Fed Faces Pressure to Rein in Wall Street Commodity Businesses

By Cheyenne Hopkins and Silla Brush  

The Federal Reserve faces pressure to restrict Wall Street’s control over commodities such as oil, aluminum and coal after lawmakers said banks tried to exploit rules and influence prices to their benefit.
“You’ve got to restore the separation,” U.S. Senator Carl Levin, said in an interview yesterday after he grilled executives from Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley (MS) at a hearing in Washington. “It’s gone way too far this integration. I don’t like the idea, frankly, of these banks being in physical commodities.”
This week, a Senate panel Levin chairs released findings from a two-year investigation that concluded Wall Street’s role in owning commodities provided unfair trading advantages and could threaten the financial system if a bank’s business suffered an industrial catastrophe. A Fed official will face questions today over why the central bank allowed lenders to
erode what was once a strict line separating banking from commercial activities.
The Fed has drawn criticism from senators who allege it engaged in weak oversight over the last decade as banks expanded into new businesses involving aluminum warehouses, coal mines and trading in electricity and uranium. The central bank said in January that it was reviewing whether to stiffen rules.

Ineffective Regulation

The Senate Permanent Subcommittee on Investigations’ 400-page report said the Fed has “a current lack of effective regulatory standards” and an “uncoordinated, incoherent patchwork” of limits on banks. Daniel Tarullo, the Fed governor responsible for financial rules, is set to testify before the panel today.
A bank shouldn’t “ever be able to corner 80 percent of the world’s supply of any commodity and that should have come to the attention of the regulators,” Senator John McCain, the panel’s senior Republican, said in an interview yesterday. “We pass laws that appoint those regulators and obviously they didn’t choose to act.”
At yesterday’s hearing, Levin sparred with Goldman Sachs (GS) executives for more than two hours over aluminum trading contracts between a bank warehouse subsidiary and clients that the lawmaker said led to higher prices paid by consumers. Jacques Gabillon, head of Goldman Sachs’s global commodities principal investments group, rejected the accusation.
“When everything is said and done, you can say there is no correlation” between wait times and price, Gabillon said.
Levin, a Michigan Democrat, responded that the executives were “in a very different mathematical world” if they wouldn’t acknowledge the connection.

Catastrophic Losses

The Senate report referenced a 2012 Fed study of four banks that found each had capital and insurance shortfalls for commodity units of as much as $15 billion. That meant that if each bank experienced a catastrophe on the scale of BP Plc (BP/)’s 2010 oil spill in the Gulf of Mexico, they couldn’t cover the losses, the report said.
The Fed, as part of its consideration of new limits on the businesses, is weighing regulations for extra capital and insurance for banks’ commodity businesses.
Banks have moved to sell commodities units amid the scrutiny and revenue from the businesses has tumbled by two-thirds from peak years.
Goldman Sachs produced $1 billion of revenue from its commodities unit and investments in commodity businesses in 2012, down from $3.4 billion in 2009, according to the Senate report, while Morgan Stanley’s commodity revenue fell for four straight years, from $3 billion in 2008 to $912 million in 2012.
Goldman Sachs said it is looking to sell the warehouse subsidiary and will wind down an uranium-trading unit after the bank didn’t receive acceptable bids when it put the business up for sale. The bank is also considering selling coal mines in Colombia, according to the report. Meanwhile, JPMorgan (JPM) has been selling off large portions of its physical commodities business.