Back to the Beginning

Here we are a little more than a year after the Federal Reserve started interfering in capital markets again. It was quite a run if you owned stocks or invested in fungible commodities. Now that QE2 is over, the U.S. credit rating has been downgraded for the first time in history, and markets around the world are tanking, it's time for a recap.

It was also about a year ago that I started this blog. I have held off on writing very much recently, letting events speak for themselves. Was there really any point in harping on the food price inflation connection to Syria's ongoing repression? Tunisia and Egypt gave us the verdict, we are now in the sentencing phase, with events on the ground providing daily impetus for banishing central bank inflationary policies to the dustbin of history.

In my initial posting, I hi-lighted a terrific article in Bloomberg Businessweek that raised the alarm bell about a new commodities trading tool called ETFs: Idahowheat Blog: A Proper Beginning.

Today, legendary investor Jack Bogle appeared on CNBC and gave his verdict on ETFs (beginning at 2:35) .

To be fair to the Fed, inflationary monetary policies may well have worked in a different era. But one has to wonder if they just did not account for the effects of de-regulation. There is simply no incentive for capital institutions to engage in what your father called investment, when there are so many opportunities to engage in mere speculation instead.

The full Bloomberg article deserves another look. Here are some of the more illuminating passages:

"Just as they did with subprime mortgage-backed securities, Wall Street banks are transferring wealth from their clients to their trading desks. 'You walk into a casino, you expect to lose money,' says Greg Forero, former director of commodities trading at UBS (UBS). 'It's the same with these products. You're playing a game with a very high rake, a very high house advantage, and you're not the house."

How did such an incredibly risky and misunderstood financial instrument come about?

"... In 2004, however, Deutsche Bank's Rich devised a commodity ETF that opened the door to retail investors when it launched two years later. There was an obstacle: The U.S. Commodity Futures Trading Commission, a regulatory board created in 1974 after a runup in grain prices, required buyers of certain commodity investments to sign a statement saying they understood the risks. The banks argued that it would be impossible to collect so many thousands of signatures for a product designed to trade like a stock. In 2005, Deutsche Bank lawyer Greg Collett, who had worked at the CFTC from 1998 to 1999, helped persuade the commission to waive the rule and let funds replace it with their prospectus. That would provide adequate warning, the CFTC concluded. Collett says he believed the fund "democratized" commodity investing."

Just as the U.S. federal government eliminated sensible laws and regulations like Glass-Steagall (1999), which were designed to prevent market manipulation, the trend continued all through the last decade. Republican lawmakers did not de-regulate because they are principled capitalists - they reacted to specific lobbying efforts designed to make certain wealthy individuals much wealthier (Glass-Steagall was repealed specifically so that former Clinton administration Treasury secretary Robert Rubin's bank, Citigroup, could operate in the new mortgage backed securities market - woops!).

At this point you may be asking where are the regulators. The Dodd-Frank legislation signed into law by the president last year was specifically designed to address complex financial instruments like ETFs:

"The financial reform bill President Barack Obama signed on July 21 includes a few provisions that may help the CFTC [Commodity Futures Trading Commission] address the commodity ETF mess. The new regulations enhance the CFTC's ability to prosecute trading abuses, and set position limits on over-the-counter swaps, like those UNG has been buying. How much the new law will help remains to be seen, says Jill E. Sommers, one of the agency's five commissioners, because Congress still needs to appropriate funds and write guidelines for implementation and enforcement. 'We'll need additional dollars to carry this out,' she says, adding that it's too early to say whether the CFTC has the authority needed to crack down on pre-rolling. 'We're at the beginning of the rule-writing process, so it's premature to say whether additional authority is going to be needed,' she says."

A few days ago the CFTC finally passed a rule designed to shed light on who was making big bets on commodities, i.e., speculating (you know, that thing speculators insist they don't do). Commissioner Gary Gensler announced there is more to come next month.

If you're under the impression that Republicans or Tea Partiers are standing on principle in order to "put the country back on track" and "stand up for ordinary Americans," think again. Tea Party champion Michelle Bachmann wants to eliminate Dodd-Frank altogether. Republicans will do everything they can to prevent Gensler from either passing new rules or enforcing them.

If you're finding it hard to reconcile rhetoric about protecting the little guy and specific actions designed to let the casino roll on, you're not alone.  The truth is, both parties are on the left, beholden to the wealthy and leaving the "little guy" standing in the middle of a wheat field in Genesee, Idaho, on a day when 1/4 of his wheat kernals are still soft and the wheat market is tanking along with equities, wondering who is really going to stand up for him.