“Here to Help”
Speech of Commissioner Bart Chilton to Commodities Week USA, Light House International, New York, NY
November 16, 2011
Hi! I’m from the government and I’m here to help. Well…it is always good to start off a speech with a joke, right? I’m glad you laughed. At the same time, though, I’m serious. I guess a reasonable question might be, when does government help and when does it hurt?
We don't live in simple times. 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. So, I guess the government was around to help with the bailout, eh? They have done so well that they've paid their senior executives 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 May of 2009, a few months after the Troubled Asset Relief Program or TARP was unveiled, 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. Then with the passage of the Commodity Futures Modernization Act in 2000, we at the CFTC moved from a prescriptive regulatory regime to what is called a principles based regulatory framework. Essentially, that meant we put guidelines or principles in place instead of hard and fast rules, we made things easier for business. So, while regulators were from the government, the only real help they were providing was getting out of the way. They got out of the way so that the free markets could roll, and roll they did. They 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. This helped to 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 30 to 1, according to its last annual financial statement. That showed that the firm had $691 billion in assets divided by only $22 billion in actual shareholder equity. And then, in 2008, it all started to unravel, and as I said, the government then helped out and covered the losses and potential losses of banks that were seen as too big to fail. So, get outta the way government and leave the markets to business. Oh, but if we need a bail out, a helping hand, we will holler. That pretty much sums it up for me. You are from the government and you are here to help, but only on demand, only when it suits our needs. Okay. Got it.
MF Global and the Mysterious Missing Millions
But, you now what? As sad as my version of regulatory history and government helping or not helping and the enormous damage to our economy and our people, we don’t need to recall the events of 2008 to have a tremendously troubling reminder that we need appropriate regulations in place now (or perhaps even months ago with regard to some rules). MF Global is the new poster child for why thoughtful financial regulation is needed, now more than ever.
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.” Our staff scoured their books, and let’s just says we bring on the Beatles here: It’s been a magical mystery tour trying to find the loot. Six hundred million is missing! If I drop a quarter at some drive-through fast-food joint, I get out and pick it up, but, $600 million? I am very troubled by this set of circumstances. I cannot prejudge what our investigators will find. Our enforcement team is on the case and have been since day one. They are from the government and they are there to help and I thank them for their tireless efforts. This is the place— investigations and enforcement—where I would hope there is not much disagreement on the value and important purpose of appropriate government. We’ve got expert staff that have been on this around the clock and who will continue to argue aggressively in U.S. Bankruptcy Court to protect investors. We will keep on and we will continue, with whatever develops in this matter, making 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. In 2005, the CFTC allowed for these things called internal repurchasing transfer agreements, or repos, using segregated funds—customer funds—under certain circumstances to earn investment returns for futures commission merchants. Last year, we proposed to disallow these internal repos used by many firms, but by MF Global, specifically. I now call it the “MF Rule.” Many firms, including MF Global, asked us to hold back on tightening up this regulation. They didn’t want that rule to go into effect. I get it, and if you ask folks who like things the way they are you just might get an honest answer. Firms make more dough when they can do the internal repos. Full stop. Not that it results in a safer and more secure financial system, or it results in better prices for consumers. Nope. It results in better returns. By the way, internal repos are not allowed in the European Union. And, the firms in the United States seemed to be doing pretty well early in the last decade before they were allowed to do the internal repos.
So, I am from the government, and I am here to help, here to help stop these internal repos once and for all. 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, which I sure hope will be no later than December 5th.
I couldn't agree more with Chairman Stabenow's statement yesterday that the fact that these funds are missing is an extraordinary breach of trust. This is DEFCON 1 for me. I am extremely alarmed. We're looking at something that could be nefarious—it could even be illegal—we don't know yet, which is why we've scrambled the jets to move quickly to protect customer funds. But as Chairman Stabenow has presciently noted, we need to ensure that we have lockdown sure systems in place to for appropriate oversight of these funds.
I said MF was the poster child for better regulation, and, like a missing child, this customer funds short-fall becomes more worrisome with each passing day. Accordingly, I have called on our Agency to instruct 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 MF Rule (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 Jerry Maguire and “show us the money” when it involves segregated accounts. Maybe they’ll find those mysterious missing millions under a pillow on someone’s sofa somewhere, but when it involves customer money, there shouldn’t be any mystery. We need to ensure that customer monies are actually where they are purported to be all of the time 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—to improve and increase our oversight and to make that rule tighter, cleaner, and—ultimately—safer, for customers and for American financial markets.
As I said, we live in complex times. Technology changes things every day. That’s certainly true in financial markets in these days of widespread high frequency trading. These traders, I have termed “cheetah traders” because they are so fast, fast, fast. In the animal kingdom, cheetahs are the fastest land animal, racing from zero to 60 miles per hour in a few seconds. In financial markets, this new species of speed trader, due to the advent of high-speed computing technology and sensitive algorithmic programs, races in and out of markets trying to score micro-dollars in milliseconds. They are changing the way trading is done all over the world. They create the multifaceted algorithms and the machines start trading, and then the programs may morph themselves and start trading in another method. In fact, the programs are so intricate that some of them gather information, even Twitter feeds and millions of bits of news, and use the data in a dynamic progression to trade. It is really remarkable.
I’m not being critical of their business, but if markets are going to be efficient and effective and less volatile, shouldn’t we regulators in government help out and try to keep up with the cheetahs? After all, financial markets impact all of us in one way or another. Prices for everything from milk to mortgages are set in these markets.
It may surprise you to learn that regulators don’t even require registration of these traders—the cheetahs. We don’t know who many of them are, their locations, or if they can pass a basic due diligence test for trading. The third largest trader by volume on the CME is a cheetah based in Prague. Good for them, but I’d like to know more about who is trading on U.S. exchanges. That’s why I’ve called for cheetahs to be registered, at the very least.
So, the players in these markets are changing rapidly. Here’s another example: 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.
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 will certainly be able to continue to use these markets. At the same time, there will be new clearing and margin requirements on traders. So that commercial hedgers can continue to use these markets, Congress sought to ensure end-users didn’t have to put forth unneeded margin. Accordingly, Dodd-Frank instructed the Agency to craft a thoughtful end-user exemption in this regard, and that’s one of the rules I expect you will see in the near future.
The law also requires us to define what swap dealers and major swap participants are. It’s clear that we need to exercise great caution when we write those definitions so that they are not so broad as to inadvertently pull in categories of market participants who shouldn’t be there.
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. Again, I am here to help.
Now, more than ever, we have to do better. We need smarter financial regulation. It’s not good enough for us to say we will help out after the fact. We need to be more proactive, particularly in this rapidly changing market environment, trying to prevent bad things before they happen.
At the same time, we need to be careful not to create a 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.
Expect the Unexpected
If we do it just right, there will be unexpected benefits. 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, so perhaps his idea of modernity was a bit different from ours. Back then, people rode around in buggies drawn by horses and houses didn’t have electricity. But there was still a lot going on. Typewriters, airbrakes, metal detectors, escalators, contact lenses, radar, dishwashers, washing machines, cash registers, seismographs, rayon and tungsten steel—were all invented in the last half of the 19th century. It was an exciting time.
The point—and I do have one—is this: we’re at a similarly exciting time right now with regard to financial reform regulations. We actually can be from the government and help out if we do it right. For the first time, we are not writing rules and regulations for a regulated 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 are vibrant over-the-counter swaps trading systems in this country, but now they will be registered entities, overseen by a federal financial regulator. 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.
For those who said passage of Dodd Frank would make this business go away, boy were they wrong—in fact, they were $100 trillion off the mark. New figures released this week indicate that the OTC market has increased 18 percent in the first half of this year—to $708 trillion. That's AFTER passage of Dodd Frank. You think perhaps this regulation might actually help American business? Perhaps, like Toby Keith sings, people actually like, actually look for "Made in America" and appreciate, "a little tag in the back that says USA."
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. 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. That will help.
In addition, all of this new trading activity with new regulatory oversight requirements will require the development of new technologies, both in the private and public sectors. The “language” of algorithmic trading will become the legal definition of how financial market activity is done, and new technologies will be needed to develop the methods with which we speak to each other. The possibilities for economic growth and competition here are mind-boggling. And I have great faith in the ability of American computer scientists, physicists, logicians, statisticians—inventors of all kinds—to come up with the fastest, the most capable, and the best financial market technologies in the world. So, let’s expect the unexpected.
Finally, just yesterday, I spoke at the New York Law School. I released some new data on the rampant increase in the number of Ponzi cases going on in the United States. We have had more than ever before. The SEC is also at historic levels, and the same goes for the FBI. Scam artists are working non-stop to get our green.
In a new book, Ponzimonium: How Scam Artists are Ripping Off America, I lay out ten Ponzi tales from 2009. I also provide 20 Red Flags of Fraud and an Investors Checklist for people to use before they invest their hard earned dollars. Here is a circumstance where we don't need a new rule or a new law. We need consumer education and financial literacy. For my part, I'm from the government and I've tried to help on this by putting out this book. However, people need to be educated to protect themselves.
I am not sure we sorted out all of the places where government can and can't help, but I do hope that we have at least put a little perspective on the appropriate role of government. I know everyone doesn't agree with me. That's why we live in a great democracy. It is also why I'll be pleased to listen to you now and to take some questions.
Last Updated: November 16, 2011