“Market Madness”

Speech of Commissioner Bart Chilton before the Exchequer Club, Washington, DC

March 21, 2012


Good afternoon. It’s good to be with you today.  Thanks for having me and thanks especially to Bradley Edgell for the kind invitation.

Brackets and Market Madness

How many of you filled out your brackets for the NCAA March Madness? If you’re like me and one of my picks gets eliminated (like Purdue did on Sunday), it changes everything, doesn’t it?  It looks good on paper at the start of the first round but later in the month it has changed a lot.  There are upsets.  Favored teams get eliminated.  Underdogs win.  The brackets are always changing.

And just like March Madness, sometimes in the financial world, we feel like we are in “Market Madness.” We watch the ball change teams with lightning speed, the scores change with amazing rapidity, and the referees have to work incredibly hard to make sure the players stick to the rules.

Allow me to explain. Just think about the incredibly elaborate, intricate and inter-related global financial markets of gargantuan size and breadth—churning, burning, millisecond-splitting, markets operating nearly every day all day.  It is easy to see why some would believe there is a lot of market madness.

It is actually amazing that it all works so well.  But then again, we know there have been, and continue to be, issues where markets do strange things, where the financial players don't do what they are supposed to do, and where technology doesn't work like we thought it would, could, or should.


We have banks and other institutions (like AIG, the American International Group insurance company) which were so large that just a few years ago when they were about to be permanently side-lined, we—all of us—had to provide hundreds-of-billions of dollars in a hideous, budget-busting bailout: talk about market madness!

The Financial Crisis Inquiry Commission (FCIC) was established to look at what happened. It concluded the Troubled Asset Relief Program or TARP was needed due to two culprits to the calamity.

  • One culprit: regulators and regulation.  You see, in 1999, Congress and the president deregulated banks.  Banks were no longer bound by that pesky Depression-era Glass-Steagall Act that cramped their style and limited what they could do with the money in their institutions.  With the repeal of Glass-Steagall, regulators got the message to let the free markets roll.  And, roll they did—right over the American people.
  • The second culprit:  The captains of Wall Street.  FCIC concluded that since they were allowed to do so much more without those annoying rules and regulations, they devised all sorts of creative, exotic and complex financial products.  Some of these things were so multifaceted hardly anyone knew what was going on or how to place a value upon them.

Take for example, Credit Default Swaps (CDSs). These we're bets upon bets that certain things would actually fail.  And these CDSs were sold and resold around the Street to the point that few understood what they had and how much they were worth.  The value of CDSs was in the eye of the beholder.  Folks were over-leveraged if their books called for it to be so.

A case in point is Lehman Brothers which was leveraged 30 to 1, according to the last annual financial statement.  That statement showed the firm held $691 billion in assets divided by only $22 billion in actual shareholder equity.

If all those mind-altering financial products weren’t enough to propel the market madness, remember that all of it was completely and unreservedly unregulated. It would be like playing the March Madness tournament without any referees and few real rules.

Ginormously Humongous

CDSs were a significant component of creating this ginormously humongous dark market with no oversight by regulators.  When I say ginormously humongous, that's a technical term. You see, we at the CFTC currently oversee roughly $5 trillion in annualized trading on regulated exchanges, but the global over-the-counter (OTC) market is roughly—here it comes—$708 trillion.  If you Google ginormously humongous, it should say, "See OTC markets."

Here is the 2008 economic game recap: the economic disaster was created due to (1) weak or non-existent oversight and regulation; and (2) Wall Street creativity and a penchant for the exotic that created financial products so complex they would give the best final four prognosticators a migraine.

MVP:  Dodd-Frank

When Congress saw the monstrous economic mess, a mess of which we are still crawling out, in 2010, it passed and President Obama signed into law the Wall Street Reform and Consumer Protection Act—otherwise known as Dodd-Frank.  The Act is over 2,000 pages long, and has over 300 provisions requiring rulemakings, 80% of which are to be promulgated by the SEC, the CFTC, the Fed, and the CFPB (Consumer Financial Protection Bureau).

We passed a new final rule yesterday bringing us to 29 complete with 20 or more still to go. We should get down to the Sweet 16 sometime in April and I expect we will meet our Congressional mandate by the end of September.

What I'd like to spend the most of the rest of our time together talking about is the final four of our Dodd-Frank rulemaking. I don't mean that these will be the last four rules to be approved, but the most important, most critical rules, as I see it, for our Agency.

    1. The first final four rules have to do with increasing transparency by implementing mandatory reporting requirements for all swap transactions. Once these rulemakings are complete, we will never again have dark markets trading hundreds-of-trillions of dollars in a totally unregulated environment.

    2. The second final four rule is mandatory clearing for standardized swaps. This final four rule will decrease systemic risk (that same type of risk that resulted in the bail out) by incentivizing clearing of swaps, and reducing the risks to the financial system that large financial players created by making cavalier, Hail-Mary bets that could lead to or greatly exacerbate a financial crisis. Again, think about this final four rule as stopping what took place in the lead-up and in 2008 when our economy was brought to its knees.

The clearing mandate rule would also reduce the systemic risk created when a large and interconnected swap dealer fails and is unable to make good on its promises (think Lehman Brothers in 2008).  It would stop the "domino effect" that one large entity could have on those with which it does business by putting most of the swaps clearing through a regulated clearinghouse, and ensuring increased capital and margin standards for bespoke transactions.

    3. The third final four rules are the governance and business conduct standard requirements for swap dealers and major swap participants. These rules would put minimum sideboards on how companies should operate. Like the other rules, governance and business conduct standard rules will decrease systemic risk by ensuring centrally important financial players (Swaps Dealers and Major Swaps Participants) are not simply left to their own devices without any rules and are accountable for adopting prudent standards of conduct. 

For those that still contend that ultra-free markets are always best, I suppose we will just have to disagree. Sure we want free markets, but if we have learned anything from the economic mess, it should be that too much of a good thing can be very bad, and very expensive.

By the way, I won't mention the two firms by name, but as you will recall, there were two that established funds that were, at best, substandard funds, and the firms not only steered their customers—their own customers—to these funds, but the firms then bet against the funds. Tell the people who were victims of that gross misconduct that these firms don't need business conduct standards.

And as an aside since we are talking about conduct, there is a new provision in our new anti-manipulation authority that specifically prohibits false reporting and allows the Agency to impose appropriate fines. This little-known, but important provision is something that we need to use whenever we see deceit from those that we regulate.

    4. The fourth, and last, final four rule is speculative position limits. I'm going to spend a little more time on this one because it is something that we have needed and need now more than ever.

It is ironic that Congress instructed us to implement these limits before almost all of the other rules. Of the over 50 rules that our Agency was to complete, only a few—less than 6—were to be done sooner than a year. Position limits was one of those. That is how pressing Congress thought it was that we put limits in place.

In the wake of 2008 when crude neared $150 a barrel and gas prices reached their highest ever at $4.10 a gallon on average nationwide, Congress told us very specifically to impose position limits. By the way, there is nothing in the fundamentals of supply and demand that would link that roller coaster ride on prices. Congress was clear, the CFTC was to implement limits a year ago January.  But guess what?  Not only have we not done it, but as some of you know very well because of the associations you may be part of, there is already one lawsuit against the government to stop us from doing so.

So, here is the status: the Commission passed a final position limits rule in October, but it has yet to be implemented because in addition to the lawsuit, we have actually been waiting and waiting and waiting, of all things, for a joint rule with the SEC on definitions to be approved before the implementation clock starts ticking.

The problem is this:  we need these limits now.  I’ve been calling for them since 2008.  We have needed them for years.  If you’ve been to the gas station lately or watched the news, you know people are experiencing a lot of pump price pain.  Folks are making decisions between food and fuel. If prices were fairly discovered, then it might just be tough luck, but prices are being impacted by excessive speculation and that isn’t right. It isn’t good for markets, for consumers or for the economic engine of our democracy. For every $10 increase in the cost of a barrel of crude oil, it slows our gross domestic product by a half a percent. When an economy grows at perhaps 2 percent, a half of a percent means a lot. And given where we have been in crawling out of the economic hole created in 2008, we need all the help we can get with the economy. I didn’t blame President Bush for gas prices in 2008 and I‘m certainly not blaming President Obama. Oil and gas prices are determined by a myriad of variables. That said, our Agency has influence over speculation and one of the things we can and should do—because, I don’t know, it is the law—is to ensure that these position limits go into place.

Now, before some of you who have an opposing view about speculation get too worked up, let me say two things: 1. The CFTC is not a price-setting agency.  That isn’t our job.  However, we do have a mission to ensure that the price discovery process is fair.  Position limits can assist in ensuring prices are fair; and 2. I know we need speculators.  I know I know I know—there are no markets without them.  Speculators are good.  But like a lot of good things, too much can be problematic.  Therefore, it is the excessive speculation that can cause problems, contort markets, and result in consumers and businesses paying unfair prices and negatively impacting our economy.

Some people say:  “Well these markets have worked pretty well over the years.  How can you really tag speculation with being a problem in 2008 and is it more than just a guess that excessive speculation is a problem today?”

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 these traders aren’t passive all the time, but we do see a pattern.  In fact, new CFTC data says that massive passive long speculators have shorts outnumbered 12 to 1. Like a rising tide lifts all boats, when we see this unprecedented increase in speculation, it has an impact.

I’m not suggesting that the Massive Passives, or speculators in general, are actually driving prices.  Let me be clear.  I’m not proposing they were all in cahoots and decided to raise oil prices.  What I am saying is that they contribute to price swings, and have a proportional impact in markets based upon their size as a whole, and certainly individual traders can push prices around if they have a large enough concentration.  When prices are on the rise, like now, and the Massive Passives and others get into markets, they can push prices to levels that may be uneconomic—certainly not tied directly to supply and demand—and the prices may stay higher longer than they normally would.

By the way, although it isn’t as interesting to the media and others, the same takes place when speculators exit markets.  That’s why prices shot down so far in 2008 by the end of the year.  Every trader was bailing from the markets because of the bottom falling out of the economy and prices for a lot of things tumbled.

Now, if people believe there was a lot of speculation with that $200 billion infusion back in 2008, guess what?   It is even higher this year.  In energy markets, it’s 43 percent higher than in June of 2008.  Is that excessive speculation and is it impacting prices?  I think so and so do many members of the U.S. House and Senate.  Just a couple weeks ago, we received a letter from 23 Senators and 45 Members of the House.  They were clear:  get on with position limits already.  We gave you that tool.  Use it now.  Also, President Obama has recently been saying, “When uncertainty increases, speculative trading on Wall Street can drive up prices even more.”

But you don’t have to take it from me, from Senators or U.S. Representatives, or from the President of the United States.  In fact, you don’t have to take it at all. I know that many of you in this crowd won’t.  Nonetheless, let me lay one more piece of research on you with regard to speculation.  This one doesn’t come from some lefty activist group.  It comes from one of the big Wall Street banks.  Its researchers said that each million barrels of net speculative length adds as much as 10 cents to the price of a barrel of crude oil.  The speculative length is a known quantity.  With a little math, you can determine that the “speculative premium” on oil these days is around $23 a barrel—and that translates into about an extra 56 cents for a gallon of gas.

What that means is this:  if you drive a Honda Civic, the speculative premium costs $7.39 every time you filler-up.  If you drive a Ford Explorer or F-150, the total is $10.41 and $14.56, respectively.  I don’t know how often you fill up, but over the course of a year we’re talking real money—hundreds of dollars.  Imagine a trucker who pays a speculative premium of $112 more to fill up a Freightliner with two standard 100 gallon diesel tanks. It costs him or her $112 each fill up. And if you extrapolate those numbers to the trucking industry as a whole, the annual cost is $29.1 billion.  For the airline industry:  $9.8 billion.

Our position limits rule is one of the only tools regulators have in our regulatory shed to combat unfair prices.  We need to use it and we need to do so immediately.

And now, I have a somewhat controversial suggestion.  I've made it clear here and many other places that I think we these limits—now—and that in addition to the lawsuit, regulators have been derelict in not getting them in place sooner.  We keep hearing that imposition of limits is being held up because it's contingent upon our issuance of a swaps definition, and Dodd-Frank requires that we do that as a joint rulemaking with the SEC. So far, we haven't been able to get that through the hoop.  Well, here's my idea.  Congress envisioned just this sort of logjam, and inserted into Dodd-Frank a "jump-ball" provision—that is, if the agencies can't agree on something and it frustrates a statutory mandate, we can "tap the ball" to FSOC—the Financial Stability Oversight Council—for a decision.  This provision has never been used, but today I am saying that perhaps, given the critical importance of position limits and the purported hang-up, it's time to pass the ball to FSOC on our definitions regulation.  I realize this is a highly unusual and perhaps incendiary move, but we have a responsibility to act here, and it's high time we do so to protect markets and consumers.

Will position limits take us back to the days of $1.00-per-gallon gasoline? Oh, heck no.  Limits will, however, if we can survive the court challenges and implementing delays—help reduce the pump price pain.

End Game Summary

In sum, if we implement all of these Dodd-Frank rules expeditiously—the way Congress intended—it will ensure that the largest financial players are held accountable to the public.  As the financial crisis and the decade of deregulation that led up to it showed, large financial players, with a conscience that in many cases seems to extend only to the next fiscal quarter, cannot be trusted to totally self-govern.  Don't get me wrong. There were some impressive innovations that took place in the unregulated environment. And as far as the regulated futures exchanges go, they did very well under a principles-based set of rules. No firm went under in 2008 because of the regulated futures exchanges. However, as the economic crisis of the last few years has shown, large financial players’ irresponsibility can have a devastating impact on the American consumer and American businesses.  The Dodd-Frank Act, at its core, brings some basic rules to the market madness and ensures that a regulatory referee remains on the court in the multi-trillion dollar swaps market and that the public, the American consumer and American businesses, have a voice in the midst of those 160 million or so financial transactions that occur on a daily basis.

The Letter

Finally, I don’t want to finish without discussing MF Global for a moment. Let’s be clear:  this was a slam dunk in our grill reminder that we need appropriate regulations in place now.  MF Global is the new poster child for why thoughtful financial regulation is needed more than ever.

No matter how we explain the dire circumstances surrounding this MF Global debacle and those mysterious missing millions, I can’t express what an unfortunate situation this has been for many MF Global customers.  I have a one paragraph letter I have been carrying around for a few weeks. I received it in January. I have it here and I want to share it with you.  The letter says:

    “I am 75 years old and my husband is 76 years old.  We take care of our brain injured son who is 55 years old.  All of our money—over $900 thousand—was invested in commodities with MF Global.  We have no income except for a small Social Security check for both of us and some for my son.  We will be losing our home we have lived in for 30 years if these funds aren’t returned to us soon.  We really made a mistake by trusting too much.  We are too old to work anymore.  All of our strength we have goes to caring for our son.  Can someone please help?  We are desperate!"

I’m not going to use their name or tell you where they are from because I didn’t check with them, although I tried. You see, when I tried their phone had been disconnected.  I’ve been thinking about them a lot lately in order to remind myself that MF Global can't be reduced to an esoteric policy matter.  It is a real circumstance with real victims. If I have anything to say about it, for those that violated the law, it will have real culprits who pay the full price for their misdeeds.

Job One for our Agency is always—no ifs, ands, or buts—to ensure that customer funds are held sacrosanct in segregated accounts, and that they are safe and secure.  In this case, those funds were not secure.  Hundreds of millions of dollars isn’t where it should have been.  Aside from trying to find and claw back all the funds and conducting our investigation, we also need to ensure that we do all we can to avoid this happening in the future.

I have suggested several things that can be done:

  • One, we should insist upon regular and robust deep data dives.  By this I mean we need to routinely ensure that customer funds are where they are supposed to be.  Rather than accepting a firm’s word that the money is where it is supposed to be, we need to do the Jerry Maguire and insist that they “show us the money.”
  • Two, we should allow customers a choice of how or if their funds in segregated accounts are used.  People make choices about the types of investment that can be made with their money in their pension funds.  They should be able to do the same with segregated funds.  They should also be able to say:  “My money sits there as margin and nothing can be done with it.”
  • Three, Congress should approve legislation to establish an insurance fund to serve as a backstop for customers like the family I told you about should there be a loss in the future.  The securities world has such an insurance fund.  We all know the banking world has the Federal Deposit Insurance Corporation.  We need such an insurance fund in the futures world.


I am grateful for your attention.  Let me just finish by saying that like the NCAA March Madness, things are rapidly changing.  Markets and traders are morphing.  Laws from less than two years ago don’t even mention things—like high frequency traders (those I call cheetahs because they are so fast)—that are clearly issues for regulators today—something we didn’t have time to discuss.

If our brackets are somehow off, if we don't have the rules just right, let us know.  Rulemaking is a team effort. There's no free throw.  We need your help to ensure that market madness doesn't last forever.

That's the game. Thanks. I'll be pleased to take questions.

Last Updated: March 21, 2012