By Anna Louie Sussman
WASHINGTON Jan 15 U.S. lawmakers at a Senate
hearing on Wednesday pushed financial regulators to speed up
efforts to limit Wall Street's role in physical commodities
markets, pressing for a pivotal policy shift after a decade of
A day ahead of the hearing, the Federal Reserve laid out for
the first time its growing concerns that risks to the financial
system from banks leasing oil tankers or owning power plants are
"difficult to limit and higher than expected."
It also raised concerns about serious conflicts of interest
The packed hearing, which lasted over an hour, offered
senators a chance to delve further into the Fed's thinking,
pressing Michael Gibson, its director of bank supervision and
regulation, on why the central bank is not moving immediately to
impose new rules.
"The Fed's proposal yesterday is a timid step, it was too
slow in coming, and there is still too much that we do not know
about these activities and investments," said Senator Sherrod
Brown, who led the hearing.
Gibson told them that new restrictions are likely.
The panel also questioned whether banks should be forced to
disclose more about the size and scope of their commodities
activities and if banks' involvement in those markets has
inflated the costs of key raw materials, such as aluminum.
Senator Elizabeth Warren described the Fed's review as "a
step forward, but a meager one".
While the lawmakers raised concerns about banks' exposure to
opaque commodity markets, the hearing did not reveal significant
new details on Fed policy or any new pledges of action from
In a preliminary notice on Tuesday seeking public comment on
possible new limits, the Fed cited real-world risks, including
the BP Gulf oil spill and last year's Quebec oil train disaster,
as examples of the multibillion-dollar catastrophes banks face
by being involved in the risky, messy world of commodities.
The notice also suggested possible remedies, including
limits on assets as well as restrictions on trade of some types
of commodities, and posed questions to draw public input.
The session follows months of growing public and political
pressure to check banks' decade-long expansion into the
commodities supply chain.
In the first such hearing last summer, metals users
complained Goldman Sachs and others that own metal
warehouses had contributed to higher prices.
Some saw the Fed's so-called "advance notice of proposed
rule making" - an optional initial step in the potentially
years-long process of writing new rules - as a strategic
political ploy to deflect complaints over inaction.
It will accept public feedback for 60 days.
Others saw signs of a potentially major crackdown ahead, as
the Fed questioned the initial rationale for letting banks trade
and invest in raw materials, and said even arm's length
"merchant" investment deals may not be safe enough.
"The tenor of the analysis and the questions means the Fed
has already made up its mind to limit severely bank
participation in physical commodity markets," said Craig
Pirrong, a finance professor at the University of Houston.
FERC AND CFTC TOO
Two other regulatory enforcers also testified.
The U.S. Federal Energy Regulatory Commission (FERC), which
regulates electricity and natural gas markets, was represented
at Wednesday's hearing by the Norman Bay, the agency's director
of enforcement and a former U.S. attorney for New Mexico.
Bay has led a series of high-profile market manipulation
cases, one of which led to a record $410 million penalty agreed
with JPMorgan Chase & Co last year.
Although no FERC rules "apply uniquely to financial
institutions," Bay said, banks are active in many markets that
the agency oversees, owning less than 4 percent of total U.S.
electricity generation capacity and about 14 percent of natural
gas pipeline miles.
Despite their relatively small overall market share, they
may hold a larger percentage at particular hubs or trading
points, which may allow them to "retain the ability to move
prices in a manipulative manner," he said.
Also appearing was Vince McGonagle, market oversight chief
at the Commodity Futures Trading Commission, the derivatives
market regulatory body.
This summer it opened a preliminary inquiry into complaints
that banks including Goldman Sachs were inflating aluminum costs
through their ownership of metals warehouses.
The banks deny this.
Facing a clearly uneasy Fed, some banks, including JPMorgan,
are already quitting the physical commodity business, a
once-lucrative niche that has reaped billions of dollars of
revenue for Wall Street over the years but is now facing
diminished margins and stiffer capital rules.
Others, namely Goldman Sachs, have stood firm, defending an
activity they say benefits customers. Due to a grandfather
provision in a 1999 banking law, the Fed has less leeway to
restrict the activities of former investment banks Goldman and
Morgan Stanley, Gibson said.
Critics said the Fed did not disclose what it knew of banks'
commodities operations nor reveal its own analysis of the
situation, making it tough for the public to comment on
activities about which little is known.
"The only two parties that can weigh in with any kind of
semblance of specific credibility would be the Fed itself and
the banks," said Saule Omarova, a law professor at the
University of North Carolina who has been a vocal critic of the
banks' involvement in physical commodities trading.
"That's why we have a professional regulatory agency -
because we hope they will be looking into this issue on our
The notice was the Fed's first detailed public comment since
it shocked the banking industry last July by announcing a
"review" of its 2003 authorization that first allowed commercial
banks such as Citigroup to handle physical commodities.
That followed measures to eliminate the divide between
commercial banking and riskier activities, a distinction some
lawmakers would now like to restore.
"The Fed is absolutely right when it says we need to
consider strengthening the limits on bank participation in
physical commodity activities," Senator Carl Levin said,
confirming for the first time his permanent subcommittee on
investigations was also analyzing the issues.
RISKS ARE 'HIGHER THAN EXPECTED'
In Tuesday's notice, the Fed said even banks that do not own
infrastructure like oil storage tanks may face a "sudden and
severe" loss of public confidence if assets or physical
commodities they own are involved in a disaster.
"The recent catastrophes accent that the costs of preventing
accidents are high and the costs and liability related to
physical commodity activities can be difficult to limit and
higher than expected," the Fed said in the notice.