Speech of Commissioner Bart Chilton at Washington University in St. Louis, St. Louis, MO
April 15, 2013
How do you do Wash U? Thanks to President (James) Bullard and Professor (Christopher) Waller for the invitation to be with you today. I’m sure each of you knows this, but what lucky folks you are to have the benefit of spending some time with these “smartest of the smart” economists. I’m envious.
My last time here was October 17th, 2000 for the presidential debate between Vice President Gore and Governor Bush. I was with my boss, and am honored to say my friend, Dan Glickman, who was the U.S. Secretary of Agriculture. After the debate, Secretary Glickman and a few dozen surrogates for each campaign went into the “spin room” and gave their perspective on the debate. We all watched the same debate, but as you might know, the views on what took place were dramatically different.
When I was a kid, I adored looking through those kaleidoscope tubes. The small bits of glass with myriad reflections gave you such different perspectives. Spin the end of the tube and it would change; even though you were focused on the same object—kinda similar to that Wash U spin room. So today, like kaleidoscopes, let’s look at the futures markets from a few different perspectives. After my comments, I'd like your MBA-based subjective, introspective, perspectives...umm...respectively. Cool? Cool.
Okay. Okay. First, I know you all are MBA-bound prodigies, but let’s get a baseline from which to work. These futures markets are steeped in a hell of a history. Hell of a history, I say. They were started for producers and processors—farmers and ranchers, millers and feedlots—and most importantly from my perspective, for consumers.
People were hungry for ways to hedge their risk and get a fair price at harvest time and in lean times. At harvest, the markets would flood with produce; grain would rot with over-supply; and producers would suffer the consequences. Then, in the winter, 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 the rest of the year. Consumers were gouged at certain times when supplies were scarce. The costs incurred were passed to the ultimate purchasers—households and families. Producers, processors, and consumers were weary of the volatility. So, in 1848—just five years before Wash U started—25 guys got together above a feed store on Water Street in Chicago and started what would become the Chicago Board of Trade. In addition to grain merchants and a banker, that assembly included some unexpected folks: a bookseller, a druggist, a hardware dealer and a tanner, among others. Guess what? It worked by helping even out prices. What this commodity consortium created still impacts us today—even if we’ve never been near a farm or a mill. All right, that’s the baseline.
Futures Today—You Better You Bet
Fast forward to today. We still have commercials who hedge their risk (farmers and processors, etc.) and speculators who continue to bet they can make money from a futures contract by selling it later if prices change. One thing that is different, however, is that the markets have expanded well beyond the ag commodities to energy, metals and financial products.
What they started back in Chicago was not only good, it was fantastico. Then, markets got even better. Today, 165 years later, we want these markets to be even better. “You better, you better, you bet.” (It's “The Who” and President Bullard, Professor Waller and I know it. If you're too young to know it, Google or Bing it...whatever. “You Better You Bet,” or the Alaska version: You better, you better, you betcha.
The question is: Are these derivative markets better? Wanna bet they’re better? You bet? In truth, the answer is definitely debatable. That’s because it depends upon your…perspective, my new-found kaleidoscope comrades.
There’s a lot of fresh liquidity—more liquidity, more volume, bigger markets. Bigger should be better? Bigger, more liquid markets should equal closer bid-ask spreads and better pricing. You guys are smart. You learned that years ago…you! One might bet that consumers should benefit, too, right? That should be better.
Betcha can hold that thought—bigger is better.
Bigger is Better?
Has anyone seen that series of AT&T commercials with Beck Bennett and the kids? He’s that super funny comic, sort of our present-day Art Linkletter or Bill Cosby when it comes to interviewing children. (Again, Google, Bing and Yahoo are your friends). Anywho, Beck is the interviewer in a focus-group-like setting with kids. He asks them, “What’s better: bigger or smaller?” The kids yell out, “bigger” before the next question, which is, “Which would you rather have, a big tree house or a small tree house?” They, of course, all want a bigger tree house…you betcha they do. One explains, “If it’s big enough you can have a disco,” while another comments that a small tree house wouldn’t have room for a flat screen TV. “Bigger is better,” is the tag line on the commercial.
Perhaps the AT&T marketing gurus are too young to remember what the Department of Justice said about that bigger is better stuff, although AT&T is something like the second largest company in the States and 14th largest in the world. I guess they know what they are doing. Anyway, Ma Bell remembers. Bing it baby, or Bing Baby Bells, whatever. The point: Kids think bigger is better.
We Want More
There’s another one of those commercials where Beck asks “Who thinks more is better than less?” A little girl explains, if we like it, “…we want more, we want more.” “It’s not complicated,” goes the tag line.
Well, if your perspective is that of a six or eight-year-old, all of that may make a lot of sense. Bigger is better. More is better. When it comes to futures markets and you wonder if bigger markets with lots of liquidity and more traders are better, your gut reaction maybe to say, “No duh Sherlock.”
However, it actually is more complicated than that. Admittedly, if one looks at it from the exchange kaleidoscope perspective, exchanges make money from bigger volume, more traders. You might not even care about the price of anything. Bigger is better. More is more. You like it. You like it. You la la like it. You want more.
But, what about those Chi-town thought leaders back in the day—in 1848? What about consumers? Is more always better? Is bigger always better? Sometimes, is more, less?
Massive Passives and 2008
Let me give you one scenario, which happens to be based upon, well…fact. At least it is based upon fact from my and many other peoples’ kaleidoscope perspectives. In three short years, between 2005 and 2008, we saw over $200 billion come into U.S. futures markets. That’s a whole lotta liquidity—200B. That’s more volume. Gotta be better, right? Well, there was something different about these playas, that is: the speculators that gave the green. These speculators were new to the markets—the likes of pension funds. There’s nothing wrong with pension funds. (In fact, a lot of people like pension funds so much, they are still pretty peeved that theirs was cut in half due to the economic collapse). But that’s another tale too tough to tell—too tender to the touch tonight, perhaps another time.
In addition to pension funds, this $200 billion that came into our futures markets included exchange traded funds (ETFs). There’s nothing wrong with ETFs. The problem is: they, all these new speculators—the pension funds, ETFs, index funds and some others—had a different trading strategy. They had a different perspective than previous speculators. And, they deserved their own moniker—their own name.
I call these new speculators Massive Passives: voila! Here’s why. They are ginormous—so they are massive. And, they have a fairly price-insensitive trading strategy—so they are passive—Massive Passives. They don’t get in or out of markets based upon the crop year or the harvest. They don’t, by and large, make decisions about a drought, a cold winter or the summer driving season. Their bet is many years out. They invest like people who invest in the stock markets. People who invest there often park their money and leave it for years. A lot of our parents did, or do, just that. Many stock market investors do it today.
Sonny Boy, Girly Sue, let me explain investing to you.
As a stock holder, when we get older,
you’ll remember this chat about stock this and stock that.
You’ll recall I said with a grin that these shares of…AT&T or something akin, will be worth something then.
We’re gonna hang onto these bad boys.
Someday, when then arrives, we’ll be rich.
It will change our lives. That’s how wealth derives.
I’m pretty sure that’s exactly how the conversations went down. And, that’s sort of how the Massive Passives have operated. You see, they wanted to diversify their portfolios beyond stocks and bonds and get into futures. And the futures industry said, “Sure, come one come all. Bigger is better. We want more. We want more.” So, the Massive Passives brought the buckaroos and parked them—like a stock—in a bunch of futures—ags, metals, financials, and energy. They call this bigger is better moolah movement the “financialization of futures.”
Here’s the troublesome part. Too much one-way wagering—like Massive Passive long speculation—can influence prices. Let me give you an example: crude oil. We know crude and related energy commodities impact so much of our economy because they are used to produce and transport so many things. At the beginning of 2008, a barrel of crude was in the $90s. By the time summer rolled around, it had vaulted to over $140, creating the highest ever gasoline prices in our nation’s history—$4.10 a gallon. The thing is: Even though prices change radically, not much changed in the way of supply and demand. Folks searched for some volatility causation. But, what we found was the big influx of Massive Passive dough. Then by December, as the entire economy was collapsing, even the Massive Passives weren’t so price insensitive. They got out of the market. Prices plunged to the $30s. Again, this took place without much in the way of any supply demand relationship.
You don’t have to take my word for it. A perspective from a top notch researcher at Goldman Sachs—one of the largest speculators on earth—said long speculation in markets does impact price. He even quantified it. Even expert researcher Luciana Juvenal at the Federal Reserve Bank of St. Louis came to similar conclusions. Researchers at Rice, MIT (Massachusetts Institute of Technology) and a plethora of other places say comparable things. There’s good and plenty of evidence—reputable and reliable substantiation—documenting what many of us simply know: Excessive speculation can help push prices around, and businesses and consumers can suffer.
How do we ensure that these 165-year-old markets keep working properly under these circumstances? 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. They would limit the size that traders may control in a given market. So far, however, they’re not in place. That is due to the biggest speculators on the planet and their litigation efforts. My bet and I’d betcha, is this: The efforts to stop position limits will eventually fail. Congress told us, in no uncertain terms, to get it done. I intend to see that we do that—you betcha.
A Cheetah Taped to Grandma
There’s one more AT&T commercial you may recollect. This is the one where Beck asks the kids if faster or slower is better. They all like fast, of course. Then he asks, what’s fast? One kid says, “My mom’s car and a cheetah.” Then the kids are asked, “What’s slow?” to which a young boy says, “My Grandmother is slow; I bet she would like it if she was fast.” Beck proposes, “Maybe give her some turbo boosters?” But, the boy suggests, “Tape a cheetah to her back.” Beck says, “Hmm, seems like you’ve thought about this before.” The tag line for the spot is: “It’s not complicated. Faster is better.”
Well, just like my perspective that bigger and more isn’t always better, and that more can be less, I’m not so sure that faster is always better in trading. If we look at another key change to markets from back in the day, there’s also a lot of gee whiz, crazy cool, lightning-fa fa fast technology. There are algorithms that mine newsfeeds. They quantify, analyze, calculate and compute things most people would never ever dream. And, they do it quicker than a blink of an eye.
These speed demons are called high-frequency traders (HFTs), although a few years ago I thought they, too, needed a more descriptive name. I came up with Cheetahs. The fastest land animals, not like a Boston card cheater.
The problem with fast in this regard is this: I speak with commercial market participants regularly who suggest the cheetahs are taking advantage of markets. They know the cheetahs are sort of like the new middlemen. And, they are out there 24-7-365 trying to scoop up micro-dollars in milliseconds.
Lots of commercial hedgers try to trade fast, but they have explained their circumstances. Say you are merging onto a freeway. You are ready to get on, ready to trade. Just before merging, five or six cheetahs zoom zoom past like they are in the fast lane and jump in the market ahead of you at a certain price. If you’re a little slow, you can still get on the highway but not at the price you intended.
A study late last year, which was conducted in conjunction with the CFTC, said in essence that cheetah trading imposes quantifiable costs on small investors. Aggressive cheetahs make a lot of money, and they make their biggest paydays when they trade with small, traditional traders. This could end up pushing smaller, non-cheetah traders out of markets. From most perspectives I can think of, that sort of fast isn’t better.
To be clear, I’m not proposing we get rid of neato, gee whiz technology in markets or we make the cheetahs an endangered species. They have some real attributes—you bet—like speed, smarts and portability. But, we need only to go back to May 6th 2010, when the Flash Crash occurred. The Dow Jones lost almost a thousand points in a matter of minutes. Cheetahs played a part in the entire damaging debacle, and as some of us recall: life in the fast lane can surely make you lose your mind, and a mind is a terrible thing to waste.
Today, we have no rules or regulation to deal with the cheetahs. I’m not suggesting slow is better than fast, I’m just saying we need to look at these things from a few perspectives. We shouldn’t just accept that all is good with speed.
The questions that folks should ask are these: Are markets performing as they should? Are they, in particular, benefiting consumers? What, if anything needs to be done?
We all have our own cool-colored, multi-faceted Kaleidoscope opinions based upon our proficiencies and experiences. That’s an enormous value we have individually, but it also benefits our schools, businesses, our communities and government institutions. Learning about these diverse perspectives makes us better. That’s why I want to hear what you think.
I appreciate your attention and really value the opportunity to be with you at Wash U. You betcha, I do.
Last Updated: April 15, 2013