“How to burn the speculators” – Galbraith

Oil_barrel "On these matters, there is a quick fix. Under pressure, the cftc is closing the London loophole. Early in the next administration, Congress must slam shut the Enron and swaps loopholes. Index speculation should be curtailed by making such strategies illegal for regulated pension funds and by imposing limits for all traders on how much they can buy or sell. Investment banks using credit default swaps to enter the commodities markets should be regulated to the standards that apply to speculators, not as if they were heating-oil vendors hedging against a warm winter. Investigations now under way at the Federal Trade Commission, the Federal Energy Regulatory Commission, and the Department of Justice should be intensified, and criminal manipulation of the markets, if detected, should be punished.

Finally, the federal government should burn the oil speculators by selling up to 4 million barrels a day from the Strategic Petroleum Reserve. And as economist Tom Palley has pointed out, consumers can help too. An awful lot of gas is stored in cars. If people stop topping off and make do with half a tank, they’ll back up supply and lower demand. It’s a brilliant suggestion and definitely worth a try.

And while this is being done, and especially if all this smoke leads to fire, someone should ask, "What did Henry Paulson know, and when did he know it?""  Galbraith


Am I beating this horse to death?



…Because the horse isn’t dead yet.



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27 Responses to “How to burn the speculators” – Galbraith

  1. zanzibar says:

    “..the federal government should burn the oil speculators..”
    “What did Henry Paulson know, and when did he know it?”
    – Galbraith
    I wonder if Galbraith would also like to burn the oil speculators that have driven the price of crude and natural gas down over the past few weeks?? Its worth a few minutes checking out the graphic on the Big 5 production and capital outlays.
    And what about the Federal government that encouraged speculators under the euphemism of the new age of risk management that drove up the prices of financial stocks as well as MBSs, CDOs & CDSs that provided much “accounting profit” and billions in bonuses to the Wall Street titans?
    And what did Bob Rubin, Alan Greenspan, Chris Cox, Barney Frank, Chuck Schumer, Chris Dodd and the countless others on Wall Street and DC know and when did they know it? Will we ever find out?

  2. b says:

    There are about $60 trillions notional value in outstanding Credit Derivative/Default Swaps (CDOs) based on a notational value of real credit papers that might be about $6 trillion (mostly dubious) debt.
    What happens if the U.S. ‘regulates’ those away now (which it should have done form the onset.)
    Will any major bank survive?
    The commodity call/put business was the last profitable business the big banks and hedge funds had.
    Take that away and then what?

  3. Mark Logan says:

    “Hmmm. pl”
    Giddy up, Gold.

  4. Dave of Maryland says:

    At least I do not subscribe to the Mescalero Apache school of horse employment. According to Army legend, their method was to ride the horse until it lay down, unwilling to continue. Then, they built a fire under the horse to get it on its feet. Then, they rode it until it died. Then, they got a new horse. Hmmm.
    Like our oil supply, those were imported horses.
    Nothing changes.

  5. shepherd says:

    A CDO is a collateralized debt obligation, not a default swap, but you’re right in the size and scariness of that market. Do you have a source for your $6 trillion of mostly dubious debt? Although the danger is real, that seems to me to be an overstatement.

  6. m savoca says:

    as reported by gretchen morgenson in the new york times, creating and trading credit default swaps is the largest derivatives market in the world and as of last winter represented a notional valued of more than 43 trillion dollars. That figure is likely well above 50 trillion as we speak.
    CDS can be strutured and as such spin off secondary and tertiary investment instruments (deals, trades) Dependant on complex underlying counterparty risks.
    these trading systems have been invented by “quants”… students who graduated with advanced degrees in physics and probability and found wall street would pay them more to take their math modeling skills and apply them to squeezing out profits arbitraging different investment tactical outomes.
    in other words the brightest, and behind them the most powerful people in our economy are making huge sums of money (and will be loosing same) doing littlle more than repackaging debt insturments, and insurance bets on futures outcomes and selling same for huge service fees.
    keep in mind that CDS are bets and insurance policies…they are unregulated, and most important unlike normal insurance policies, like house, life, health, etc…the people on each side of the policy (bet) do not have to posses what we would call an “insurable interest”… in may cases those writing, and those buying CDSs have MO relationship to the underlying security or business they are betting upon.
    our economic system has become perforated with corruption, quackery and indolence…we make less and less of a world market trading value and the money changers have not only taken control of the temple, they control the nation and its politics.
    the country is in very deep trouble.

  7. Kevin Goudy says:

    I’d like to hear what an Apache has to say about the truth of this “Army legend”.
    Also, I’m all for beating the oil speculators but think that the horses should be left alone.
    Buzz G.

  8. m savoca says:

    yes Colonel Lang
    Galbraith is right, releasing crude from the SPR would be an effective way to break the market hold that options and futures traders have grasped upon this market.
    it is interesting to note that the week the SPR was closed to taking more oil deposits, that was the time the futures market began to weaken.
    it has been argued that futures market manipulation can not take place with out a place to physically hold or store some of the spec’d oil.
    Well, the salt mines in Louisiana was just such a place.
    coincidence, maybe… or maybe not.
    watch what happens to home heating oil this winter…lehman brothers owns a major portion of this futures market

  9. zanzibar says:

    A central issue with the entire CDS market is its completely opaque. Many of these OTC contracts have all sorts of optionality built into them. Many were written up at breakneck speed. No one really knows what’s in those hundreds of pages of legalese which I’m sure is open to interpretation.
    While the going was good it provided a nice virtuous cycle. It allowed insurance companies like AIG to write “default insurance” and collect premiums to bolster earnings. It allowed hedge funds like Fannie & Freddie to “hedge” their private label CDO portfolio at very nominal costs. And it allowed ratings agencies the alchemy to convert dubious paper to AAA – of course for a fee. Voila! No one need do any due diligence on what these contracts really were about. Just grow balance sheets and mark-to-market gains and use Enron style derivative accounting to show double digit earnings growth each quarter. Bonuses and stock option compensation flowed in the hundreds of billions.
    All our politicians and regulators and central bankers just kept cheerleading the marvels of the American financial economy as leverage was piled on leverage.
    A few souls like Volcker warned that we were skating on thin ice. But they were ignored in the money making mayhem as the virtues of American style capitalism were trumpeted and the infectiousness of greed was spread to all continents. Now these paragons of capitalism make dyed in the wool communists blush as they squeal for taxpayer bailouts and backstops. The Ponzi scheme will ultimately have to be unwound. The sooner we do it and clear the markets the sooner we can get back to rebuilding our economy but it seems that the powers that be want to drag it out with maximum obfuscation.

  10. b says:

    @shepard – you are correct – I meant CDSs
    Now the CFTC is “surprised” …
    A Few Speculators Dominate Vast Market for Oil Trading

    The CFTC, which learned about the nature of Vitol’s activities only after making an unusual request for data from the firm, now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency. That figure may rise in coming weeks as the CFTC checks the status of other big traders.

  11. Curious says:

    wait until they find out, how much they bribe congress. (Goldman Sachs? Hey isn’t that Paulson ex job?) …har har…
    Cleptocracy. Same old. same old.
    A Few Speculators Dominate Vast Market for Oil Trading
    Using swap dealers as middlemen, investment funds have poured into the commodity markets, raising their holdings to $260 billion this year from $13 billion in 2003. During that same period, the price of crude oil rose unabated every year.
    CFTC data show that at the end of July, just four swap dealers held one-third of all NYMEX oil contracts that bet prices would increase. Dealers make trades that forecast prices will either rise or fall. Energy analysts say these data are evidence of the concentration of power in the markets.

    “When the CFTC granted the 1991 hedging exemption to J. Aron (a division of Goldman Sachs), it signaled a major shift that has since allowed investors to accumulate enormous positions for purely speculative purposes,” said Rep. Bart Stupak (D-Mich.) Now, he added, “legitimate businesses that hedge and take physical delivery of oil are being trampled by the speculators who are in the market purely to make profit.”

  12. JohnH says:

    Just so everyone is clear, it was Bill Clinton who opened the Enron loophole. It was in the last bill he signed. And, yes, he knew it was there. That set the stage for the California electricity crisis and the current, secretive oil speculation.
    Clinton also signed away Depression era protections preventing mergers of insurance companies, banks, and investment banks, setting the stage for the sub-prime crisis. This happened just as Hillary was about to run for Senator from New York, trying to become a representative for Wall Street in Congress.
    People often talk about how we got where we are, but they rarely name the culprits. If it weren’t for Clinton’s craven behavior, there would be no horse or any need to beat to death today. Of course, the Republican majorities in both houses share responsibility, since they eagerly passed both bills. McCain’s economic advisor, Phil Gramm, who was then a Senator from Texas, helped lead the charge.
    Economist Tom Palley’s suggestion about not topping off the tank is one of the most bone-headed, elitist suggestions I have ever heard–most people I know can’t afford to fill their tanks, much less top them off.

  13. ISL says:

    Galbraith is absolutely right that using the Strategic Reserve to unpredictably alter the price of oil would make it much harder for speculators to make money (burning them) and thereby encourage them to speculate in other commodities (which are less essential to the economy).
    The media has often noted that one of the causes of the rise in oil price was the dollar’s fall in the dollar. Yet, it is an insufficient explanation as the dollar has only fell 10 or so percent – $7 – $15 of the $45-$70 run up in oil in the last 8 – 12 months (epending on where the “baseline oil price” as determined by some sort of trading balance between anticipated demand and predicted supply). That left quite a bit of room ($40-$80) for upside speculators (now there are downside speculators, who could be burnt by uncertainty in how much oil would be released).
    I recall something similar happening before Iraq War 1. Bush would make a threatening statement and oil would go up. Then someone in his administration (or Sadam) would make a reconciling statement and it would go down. This wavy cycle repeated over many months. I assume many speculators made a lot of money, paid for at the pump.
    Would not be surprised if some WH folks used their insider knowledge (what the prez would say and when) to make a bundle.
    Of course in Iraq war reprise, statements were all negative, so things in the oil market played out differently (plus the WH was claiming that the war would lower the price of oil!)

  14. jamzo says:

    petroleum markets are a symptom
    financial markets
    bonds, stocks, mortgages, commodities
    have been thoroughly deregulated over the past two decades
    some have made a lot of money
    for most people it has been a costly experience
    no political leader
    has taken a stand and pointed to a clear cut program of market reform

  15. Today’s WashPost front page article (8/21/08) on oil speculation and seems to indicate major problems in regulatory gaps.

  16. agog says:

    Col. Lang,
    I have no doubt that speculators/investors are responsible for a some of the higher oil prices we see now. Could it be that they are making a bet on future scarcity?
    Michael Klare in the latest issue of LRB writes:
    “In the 2008 report IEA analysts increased their estimate of decline rates in mature fields to 5.2 per cent a year, up from 4 per cent in 2007. This means that 3.5 million more barrels a day would have to be generated elsewhere every year just to hold production levels steady. By 2013, the industry will have to generate 24.7 million barrels a day in additional capacity in order to reach the predicted target of 94.1 million barrels [demand] a nearly impossible task.”
    24.7 bpd in new supply in five years’ time seems improbable. Instead of railing against speculators it might be more useful to call on governments to set in place sensible energy policies. On the individual level we can consider investment strategies to insulate ourselves from inevitably higher energy costs, and, dare I say it, try to live a bit smaller.
    There is a whiff of denial to all this blame the markets anger.

  17. Paul says:

    The surface of speculation in oil futures is just now getting scratched. Sooner of later we’ll learn if some of it was/is criminal. Of course, those who made fortunes will claim that it was all legal given the loopholes in relevant laws.
    I don’t know enough about the business practices of that world, but in every enterprise “legitimate” endeavor is usually accompanied by a lot of illegal activity. It’s my sense that much will be found to be illegal and unethical. Given the damage to the economy, whatever went on (and perhaps still going on) is EVIL.
    In response to Pastor Rick’s posit about confronting evil, “My Friends” McCain said, with a straight face: “Destroy it”. Let’s hold that loudmouth to his own words on speculators. Where’s Phil Gramm?
    The fleecing of the public and the re-distribution of wealth to the mighty in the face of Iraq, Afghanistan, poverty and joblessness is over the top and hard to fathom that it could happen in America.

  18. Cieran says:

    Just so everyone is clear, it was Bill Clinton who opened the Enron loophole. It was in the last bill he signed. And, yes, he knew it was there. That set the stage for the California electricity crisis and the current, secretive oil speculation.
    Before you ask everyone else to get clear on something, you may want to test the waters yourself. To whit:
    First and foremost, the Enron loophole did not “set the stage” for the California electricity crisis, simply because said crisis began long before Phil Gramm inserted that unfortunate loophole into the CFMA at the behest of Enron’s lobbyists.
    Six months before Clinton signed the CFMA into law, speculator-induced rolling blackouts were commonplace in California (exacerbated by a drought in the west that reduced the state’s own hydroelectric capacity), and lawsuits were being filed by utilities alleging that the market was being manipulated.
    Which it clearly was, but not by the Commodity Futures Modernization Act or its embedded Enron loophole.
    What “set the stage” for the California energy crisis were the incompetently-drafted deregulation statutes signed into law in the 1990’s by GOP governor Pete Wilson.
    And when one scratches the surface of who worked with Wilson to draft those ridiculous works of legislation, you find a whole slew of GOP shills-for-hire like Haley Barbour (RNC chair-turned-Enron lobbyist) and Jack Abramoff buddy Ralph Reed.
    The cupidity and stupidity that are the basis of the Enron loophole indeed deserve blame for the California electricity crisis of 2000 and 2001, but you can’t attach Clinton’s name to California’s electricity woes via the CFMA.
    That energy mess had “Made in the USA by the GOP” stamped all over it.

  19. JohnS says:

    A note on the “Enron Loophole” from Wiki:
    “The The Commodity Futures Modernization Act of 2000 has received criticism for the so-called “Enron Loophole,” 7 U.S.C. §2(h)(3) and (g), which exempts most over-the-counter energy trades and trading on electronic energy commodity markets. The “loophole” was drafted by Enron Lobbyists working with senator Phil Gramm [1] seeking a deregulated atmosphere for their new experiment, “Enron On-line”[citation needed].
    An attempt to repeal the policy was vetoed by President Bush in 2008. Several Democratic Legislators introduced legislation to close the loophole from 2000-2006, but were unsuccessful due to Republican control of the House and Senate.”

    The “Enron loophole” was actually an amendment to H.R. 4577, which was an appropriations bill for the labor, health, and education departments.
    Obama has proposed closing this loophole. Back in May, McCain said he opposed the farm bill because it doled out wasteful subsidies, and his chief economic adviser at the time, Phil Gramm, added that he opposed it because the bill also contained regulatory provisions on electronic energy trading.

  20. JohnS says:

    With regards to the Financial Services Modernization Act of 1999 (which repealed the Glass-Steagall Act that limited the conflict of interest created when commercial banks could underwrite stocks or bond. There’s plenty of blame to go around for that. From the PBS NewsHour:
    “The banking, insurance and brokerage industry lobbyists…combined their forces…to mount the best-financed campaign of influence-buying ever seen in Washington. In 1997 and 1998 alone, the three industries spent over $300 million on the effort: $58 million in campaign contributions to Democratic and Republican candidates, $87 million in “soft money” contributions to the Democratic and Republican parties, and $163 million on lobbying of elected officials.
    The chairman of the Senate Banking Committee, Texas Republican Phil Gramm, himself collected more than $1.5 million in cash from the three industries during the last five years: $496,610 from the insurance industry, $760,404 from the securities industry and $407,956 from banks…”

    One other note. Treasury Secretary Robert Rubin managed to land a top job at Citigroup right after the announcement was made that the WH would sign and Treasury would OK the repeal.

  21. Dumass says:

    “If people stop topping off and make do with half a tank, they’ll back up supply and lower demand.”
    Say what? If I drive 1,000 miles a month and only fill up my gas tank 50% each time I stop at the pump I don’t see how my demand goes down one bit. All this would accomplish is that I would have to make twice as many trips to the gas station (possibly wasting more gas along the way…)

  22. matt m says:

    http://warandpiece.com/ As Laura Rozen states here….”so much for supply & demand”!

  23. Dumass says:

    m savoca said “Galbraith is right, releasing crude from the SPR would be an effective way to break the market hold that options and futures traders have grasped upon this market. It is interesting to note that the week the SPR was closed to taking more oil deposits, that was the time the futures market began to weaken. It has been argued that futures market manipulation can not take place with out a place to physically hold or store some of the spec’d oil. Well, the salt mines in Louisiana was just such a place.”
    Actually, RIK vs. not-RIK goes more to the traditional supply and demand explanation. Putting the RIK volumes on the market vs. in the SPr means a small increase in supply. Added to demand destruction = lower price 🙂

  24. Arnie says:

    Interesting article in today’s WSJ about this subject. CFTC found that one company held some 11% of positions. NYMEX trading has become price setting. The holding of positions itself is not the problem; the problem is if the entity buys too much too fast it spikes the price (or vice versa).
    Trading in futures was limited to agricultural products until the late 70s. futures trading today adds useful liquidity to many markets, but markets work only if the exercise of undue market power is prohibited. We need to drop the silly notion that markets function with inherent perfection. Obviously, manifestly, this is erroneous doctrine (just look at subprime…). Markets are as imperfect as the folks who trade in them, and they require appropriate regulation to function well, particularly when the product is required to sustain the economy.

  25. Dumass says:

    Matt m references Laura Rozen’s write up, referring to Swiss company Vitol. Vitol bought a huge position “betting prices would go up. Prices went up. Must be speculation. What a horrendous “post hoc ergo propter hoc” argument. If just taking a huge position while “betting prices would go up” was all it took to make prices go up, what happened to “Nick Leeson/Barings Bank” & “Jerome Kerviel/Societe Generale”?
    She also notes that prices went down after July 11th – per her argument if Vitol had taken a huge position after July 11th prices would have gone up rather than down! Heh!

  26. m savoca says:

    to amplify the point, the dollar amount of oil futures trading is about five times the actual dollar amount of oil that is produced and consumed.
    most futures contracts involve traders who neither produce nor consume and they try the best they can to trade the contracts to actual users prior to expirations
    when they cant, a small percentage of the time, actual storage may become necessary

  27. Arun says:

    Dear Col. Lang: this is to draw your attention to the NYT story:
    that begins
    “BAGHDAD — The Shiite-dominated government in Iraq is driving out many leaders of Sunni citizen patrols, the groups of former insurgents who joined the American payroll and have been a major pillar in the decline in violence around the nation.”
    Seems like the Iraqi govt is determined to unravel whatever measure of peace has been secured there. I hope that you write about it.

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