Public Statements & Remarks

“Trimming the Tree—Regulation and Recovery”

Speech before the Information Management Network, Global Indexing and ETFs Conference, Phoenix, AZ

Commissioner Bart Chilton

December 4, 2012


Good morning! It’s great to be with you. Thanks so much for the invitation.

Well, the holiday season is upon us. For many of our families, that means setting up and decorating—trimming—a tree. This weekend, for us, is slated for tree trimming. If you’ve ever done this, you know very well that it has to be done in a certain order. Or, if you don’t, and you’re a guy, your wife probably tells you that. Lights first, then tinsel, then ornaments, perhaps a little eggnog or a hot toddy, then the star or angel at the top, and voila, you’ve trimmed the tree. It’s a process.

So too is the process of financial reform. Like trimming a tree, there’s an order to rulemaking. That’s what I want to talk to you about today. So, break out your hot toddy—or maybe it’s coffee or tea. We’re gonna trim this tree in the next 20 minutes.

The Tree: Dodd-Frank

Lots of people’s holidays got just a little spoiled in 2008. The financial world had come crashing down, imperiling our economy. Nine million people lost their jobs in the ensuing months, and many more, their homes. The Grinch was on a raucous roll. We were Scrooged. However a couple years later, along came Santa Claus—Christmas in July—in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Now, I know a lot of folks—even as adults—are afraid of Santa Claus. They don’t want anyone knowing what they are doing, looking over their shoulder and keeping some naughty or nice list. You might say they are Claustrophobic. They have this anxiety disorder. But I’m here to tell you, people shouldn’t be afraid of Santa Claus or Dodd-Frank.

Let me explain. You see, us elves have been busy in our workshops, but we haven’t been able to maintain the pace that Congress and the President sought. There are 398 Dodd-Frank rules or regulations to be concluded by the various Federal agencies. Of those 398, only 133 are complete—only 33 percent.

We CFTC elves have made more progress, completing about 67 percent of our work by finalizing 40 rules of approximately 60 on our workbench. Even our efforts, however, haven’t met the expectations of Congress and the President. To be candid, I have low elf-esteem.

The good news is that all of that time we’ve been listening to people and trying to get our rules correct. I think, by and large, we have done so.

So now, you’re all wondering if you are going to get anything under the tree. Let me rephrase that: you are wondering what’s in store for you vis-à-vis Dodd-Frank. Well I’m here to tell you all about that by going through all 60 rules. Nah, I’m kidding, but let’s go over the good stuff by organizing the rules into three categories, or stockings, if you will: Transparency, Market Integrity and Accountability.

Stocking 1—Transparency: We want this stocking stuffed—stuffed with information and data. It may surprise you that in financial markets, there have been hundreds of trillions-of-dollars of trading taking place totally off regulators’ radar. You’ve seen how NORAD (North American Aerospace Command) tracks Santa on Christmas Eve? Well, we had no such tracking. We didn’t have a nose so bright to guide our sleigh tonight. We had nothing to determine what was out there in the over-the-counter (OTC) market space. That was a major part of the problem that caused the economy to crash. We needed transparency. “Remember, honey, put the lights on first!”

This stealthy OTC trading reaches to the North Pole and back. Try this as a visual, Rudolph. Right now, the CFTC regulates about $5 trillion in annualized, on-exchange trading.  The non-NORAD OTC trading, however, accounts for $639 trillion! That’s a brand new number. It is a global number, but nonetheless, we at the CFTC will have hundreds-of-trillions in trading to watch over to determine who’s been naughty and nice. Sorry—that’s our job.

Stocking 2—Market Integrity:  We also want to guarantee that people don’t take risks that undermine the integrity of markets or the entire financial system.

There’s no question that risk is part of markets—nothing wrong with that. Folks should be able to take as much risk as they’re comfortable with.  If they want to jump down or shoot up a chimney, that’s their business. However, if they get burnt on the way down or they overshoot on the way up, they shouldn’t be able to negatively impact all the Whos in Whoville. We call that systemic risk. Maybe “too big to fail” is a more popular term. The point is that one naughty boy or girl shouldn’t impact all of us. Thus, we’re instituting new capital and margin requirements.  We will also require clearing. That will avoid the over-leveraging problem that we witnessed in 2008 that led to the crash of Bear Stearns and Lehman Brothers. Did you know that Lehman was leveraged 30-1 according to its last—its’ final financial statement? Talk about who was naughty!

We want markets to perform their original functions: risk management and price discovery. That’s why commercial producers like farmers and fuel companies and airlines got involved in the first place. But, you know what? It was also good for consumers by easing price volatility. Market participants are changing all the time. It’s not just the folks trying to hedge their corn-cob pipe or their button nose or their two eyes made out of coal any more. The financial-zation of commodity markets has happened—big time—but let's be careful to vehemently preserve those central core values of market integrity, no matter which participants are in the markets.

This is important stuff. So, before we trim the tree any further, I want to spend just a little time on this market integrity stocking.

A Country Christmas

How many of you like country music? Even if you don’t think you like it, on Thursday, December 20th, the CMA’s (Country Music Association) “Country Christmas” airs (7 p.m. Phoenix time). You might give it a try.

The country singer Ronnie Dunn has multiple CMA awards, and a lengthy list of other awards and honors. He’s an artist I’ve really come to appreciate. Ronnie’s web site says he’s played in dives and joints and “…did hard time in a few in Arizona.” Ronnie’s song “Cost of Living” is what I want to tell you about now. Here’s the chorus:

“Three dollars and change at the pump, the cost of living’s high and going up.”

Here’s what’s interesting: When Ronnie first saw the lyrics in early 2008—before the financial collapse, the chorus line was:

“Two dollars and change at the pump, the cost of living’s high and going up.”

Wow! Wouldn’t two dollar gas make for a great Christmas? My wife and I were, initially, going to make a big road trip here to Phoenix. Two dollar gas and we maybe would’ve. But, back to the song—you know what happened? Ronnie liked the song but realized it was out of date already. So, he changed the lyrics. He changed the “two” to a “three.” It knocked people out. It took off. Why? Because real people heard it, felt it, and were moved by it.

Here’s really what that song was about. In the summer of 2008, the great influx of what I call Massive Passive trading in oil markets helped push prices skyward, and pushed crude prices to $147 and gas pump prices to $4.10 a gallon—the highest ever.

Now, we’re at an indexing conference. I know my audience and many of you are probably involved with Massive Passives, i.e. index funds, hedge funds or other types of managed money. I get it and we want you in these markets. You are good for markets. At the same time many such funds are huge and they have a predominately one-sided trading strategy—they put money in a market—and they park it. Nothing wrong with that, but that type of trading strategy is fairly different than traditional speculators.

So does more concentration in markets influence prices? There are still some that don’t believe in Santa Claus but let me say a word about that. Ask Goldman Sachs researchers (five Goldman rings), or those I visited last month at Rice University, or those I met with this summer at the St. Louis Federal Reserve, or ask the folks at MIT (the Massachusetts Institute of Technology), or read any of the other myriad studies that show a nexus between price and excessive speculation. The point is that the effect of the Massive Passives was so deep and so widespread and so continuing, that it made a country songwriter change his lyrics.

By the way, Ronnie Dunn changed the lyrics yet again earlier this year, in 2012.

“Four dollars and change at the pump, the cost of living’s high and going up.”

I hope that “four” doesn’t change to a “five.”

That’s why I’ve been such a strong supporter and proponent of speculative position limits. Like the good folks outside the grocery store this time of year, it’s important to keep ringing the bell, that excessive speculation in derivative markets has not yet been sufficiently addressed. Congress told us to fix it and so far, it’s not fixed. Why? Well, let me think: de-funding bullying, cost-benefit analysis paralysis—oh, did I mention lawsuits?

These setbacks have only made me more insistent that we do what Congress and the President instructed us to do in Dodd-Frank and that go to the epicenter of our market integrity stocking: implement speculative position limits to ensure consumers are paying fair prices. Hear me now and believe me later, I am the “Ghost of Christmas Yet to Come” on this one. We will have speculative position limits.


The other market integrity challenge has to do with technology. I mentioned NORAD tracking Santa Claus. In order for Santa to deliver all the toys to good girls and boys in one night, he needs to average 822.6 visits per second. That must be true, by the way, because it (like Santa) is on the Internet. That’s really fast.

What I want to talk about are high frequency traders (HFTs). They scoop up micro dollars in milliseconds. That’s right—milliseconds—one-one thousandth of a second. Did you know that if you are travelling at 100 miles per hour, a millisecond is the time it takes you to go two inches. Like Santa, they can cover the whole planet in one night.

I call these traders “cheetahs” because of their incredible speed. They have some admirable attributes, but at the same time, if we don’t have some rules, we run the risk that some HFT-related occurrence will genuinely harm markets.

The Jungle

Our Office of Chief Economist has just released preliminary findings of a study it’s doing on the profitability of HFTs. It’s really interesting. First of all, it finds that cheetahs take in large, persistent profits—all the while, taking very little risk. Where do they get the profits? Here’s the scary part: almost exclusively from fundamental and small investors. These cats are preying on the very people that use these markets to hedge their legitimate business risks. I’ve got a problem with that.

And, the more aggressive a cheetah is, the more profits it makes. The most aggressive made $1.92 on trades with big investors but $3.49 when trading with smaller folks. These aggressive cheetahs, preying on the little guys, were raking in over $45,000 a day during one month studied in 2010. So, it’s truly a jungle out there.


We see technology SNAFUs—situation normal, all fouled up—all the time. The Flash Crash? The Facebook IPO? We all know that technology isn’t always what it woulda, coulda or shoulda been. We see market technology SNAFUs with regularity. That’s why in order to safeguard market integrity it makes common sense to have some basic precautions in place to avoid market-threatening actions from taking place.

One: HFTs need to be registered. Crazy but true, they don’t have to be now. Heck, we’ve asked the exchanges how much volume these HFTs create and I’m astonished that they haven’t been able (or maybe willing) to tell us. We need them to be registered so we can get information like that.

Two: They should be required to test their programs before they are put into the live market and have wash blocker technology to avoid cross trading. We’ve discovered that HFTs did around 66 million wash trades in just the past few months. That’s unacceptable because…it’s illegal. Also, these programs need to be required to have kill switches in case their programs go wild.  And,

Three: We should ensure that our penalties, our fines for violations of the rules and regulations that seek to protect market integrity, make sense in today’s fast-paced trading world. More on that in a minute.

So, that’s the first two of our Dodd-Frank stockings or categories: Transparency and Market Integrity. Let’s go to stocking number three. (I bet you can’t wait—this is so much fun)!

Stocking 3—Accountability:  The question is often asked: Why is it that nobody went to prison for what took place in 2008? After all, according to the Financial Crisis Inquiry Commission (FCIC), the Captains of Wall Street took advantage of lax, or non-existent, rules and regulations that created the chaos. It would make Bob Cratchit wince.

Remember the scene from “It’s a Wonderful Life?” The one where George says to Billy, “Where's that money, you stupid, silly old fool? Where's that money? Do you realize what this means? It means bankruptcy and scandal and prison! That's what it means! One of us is going to jail. Well it's not gonna be me!”

But, perhaps sadly, the answer for 2008 is pretty direct. Nobody violated the law. Strange, but true—what was done wasn’t illegal. That’s changing with Dodd-Frank. There will now be financial firm accountability. All of the things we’ve discussed and more will be put in place, and not a moment too soon.

Just think of all the recent Scroogey things going on: MF Global, Peregrine, Wells Fargo discriminating against minority mortgage customers, Bank of America and a dozen other banks ripping off their own customers with crooked debit and overdraft fees. A couple of banks pushed their own customers into certain funds, then the banks took the opposite positions. Just last week, we prevailed on an appeal in a case where a fraudster ripped off a fraudster. Isn’t that delicious? One of these guys had bilked people out of millions of dollars and wanted a higher and “guaranteed” return for his ill-gotten gains, so he found what turned out to be another crook!

These folks all make Santa’s naughty list and they should. The point is that with Dodd-Frank there will be greater accountability in the future.

Updating Our Penalty Regime

Part of the problem is that our current level of fines is sort of a cost of doing business. They’re so low they often don’t have any real deterrent effect. Therefore, we need to re-think our penalty regime. And that’s why I’ve been urgently urging Congress in the last few days to update our fining authority.

First of all, the dollar amounts are antiquated, many times pretty much meaningless, and certainly not equal to the violation. This example isn’t a CFTC case, but it makes a point: Merrill Lynch profited $32.2 million from charging its’ own customers excessive fees. They were fined—get this—$2.8 million. Cost of doing business, right? Quite frankly, I’m tired of seeing settlements be so meager when we see all of the malfeasance in the financial sector. So here’s what I’m suggesting to Congress:

First, we need flexibility in determining what “per violation” means. This will allow the Agency to adjust requested fines (and to negotiate appropriate settlements) to be meaningful deterrents. Right now, we think about “per violation” as one day—but, in the case of HFTs, executing thousands of transactions in one second, a “per day” violation scheme is just kinda ridiculous.

Second, our penalty levels are from another century. Currently, we can assess $140,000 per violation of the Commodity Exchange Act (CEA), and $1,000,000 per violation for manipulation, and there’s no distinction in the law whether we’re suing an individual, or whether we’re suing a huge multinational corporation. That’s why I’m saying today we need some fines with teeth. I think fine minimums should be increased to at least $250,000 per individual for a violation of the CEA, and at least $1,000,000 per entity. For manipulation, $1,000,000 per individual may be OK, but I’m suggesting manipulation fine minimums for corporations be upped to at least $10,000,000 per entity

Increasing our penalty regime will add accountability to these markets that is sorely needed.


So, that’s it. We trimmed our Dodd-Frank tree. Yeah!

My message, and I doubt you thought you’d get this at a financial conference: Don’t be afraid of Santa Claus or Dodd-Frank. It’s not a bad law, and there’s not a “Bad Santa.” Although I’m sure some will (and I’m paraphrasing Arlo Guthrie here) say Santa, with all that red garb, must be a Communist; with the beard—a pacifist; and who knows what he puts in that pipe that makes him so jolly!

When I was a kid, I never asked Santa to allow me to be a financial regulator, but here I am. Still, when I get to be with a group like yours, and to talk about some of these issues that we all know are so critical to our economy and the livelihoods of people, especially consumers, who rely on these markets, it really is “a wonderful life.”

Thanks for your time and happy holidays to you all.

Last Updated: December 4, 2012