“Picture Puzzles”

Speech of CFTC Commissioner Bart Chilton Before the Third Annual International Commodity Markets, Manipulation Enforcement Conference, Washington, DC

June 24, 2009

Good evening. I hope you had a good first day. This is a great and diverse group of regulators from around the world and I’m pleased to spend some time with you while you are here. I want to thank Steve Obie, Phyllis Cela and their staff who have done a remarkable job in setting this conference up, but they do a great job every day. I also thank the UK’s Financial Service Authority (FSA) for all of their help in putting together this event and their cooperation on myriad issues of mutual interest.

Now, more than at any time in history, it is important that we are all together. The issues that have been discussed at previous conferences, and are being discussed while you are here, are the reasons that most of us are in government service: to keep markets safe and secure; to avoid fraud, abuse and especially manipulation; and to protect consumers. I congratulate you for your service. These types of jobs are all too often thankless positions. That seems true more today than at other times for financial regulators. For my part, I think these types of jobs are every bit as important as doctors or nurses, as clergy or as members of the military.

At the same time, it maybe is fair to say that most people don’t think financial regulators did that great a job during the last few years. I’m not suggesting that any individual in this room didn’t do their jobs. There was a systemic failure, and many of us happened to be “on the job” at the time. I certainly think that the U.S. financial regulatory system failed in a significant way, and I’m sure there are improvements that could have, that should have, and that will be made—not just in the U.S. but around the globe.

As most of you know, President Obama recently called for sweeping regulatory reform the likes of which we have not seen since the aftermath of the Great Depression. We certainly need it.

Specifically, the President’s plan calls for regulation into the area of over-the-counter (OTC) derivatives, requiring exchange trading for standardized OTC products, requiring mandatory clearing in opaque markets such as credit default swaps (CDSs) and OTC transactions, increasing capital requirements, increasing cooperation and coordination between financial market regulators. In addition it calls for increasing consumer protection from deceptive practices like manipulation and like the rampant Ponzimonium going on not just here in the United States, but as we now know, although not yet made public, around the world. There’s an unprecedented number of these scams going on in the United States—25 cases so far this year when we only had 13 in all of last year. And, internationally Ponzi scams have popped up across the globe—from major European and Asian cities to small island nations. Ponzi cells are popping up all over the world. And, by the way, these are only the ones we know about.

For example, in Atwood & James, registered New York corporations operating from Brazil ran a world-wide multi-million dollar fraud through, among other things, a fraudulent website. A Tennessee man named Bolze and his Las Vegas companies directed an operation in Spain that in total defrauded at least $20 million from at least 100 residents of the U.S., Spain, France, the UK, Malidives and Turkey. And, let’s not forget our neighbors to the north, Canada. So far this year, two Ponzi schemes bridged the narrow divide. I could keep going, but you get the idea.

Finally, the plan calls for a regulatory system which seeks a better view of markets and market participants. On this point, I want to expand. The CFTC regulates the futures industry, and we had a view into the futures world. The Securities and Exchange Commission (SEC) regulates securities, and they had a view into those. Banking regulators see state and national banks. The problem was, and is, that there was no single view of all markets or of the entire picture of an individual bank or trader. Many of you have a single agency regulatory regime with a greater view of your markets and market participants. Globally, however, we don’t have a clue. We don’t even come close to having a clear view of firms that are operating internationally. The organizational charts of some of these large conglomerates are astounding. Many look like spaghetti. Some of these companies have myriad subsidiaries that are registered in different nations—some to take advantage of tax laws and others, perhaps, to avoid market transparency or regulation. Some use multiple markets and financial institutions as fiscal washing machines for questionable, at best, activities. The bottom line is that we have had a global economic crisis, but we have no remedy to view global financial market participants.

We have a magazine in the U.S. called Highlights. It’s a children’s magazine. I know there are similar children’s magazines around the world. Some of you may recall what are called “picture puzzles”—that is—pictures which contain hidden items. There may be a picture of two children crossing a bridge, but there will be many other hidden items to find. They provide a lot of learning and entertainment for children.

Although you may not know them by name, adults have something similar, they are called stereograms and autostereograms. These are those pictures that trick your eyes by hiding three-dimensional images. If the viewer looks at the image in a certain fashion, one sees a totally different picture than was viewed at first glance. These are the pictures in which one may try to cross their eyes or bring them somewhat out of focus in order to look at the pictures differently. Sometimes, it helps to stand back a bit because ultimately, it’s a matter of perspective. They can take a while to crack, and they can give you a headache. Salvador Dali, the famous surrealist artist, created some impressive stereograms where one’s eyes are tricked. Computer technologies helped to popularize stereograms and autostereograms. They are pretty neat, but as I say, they can give you a headache.

There are also optical illusions like the Ponzo illusion. Now, this is Ponzo, named after Italian psychologist Mario Ponzo, not Charles Ponzi of Ponzimonium fame. A Ponzo illusion is based upon the premise that the human brain estimates an object’s proportions based upon its background. For example, Ponzo showed this phenomenon by drawing two identical lines across a pair of converging lines that looked similar to railroad tracks. The upper line appears longer because our brains interpret the converging sides, or tracks, according to linear perspective as the parallel lines recede into the distance. So, we interpret the upper line as though it were longer than the lower line—despite the fact that these lines are the exact same size.

My point to all of this is that internationally, financial regulators don’t have a clear or full view, a proper perspective if you will, to understand what is really going on with very large financial entities that could, and have, had a profound impact on our world’s economy.

Credit Default Swaps (CDSs) for example, in the United States, and many places around the world, were and to date, remain totally unregulated financial instruments. Estimates are that $55 to $60 trillion in CDSs were, at one time, traded. The insurance giant American International Group (AIG) was leveraged to a massive extent with CDSs. That collateral damage of a financial picture not seen, because it was hidden to regulators, lays all around us now (and, it’s giving a lot of us headaches). Now, we know the extent of their leveraging and their precarious financial positions. Now, we’ve played with perspective. So, are there more of these out there? Perhaps there are. Will there be more of them in the future. For sure there will be if we don’t get a better handle on what is going on that we can’t see in these hidden financial picture puzzles.

I know we are not going to solve this problem while you are here in Washington, D.C. But it is something for us to think about seriously as we all consider what additional actions should be taken to ensure that we are better prepared in the future.

What we can do is continue working together on ensuring that our enforcement efforts give us all a clearer picture. We can work to ensure that we have a view into the hidden things that we might not see at first glance. For example, companies that play one nation’s regulator off of another, or companies who hide financial records from regulators. They simply shouldn’t be allowed to trade in serious markets around the world.

The key to getting a better picture of our markets, of manipulation and ultimately of market participants that can have a huge impact on our economies is in greater coordination and consultation to ensure that we have a clearer view. It will protect consumers from fraud, abuse and manipulation and it will help our financial systems.

Now, I don’t want to suggest that we aren’t on the right path already. We are making progress. In fact, there are 140 current examples where we are working on collaborative international cases. In addition to Ponzi scams, these involve manipulations and attempted manipulation, solicitation practices, and insider dealing. The reason we are all here together is so that we can do even more. We want to be more efficient and effective.

Getting back to those autostereorgrams. There’s a movie called Mallrats where the unfortunate character Willam spends an entire day at the shopping mall trying to see the hidden picture in an autostereogram poster on display. Poor Wiliam, everyone else who walks by the poster can easily discern the picture of a sailboat—even little children. But, we can’t feel too sorry for him, because for all his efforts, he never does the obvious: he never asks a single seer for some assistance in gaining the right perspective. We’re already a step ahead of Willam. We’re here tonight.

Thank you for being here. Thank you for the work that you do—even when there are many who don’t appreciate it. Thank you for your service to consumers.

Last Updated: June 10, 2010