reporting platforms—will foster a landslide of hiring in the financial sector.

    Just like Wilde’s vision of a modern intellect, in the financial arena I see countless possibilities, innovative horizons, unbounded opportunities that this new and novel marketplace will bring to the American economy and ultimately to the American consumer. And the new regulations framing the market’s existence—and providing needed guidelines and protections—will be the foundation for a new generation of economic growth.

    Position Limits

    With that in mind, I want to start to wrap up by talking a little about a few quick policy issues. Again, the financial world isn’t simple anymore. The players in these markets are changing rapidly. Between 2005 and 2008 we saw over $200 billion come into futures markets from non-traditional investors. I call them “Massive Passives.” They are the likes of pension funds, index funds, hedge funds and mutual funds. These funds are very large—massive—and have a fairly price-insensitive, passive trading strategy. When I say this, I’m talking generally. I realize that all traders don’t do this all the time, but we do see a pattern.

    There’s good evidence that excessive speculation sometimes heats up the market and prices get out of line as a result. Rather than help to fairly discover and “make the price,” these speculators “shake and bake the price”—up or down, depending on which side of the market they’re in.

    The new U.S. financial reform law (Dodd-Frank) addresses this by requiring mandatory speculative position limits—to ensure that too much concentration doesn’t exist. We passed a final rule just last month and, while it’s not going to take all speculation out of markets—it shouldn’t—it will, once fully implemented, ensure that no one player has excessive market power.

    End-User Exemption

    Part and parcel to limits is ensuring that legitimate commercial businesses can continue to hedge their business risk. Congress wanted that. The commission wants that, too. So, commercial users who meet the requirements will certainly be able to continue to use these markets. At the same time, there will be new clearing and margin requirements on traders. Here too, Congress sought to ensure that bona fide hedgers didn’t have to put forth unneeded margin and they instructed the Agency to craft a thoughtful end user exemption in this regard.

    The law also requires us to define what a swap dealer and a major swap participant is. It’s clear that we need to exercise great caution when we write those definitions so that legitimate hedgers are not inadvertently pulled into the categories.

    I wanted to mention that today because I expect that some of you are end users. Hopefully, I’ve put your mind a little more at ease in case you’ve been led to believe otherwise by the swirl of rumors that have been out there.

    Is it Doable?

    Is all of this doable? I’ve been involved with government for a while. I see how government operates and how it can change. As I said before, we need to be more proactive. Rather than being like a fire department—maybe wearing that Texaco fire chief helmet—coming in to hose down the charred remains, we need to be more proactive. We need to be looking around the corner. We need to be more nimble and quick. We need to do that for our new market participants, and whatever other new trading elements come our way.

    Sure, we need to do better and I can tell you we have already made good progress. That’s why we haven’t done some of the rules by the date Congress told us—by July. We are being thoughtful. We are doing them correctly. We are getting them right, and we have already started what I’m talking about. It can be done. But, guess what? You do need to be involved. We can’t do it without you. We aren’t the experts, you are. Our democracy only works with full participation. With that, we can have more efficient and effective markets devoid of fraud, abuse and manipulation. With that we can have better price discovery and help fuel inject the economic engine of our democracy. I for one am not going to be satisfied with the regular regulation that got us into the financial mess starting in 2008. I want the premium. We can do this with the high test.

    Thank you.

    Last Updated: November 28, 2011