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How Big Banks Control The Price Of U.S. Commodities

photo by vonderauvisuals via Flickr

A senate led investigation has revealed that some big banks exert powerful and sometimes behind-the-scenes influence over important commodity markets.

According to the New York Times, the senate subcommittee on investigations found that through purchasing large ownership stakes in at least nine different commodity markets, JPMorgan Chase, Goldman Sachs, and Morgan Stanley are now able to influence consumer prices and glean valuable inside information for their traders, all while engaging in risky commodity trading.

Commodity markets are:

A physical or virtual marketplace for buying, selling and trading raw or primary products. For investors’ purposes there are currently about 50 major commodity markets worldwide that facilitate investment trade in nearly 100 primary commodities.”  – Investopedia  

Specifically, the investigation looks at nine different commodities and the extent to which banks have invested in them. The report details purchases by the three banks which range from 100 oil tankers to 31 power plants owned by JP Morgan.

Though once forbidden, the loosening of regulations which restricted banks from dealing in physical commodities in 2003 has allowed such institutions to engage more heavy-handedly in these formerly off-limits markets.

But just what exactly are the big banks up to, and how does it directly affect consumers? Below are the key points to understanding big banks manipulate of commodity markets.

Trading in important commodity markets could be of great risk to the economy

According to the report, all three banks investigated have been involved in billions of dollars of risky commodity trading ranging from oil, to aluminum, and natural gas.

The concern here is that by taking on risk through trading commodities at a level which exceeds a banks capital reserves, such institutions are opening themselves up to potentially catastrophic financial repercussions.

As highlighted by the Associated Press, a price fluctuation brought about by an oil spill, mine explosion, or power plant mishap could end up costing big banks more than they’re able to afford.

If the big bank bailouts of 2008 are any indicator, taxpayers could potentially wind up footing the bill in such a scenario.

By controlling supply, banks are able to manipulate prices

Through the acquisition of large quantities of aluminum and a complex type of trading which the New York Times dubbed “merry-go-round trades,” Goldman Sachs may have been able to artificially inflate aluminum prices by storing million of tons of the metal while also slowing its shipping.

In some cases the committee even found that Goldman Sachs had paid financial firms to order metal and withhold it at a different site in order to stay in compliance with load-out requirements.

This was due largely to the acquisition of Metro International Trade Services in Detroit, whom the report also states Goldman Sachs was able to harvest confidential trading information from.

The bank may have exceeded its Fed-assigned limits for holding commodities

While current Fed regulations only allow banks to hold physical assets as long as they remain under 5 percent of the banks capital reserve, the Senate report found that JP Morgan Chase had held assets equivalent to 12 percent.

According to The New York Times, however, JP Morgan Chase has already refuted the investigations findings claiming that such assets were held by the bank and not the banks holding company, which is not expressly forbidden under current Fed regulation.

The takeaway

For big banks, the surrounding legality in regard to the holding and trading of physical commodities is tenuous. Hearings will involve bank executives from both JP Morgan Chase and Goldman Sachs and are set to take place in the near future.

For now the subcommittee recommends key changes to the Federal Reserve’s regulations that include:

  • The separation of banking and commerce – this is essentially a call to reavulate the guidelines drawn in 2003 in regard to banks’ ability to hold and trade physical commodities
  • Size regulation – by clarifying the rules around the amount of commodities that banks are able to hold, it may reduce risk factors drastically
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James Pero