Speech of Commissioner Bart Chilton to the 2013 Arkansas State University Agribusiness Conference, Jonesboro, AR
February 13, 2013
Say Heeeeeey. Jellooo! It’s great to be with you here at A State. Go Red Wolves! We are actually going to be discussing “red” today. Lots of things red— rojo (Spanish), rosso (Italian), or in Dutch: rood . . . and just in time for Valentine’s Day.
First, I appreciate Professor Greenwalt’s invitation to be here. Thanks also to Dean Kennedy (Dr. Donald Kennedy) and President Welch (Dr. Chuck Welch). Thanks for the Red Wolves’ hospitality. Thanks also to Chancellor Hudson (Dr. Tim Hudson) and Dr. Deidra Hudson for rolling out the red carpet last evening for a special dinner.
Speaking of the Red Carpet, the Academy Awards are just a few weeks away, on the 24th. Who has seen the movie Lincoln? By the way, it was President Lincoln’s birthday yesterday—he’d be 204 years old. The movie is a super movie! For those who have not seen it, you gotta do so. In it, many of the compromises President Lincoln had to achieve as part of garnering support for the Emancipation Proclamation are vividly dissected and described. It is a marvelous movie, and I can tell you that for many years, such concessions and compromises between opposing interests in Washington have been painstakingly and laboriously hammered out—just as in President Lincoln’s time—in order to reach the right result. Recently, however, a lot of that has come to a standstill. President Obama spoke about this last night during the State of the Union. Too many folks are unwilling to even talk with each other, much less compromise. Instead, there is a lot of red-faced rhetoric and devious red herring arguments. The difference between advocacy and entertainment—some even call it news—has been blurred to red-alert levels. It is a shame. I’ve seen 25-plus years in Washington, and things seem to be worse than ever before for those of us trying to doing the people’s work. That’s why it is such a pleasure to get out of town once in a while, and particularly to get here to Red Wolves country.
These commodity markets—futures markets—are steeped in our proud agricultural history. How many actual producers are here today? I see my longtime friend of family farmers Harvey Jo Sanner here. Thank you for what you all do. These markets were established in large part because of your forbearers. They were started for producers and processors—farmers and ranchers, millers and feedlots—and for consumers.
We all know the history: folks needed a way to hedge their risk and get a fair price at harvest and in lean times. At harvest, the markets would flood with produce; grain would rot with over-supply; and producers would go into the red. In winter months, grain was scarce, and millers couldn’t afford it. That wasn’t working for anyone—not so much. Markets needed a fair price at harvest and at other times of the year. And for consumers, they were gouged at certain times when supplies were scarce. The costs incurred by producers and processors alike were passed on to the ultimate purchasers—homes and families. Producers, processors, and consumers were all tired of costly seasonal price volatilities. So, one morning in the mid-1850’s came a noise: “ahh.” Then, the red skies parted . . . and, behold, the futures markets began.
Well, it worked out beautifully. Speculators—non-commercial interests—got into the business providing the liquidity and narrowed spreads for producers and processors—the commercials—if you will. And prices even evened out for consumers. The futures markets effectively calmed the volatile price movements that had huge social and economic costs for our society.
These days, we have futures contracts for everything from hard red wheats and other agricultural commodities to energy, metals and financial products. But the origins of these markets are with many people just like you—folks interested in agriculture.
Red Solo Cup
So here’s the question, and I’ve heard it from many producers and commercial ag interests: Are markets continuing to fulfill those important fundamental purposes of the markets from way back in the 1850s? Are the markets still providing a place for producers and agri-businesses to appropriately hedge their risks and for fair price discovery for consumers? Well, that’s a worthy question, Grasshopper. Can I get an “amen?”
Here’s what we do know: markets have been, and are today, right this very moment, morphing. It is happening now. Look around, can ya’ smell it? They are changing and mutating. That’s not always a good thing. That mutating stuff is a little scary, right? Right! If you’ve ever seen a poisonous Giant Redheaded Centipede (Scolpendra Heros for you entomologists), and they have ‘em here in the Natural State, ya’ know what I mean. For the record, I oppose Giant Redheaded Centipede futures markets. In fact, I’m not afraid to say it, I oppose Giant Redheaded Centipedes. I’m not frightened to take a position on them—they’re nasty.
The potion in my notion, and in point of fact I actually have one, is this: markets are mutating, morphing, transforming, changing . . . whatever, what have you. But, you don’t have to take it from me—the longhaired Giant Redheaded Centipede opposing dude. In order to fully appreciate what has been going on, we need to only look to the report of the Financial Crisis Inquiry Commission, or FCIC. They sound official, right? Well, they sound like that for good reason. The Commission was comprised in the wake of the 2008 red lava economic meltdown after taxpayers had collectively gone into the red by bailing out Wall Street to the hot and tasty tune of—wait for it—more than $400 billion buckaroos. The Commission was comprised of folks who Congress asked to explain wha wha what exactly happened. How did things go so horribly wrong?
I’ll tell ya’ what, in essence, FCIC said. There were two culprits to the calamity:
Lax laws, rules, regulations and regulators—that’s guys like me—who weren’t paying attention; and
The Captains of Wall Street who took advantage of the lax laws, rules and regs and the “asleep at the switch” regulators.
You all know that great Toby Keith song, Red Solo Cup?
“Red solo cup, I fill you up. Let’s have a party, let’s have a party.”
Well, for about eight years, leading up to 2008, there was a big party on Wall Street. They proceeded to party. The high-flyers were taking speculative risks beyond anything we’d ever witnessed. Many times these were wild, casino-like financial instruments—derivatives, on say, bundles of mortgages—that wrecked our economy when they crashed. Nine million people lost their jobs—millions more their homes. Oil prices soared to near $150 a barrel and gasoline prices reached an all-time and still undefeated “champeen,” high of $4.10 per gallon in June of 2008. People had to choose between food and fuel. And as all this was going on, technology intervened in the markets like never before.
So today, to get back to the question I posed—that is, are the markets still working for you? I want to focus on three things: speculation, technology, and the culture in our financial sector. All of these things are changing these important markets and have the red zone potential of altering those key fundamentals that I spoke of earlier: hedging risk and price discovery.
First, speculation: in the summer of 2008, the great influx of what I call Massive Passive trading in oil markets helped shove prices skyward to push crude oil to $147.27, resulting in that $4.10 a gallon at the pump. During this time, by the way, the fundamentals of supply and demand were fairly steady. These Massive Passives, i.e. index funds, hedge funds or other types of managed money, are huge and they have a predominately one-sided trading strategy—they park it in a market and leave it there. Thus “Massive Passives.” We call it the “financialization” of commodity markets. Maybe a pension fund wants to diversify into commodities. Nothing wrong with that, but that type of trading strategy—Massive Passive—and the size of the money we’re talking about concentrates our markets.
Here’s the worrisome part, the part that gets at “is it still working for you?” Too much speculation (particularly Massive Passive speculation) in markets can influence prices. But don’t take my word for it. Goldman Sachs researchers say such speculation in markets does impact price. So do researchers at Rice University, not to mention Massachusetts Institute of Technology. Myriad other studies show a nexus between price and excessive speculation. And most notably, the Red, I mean Fed—the Federal Reserve Bank of St. Louis also has produced a study showing a link between commodity speculation and prices. So, there is plenty of evidence. (By the way, I’m so honored to be here with Jim Bullard, the great President of the St. Louis Federal Reserve. I expect and am optimistic that what Jim portends about the economy is correct. I’m optimistic, too, about this year, Jim). But the point here is that there is plenty of reputable and reliable evidence documenting what many of us simply know: that excessive speculation can contort markets.
In the other corner are those who say speculators haven’t pushed prices around and that it is supply and demand fundamentals that explain prices. Here’s a test: if what they’re saying is true, then we should see commercial traders (your producers, processers, merchants, etc.) dominating the market during periods when prices are changing. Our staff has looked at trading in crude oil and has found that commercials are a part of only a tiny fraction of the trades that account for price changes. In other words, non-commercials—speculators—are dominating the price discovery process in crude oil. The issue isn’t whether speculators affect the market; the issue in many instances is that speculators have become the market. I’m glad CFTC staff is doing this kind of research and I hope we will soon make it public. Let’s add our staff’s commendable work to the mounting pile of evidence that speculation-driven financialization has fundamentally changed commodity markets.
So, what’s to be done? How do we ensure that these 150-year-old-plus markets keep working for you? Well, Congress and President Obama told us to put in place what are called speculative position limits as part of the financial reform law in 2010—Dodd-Frank. So far, however, they’re not in place in large part because the largest speculators on the planet are gripping position limits like Charlton Heston’s gun. They’ve tried to kill them on Capitol Hill when the bill was considered. They tried to defund them. They tried to mute them through the rulemaking process, and now they are trying to litigate them to death.
There was another song out awhile back by Ronnie Dunn called “Cost of Living.” The chorus goes like this, “Three dollars and change at the pump, the cost of living’s high and going up.” But, here’s what’s interesting: the original lyrics said, “Two dollars and change at the pump, the cost of living’s high and going up.” So, he changed it to “three” to keep up with the times. And, just about a year ago, he changed it again—this time from three dollars to four dollars. Anyway, the song took off since real people heard it, felt it, and were moved by it. And my concern is, we need to ensure that uneconomic factors—non-fundamentals—don’t make Ronnie change it to “five.”
Today, energy costs for most families have risen more than 20 percent since 2001. This hurts not only American households, but also American business—like many of your businesses—that rely on energy. According to the Energy Information Administration (EIA), nearly nine percent of our economy or $1.4 trillion is spent on energy annually. Imagine if that figure dropped by just ten percent—$140 billion freed up for investment and economic growth.
So that’s why I continue to lead the charge for position limits—to help keep the markets working for you. The efforts to stop position limits will ultimately fail. Congress told us in no uncertain terms to get it done, and I intend to see that we do that, before more families and businesses go into the “red” column on their balance sheets.
Okay, now, let’s talk tech. Specifically, are rapid—and sometimes almost incomprehensible—changes in technology helping or hurting our markets? Unlike the days of chalkboards and human-to-human interface, high frequency traders (HFTs) now scoop up micro-dollars in milliseconds. That’s how fast they trade. That’s one-one thousandth of a second. If you’re going 100 miles an hour, a millisecond is the time it takes you to go two inches. I know that to be true because it is on the Internet (I’m a French model . . . bonjour). I call these HFT speed demons “cheetahs” because that’s how fast they move—nada to 60 in just a couple seconds in the case of the animal—even faster for these red hot cats with their HFT programs.
I speak with agri-business folks all the time who suggest these cheetahs simply scoop some of the cream off the top of markets, without providing any real benefit to price or risk management. Many of the agri-business guys try and trade fast, but they have explained their circumstances to me like this. Say you are merging onto a highway. You are ready to get on. You are ready to trade. Just before you merge, five cheetahs zoom zoom past and jump in the market ahead of you at a certain price. Sure, these agri-business guys get on the freeway; they get into the market, but they do so after the cheetahs have raced by and scooped up some micro-dollars—and have moved the price. And so the price the agri-business guys get is not as good, but they end up passing those costs onto consumers. Well, is that really what the markets were meant to do? Are the cheetahs the new market middle men?
A study which was conducted in conjunction with the CFTC said, in essence, that HFT trading imposes quantifiable costs on small investors. This could end up pushing smaller, non-HFT traders out of the futures markets, depriving those guys of market benefits and depriving the markets of their pricing inputs. No matter how you look at it, that’s not good.
I’m not suggesting we get rid of technology in markets or we make the cheetahs an endangered species. They have some real attributes which I’ve discussed publicly many times. If we don’t have some basic rules of the road for their behavior, however, we run the risk that some cheetah-related occurrence will significantly harm markets, market participants, and consumers.
We need only to go back to that Red Letter Day, May 6th 2010, when the Flash Crash occurred. Markets went into the red and tumbled for 20 minutes. Cheetahs were part and parcel to the entire damaging debacle. We also see mini flash crashes all the time and, remarkably to me, we have not done much to prevent another major flash crash. We could have a red alert flash crash this afternoon.
By the way, HFTs aren’t even mentioned in Dodd-Frank. The Flash Crash happened after the bill was pretty much done. That’s how wicked-fast the markets are mutating. So while there are some specific things that I have suggested we do at our Agency, I hope Congress acts to give us the tools that will help us keep the cheetahs in their cages.
So let’s put some sensible rules in place—wash trade blockers, kill switches for “feral” trading, harmonized circuit breakers for related markets—and ensure that these markets continue to provide risk management and price discovery benefits for the guys who originally developed, used, and profited by them.
Finally, boys and girls, I want to tell you a bit about a children’s story. Once upon a time in a faraway land there lived a sweet young maid named Little Red Riding Hood—yeah, her. Golly gosh Beaver, ya’ know how they talk about violence on television and in the movies and how it has become so much worse than it was in the past, and all that stuff? Well, I’m not sure the stories were always so tender and touching.
So, I’m not talking the 2011 movie, the Leonardo DeCaprio “Red Riding Hood” movie. Red Riding Hood wasn’t so little in that movie and she had, well, matured. I’m talking about the original European fairytale, “Little Red Riding Hood.” In this original Grimm’s fairytale, the child walks through the woods to deliver her sick Grandmother some food. She stops to pick some flowers and the Big Bad Wolf shows up at the Grandmother’s place and pretends to be Red Riding Hood. The Grandmother buys it—talk about the troubles with old age! The Wolf chows on the Grandmother. Bummer, forget your granddaughter, get eaten by a Big Bad Wolf. But it doesn’t end there, of course.
Let me say for the record . . . there were no Red Wolves involved! The color of the Big Bad Wolf was never identified as far as I know. Nobody from A State, or anyone who has ever been to A State, was complicit in the aforementioned Red Riding Hood Grandmother incident. They didn’t even know Red or her Grandmother, for gosh sakes. Jeez Louise, Beaver, why are you even raising the issue? These are nice people.
So, Red, through several obstacles finally makes it to her Grandmother’s house where now the Big Bad Wolf is trying to pull the switcheroo on Red. He is portraying the Grandmother, which he has recently, um, consumed. Red, after a few questions, starts to get a visual and says something like, “Grandmother, what big teeth you have.” To which the Big Bad Wolf in Grandmother’s clothing says, “The better to eat you with.” The Big Bad Wolf then devours Little Red Riding Hood. It was easier than the Grandmother—old folks are tough, I guess. After all, Red was “little” or “fun sized.” Many kids, like me, were left with that for a few seconds before the totally bogus ending of the story was revealed. A huntsman—outta nowhere, like a space alien—appears and comes into the house and cuts open the Wolf and saves both Red and the Grandmother. Yeah, gimme a break of that Kit Kat bar, right! We know what horrible things happened to the fun-sized Red, and how they are involved in a cover-up. We know how they tried to sanitize it. All I’ll suggest is that if you read a fairytale by some fellow or fellows named “Grimm” you deserve what you get. Even though we didn’t have a movie rating system way back then, there was some truth in advertising (even with an extra “m”). Damn those grim stories.
Now, ye of little faith, before you think I’ve stopped carrying on your wayward son from futures, markets, Massive Passives and technology, hold your horses, or cheetahs or wolves of a color of your choice. Whatever they are, just hold ‘em a cotton-picking, or corn, bean or rice-picking minute! Maybe it is Minute Rice—I forget. The rice guys can help me out later.
When I was in college, I took a class entitled “Philosophy of Fairytales” and in it we actually discussed Red and her Hood—ya’ know, the forest. Turns out, there is more to the story than it appears. There is some symbolism and such at play. So there! I have a point and it is going to be backed up by, um, college.
Ya’ see Red was the innocent consumer. She believed in the system. She believed in the financial and government structures. They were there to protect her. She was always taught that they were worthy of trust. But, they took advantage of her good nature. For gosh sakes, they ate her Grandmother—otherwise known as “Red’s Retirement Fund.”
Have things changed much since Red’s debacles? Not so much. You see, all we need to do is to think about a partial list of recent financial firm indiscretions: MF Global and Peregrine used Red’s money, their own customers’ money, and lost it. Wells Fargo discriminated against Red—just because of her hood color—and took advantage of 30,000 minority mortgage customers. Bank of America and a dozen others ripped off Red and thousands more with crooked debit and overdraft fees. A couple of banks pushed Red and a bunch of their own customers into certain funds, and then took the opposite positions. And, more recently, the Libor scandal was unearthed. Big banks monkeyed around with key interest rate benchmarks.
Libor—what the heck is that? Well, anybody’s kids have a student loan? When these dudes (and that’s what they sometimes called each other) rigged the rates, it affected almost everything people buy on credit, even a college education. You buy a car, an F-150, a Case or a Deere on credit—yepper—Libor rates impact you.
What’s all that mean? Well, the Big Bad Wolf is at the door and we need to let him know wassup. Listen to this: at any given time, my agency is looking at 750 to 1,000 individuals or entitles for violations of the Commodity Exchange Act. Just when folks might think the worst financial crimes are behind us, the hits keep coming. It is a bit like the carnival amusement, “Whack-A-Mole.” Ya’ know where the little red-headed stuffed critters pop up and the patron must hammer them down as quickly as possible. With so many cases out there, we regulators need bigger and heavier hammers.
Still, we catch a lot of bad critters. The Libor penalties have so far been in the hundreds-of-millions of dollars. One was a billion-and-a-half. Will these multi-hundreds of millions in monetary penalties and more prescriptive oversight efforts stop such Big Bad Wolf behavior from occurring? Will they be enough to encourage a true “culture shift” on Wall Street and LaSalle Street? Well, perhaps.
But there’s more to it than whacking moles or wolves—these firms—with penalties. A culture shift conversation needs to happen at the highest levels of our economic infrastructure. It is possible that this is starting to occur. Take Barclays' new CEO Antony Jenkins, who recently said that Barclays’ bankers had long gone after short-term profits at the expense of values and the firm’s reputation. "We must never again be in a position of rewarding people for making the bank money in a way which is unethical or inconsistent with our values," he said. Kudos to Antony! Or there’s Andrea Orcel, the head of investment banking at UBS who said financial institutions have become “too arrogant, too self-convinced.” Now, that’s the ticket!
I’ll give these two folks credit because it’s due. It’s about time somebody in the forest—in the financial sector—started talking about its culture. That's the right message. That's the culture shift that is needed. I’m optimistic, but we’ll see if others join in. And we will see if those who talk the talk can walk the walk. Until then, regulators need to keep whacking the moles.
As we wrap up, I’ll say there’s nuthin’ wrong with having a good time. I’m okay with red hot and even red neck revelries. And, there’s certainly nuthin’ wrong with making money. But when the fundamental purpose of these markets that we spoke about —allowing for producers and commercial interests to hedge their risks, or for consumers to rely upon real price discovery—are compromised, then it is time for us to step in and ensure fair play. When the monied interests mess with markets, we can’t stand for it. Innocent people should not suffer from others’ misdeeds. These markets impact the prices people pay for just about everything they purchase—be it a gallon of milk or a mortgage. Regulators have a duty to ensure these markets are efficient and effective. And that’s especially true in agriculture. That’s a big deal.
So, that’s Red. Best wishes on the rest of the conference.
“I love you red solo cup, I lift you up
Proceed to party . . .”
Thanks my friends. Proceed to party.
Last Updated: February 13, 2013