While Bernanke Prints, CFTC Will Impose Capital Controls

As we wrote earlier in the month, the CFTC will soon announce its new schedule of speculative position limits for commodities, which could have profound short and intermediate term price implications, especially if some of the large "commodity ETFs", such as USO, are forced to liquidate or simply not roll over maturing futures contracts. Among other unintended (or intended) consequences, the public energy utility business model could be forced to radically change, and main street could be faced with higher margin requirements. As we've written, these near term reforms are just the tip of the iceberg, with more substantial changes coming in 2011 as a substantial portion of the $600 trillion global derivatives market comes under the purview of ex-Goldman MD Gary Gensler and his CFTC.

As to the exact timing of the announcement, we were able to find only one source, Platts, the "leading global provider of energy and metals information" (emphasis and brackets ours):

Commissioners with the CFTC had originally planned to consider a new rule on position limits at their December 1 meeting, but that rule likely will not be considered until either the December 9 or December 16 meeting, CFTC Chairman Gary Gensler said Friday [November 19, 2010].

The relevant provisions in Frank-Dodd require the new position limits to go into effect no later than 180 days from the bill's July 21, 2010 signing, which would be January 17, 2011. Mark your calendars and watch your stops in energies and precious metals, as these are the two major target sectors.

The big lobbying effort in favor of the "strongest possible speculative position limits" is the Commodity Markets Oversight Coalition (CMOC), which appears to be an affiliate of the New England Fuel Institute's Legislative & Regulatory Action Center. Indeed, the letter sent by the CMOC to the CFTC cited in the Reuter's article we quoted in our November 4 post was submitted by Jim Collura, Vice President of NEFI Action Center. The letter begins:

Formed in 2007, the Commodity Markets Oversight Coalition (the "CMOC") represents an array of interests, including commodity producers, processors, distributors, retailers, commercial and industrial end-users, and average American consumers. CMOC was established to promote government policy and regulation in the commodity trading markets - including the energy and agricultural markets - that preserve the interests of bona fide hedgers and consumers and the health of the broader economy. We seek stable and reliable commodity markets that perform a price discovery function reflective of tangible economic fundamentals, and that are free of manipulation, fraud, and excess volatility and speculation.

The last decade has shown that inadequate transparency, oversight and accountability in the derivatives markets contribute to excessive volatility and speculation. This leads to price uncertainty, unexpected and unwarranted price spikes, and diminished end-user confidence in these markets. Representatives of

CMOC member groups have testified before the U.S. Congress and the Commission on these issues.2

The commodities futures and derivatives markets were established as price discovery and risk management tools for bona-fide hedgers of physical market exposures. While speculators play a vital role in keeping markets functional and liquid, excessive speculation causes markets to become unhinged from economic fundamentals. In 2007-2008, opaque derivatives trading and excessive speculation contributed to the largest commodities bubble in U.S. history.3 The damage to the U.S. and global economies caused by this bubble and its bursting highlighted the need for significant reform and lead the Congress and the President to enactment the derivatives reforms in Title VII of the Dodd-Frank Act.4

No mention of Federal Reserve money printing as a possible cause. Presumably, Chairman Gensler will have the wisdom to know precisely how much speculation is warranted in a given market.

Aside from nominal lip service paid to "free markets" and "price discovery", the letter reads as a veritable anti-market wish list, including calls for new prohibitions on "insider trading" (you didn't think the SEC would get all the fun), for new authority provided to the CFTC that would allow it to unilaterally identify and liquidate "swaps that are 'abusive' by virtue of being potentially detrimental to either the stability of the market or its participants", and for the CFTC to "scrutinize" computerized trading programs (not limited to high frequency trading, but all computerized trading). There is also a call to define "Major Swap Participant" in such a way that would impose CFTC registration requirements on any large ETF or ETN, even ones with no connection to commodities.

While the tone and content of this trade association's letter is anti-Wall Street, it's important to look beyond the folksy rhetoric of helping the little guy and realize that all of this is a vain attempt to block new hot money from rolling off the Fed's printing press into hard assets, and into paper assets instead. This can "work" for a time, but it's like putting a band aid on a geyser.

In addition, we cannot know the behind the scenes wrangling taking place, where thousands of new bureaucratic pen strokes will make and break businesses. For example, NextEra Energy Power Marketing, LLC, an affiliate of the Florida Power and Light utility, sent its own comment letter to the CFTC, in which it raised concerns about specific unintended consequences of Frank-Dodd (emphasis ours):

We are specifically concerned that an overly broad drafting of the rule regarding the aggregation of position limits pursuant to the requirements to establish rules under Section 737 could have unintended consequences resulting in violations of certain federal and state laws applicable to energy companies. For example, certain regulatory requirements imposed by the Federal Energy Regulatory Commission (FERC) that apply to traditionally regulated public utilities and its affiliated energy marketers would render the aggregation of positions these types of affiliates in violation of certain FERC regulations.

Specifically, interactions between a traditional, franchised public utility possessing captive customers and its "market-regulated power sales affiliates" (i.e., affiliated energy marketers) that are authorized to transact wholesale sales of electric energy at market-based rates pursuant to Section 205 of the Federal Power Ct (FPA) are subject to the Affiliate Restrictions Regulations imposed by FERC.1 In relevant part, the Affiliate Restrictions Regulations require the functional separation and independent operation of such entities, and are intended to prevent potential affiliate abuse, including cross-subsidization issues, that could benefit shareholders to the detriment of captive ratepayers.2 The violation of such regulations can result in an affiliated energy marketer's loss of its market-based rate authority.

...

The failure to comply with FERC's Affiliate Restrictions Regulations, even an inadvertent failure, could expose NextEra and FPL to civil penalties of up to $1 million per violation per day and could result in the suspension or revocation of their respective authorizations to engage in wholesale sales of electric energy at market-based rates under FPA Section 205.4.

While we're no fan of state granted monopolies, such as public utilities, this is simply to illustrate that the full scope of the new sweeping reforms cannot be known, nor the total cost. What is known is that the new regulatory burdens will be substantial, and national productivity will suffer immensely as millions of man hours and dollars are spent on pointless restructuring, lobbying and compliance. Meanwhile, Chairman Bernanke and Chairman Gensler think they've figured out how to beat Mr. Market. Talk about the ultimate Fatal Conceit.