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Senate report criticizes Goldman and JPMorgan over their roles in commodities market
By Nathaniel Popper and Peter Eavis
The New York Times
Wednesday, November 19, 2014
http://dealbook.nytimes.com//2014/11/19/senate-report-criticizes-goldman...
A two-year Senate-led investigation is throwing back the curtain on the outsize and sometimes hidden sway that Wall Street banks have gained over the markets for essential commodities like oil, aluminum, and coal.
The Senate's Permanent Subcommittee on Investigations found that Goldman Sachs and JPMorgan Chase assumed a role of such significance in the commodities markets that it became possible for the banks to influence the prices that consumers pay while also securing inside information about the markets that could be used by the banks' own traders.
Bankers from both firms, along with other industry executives and regulators, will testify about the allegations at hearings on Thursday and Friday.
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The hearings will cover topics like the conditions at a Goldman-owned coal mine in Colombia and the airline fuel arrangements that Morgan Stanley struck with United Airlines.
The report provides an unprecedented level of detail about the enormous global operations the banks have built up in recent years since politicians and regulators lifted long-time curbs on banks owning physical commodities and infrastructure.
The investigators found that regulators have struggled to respond to expanding ambitions of the banks to get involved in every aspect of the production and sale of commodities.
Some banks, including JPMorgan, have recently been pulling back from the commodities markets, partly in response to the public scrutiny of the activities and partially because of the shrinking profits in commodities businesses. But Goldman Sachs and some others have stated a desire to maintain their roles.
The chairman of the Senate subcommittee, Carl Levin, Democrat of Michigan, said that the current rules were not adequate to stop the problems.
"We've got to get banks out of this kind of business because of the risk to the economy and the possibility of manipulation," Mr. Levin said in an interview on Wednesday.
The 400-page report, which was made public on Wednesday evening, included case studies on nine commodities in which banks have taken big positions, including the 100 oil tankers and 55 million barrels of oil storage that were owned by Morgan Stanley, and the 31 power plants owned by JPMorgan at one point.
The subcommittee discussed several reasons that these commodity operations could create problems. The potential for price manipulation and the unfair advantage that banks can gain in these markets were among the top concerns expressed by Senator Levin and Senator John McCain, the top Republican on the subcommittee.
But both senators also echoed previous warnings that the the enormous holdings of oil, uranium, and other hazardous materials could expose the banks to significant legal liability that could, in turn, lead to runs on the banks.
A 2012 study by the Federal Reserve, cited in the report, found that banks have not put aside enough money and insurance to adequately prepare for the "extreme loss scenarios" involving commodities.
"Imagine if BP had been a bank," Senator McCain said on Wednesday, referencing the Deepwater Horizon oil spill that BP for which BP has had to pay billions of dollars in damages. "It could have led to its failure and another round of bailouts."
Senator Levin, though, put the most emphasis on Goldman Sachs' role in the aluminum market, which was the focus of an article in The New York Times.
In 2010, Goldman Sachs purchased Metro International Trade Services, a Detroit company that is responsible for storing most of the exchange-traded aluminum in the United States.
That purchase was made at the same time that Goldman was beginning to significantly ramp up its trading in aluminum. From 2010 to 2013, the firm's holding of the metal increased significantly each year, to a peak of $3 billion worth of aluminum at one point in 2012.
The Senate subcommittee alleges that Goldman used unorthodox measures at its warehouses in Detroit that made it harder to get aluminum out of the warehouses and raised the prices paid by aluminum users such as auto makers and brewers.
Goldman has previously said that the delays in getting metal out of the warehouses were a result of the decisions of customers, who actually owned the metal.
But the investigators found that Goldman created new and unusual incentives that encouraged a few significant financial players to move their holdings between Goldman-owned warehouses, making it harder for other customers to get their metal out. The New York Times had referred to this as the "merry-go-round of metal," a description the Senate subcommittee also used.
Goldman has categorically denied that its policies in Detroit had any role in pushing up prices for consumers. The bank noted on Tuesday that 75 percent of the aluminum held in storage is not subject to any queue, and that the price of the metal has been falling steadily since 2008.
Within Metro, though, employees complained about the new practices instituted by Goldman, which were approved by the Goldman employees on Metro's board, and resulted in long lines of customers waiting to remove aluminum.
"I remain concerned, as I have expressed from [the] start, regarding 'Q management,'" Mark Askew, an employee at Metro before it was purchased by Goldman, wrote to Metro's chief executive in 2010. Mr. Askew later resigned from the company.
The London Metals Exchange opened a formal investigation into the practices at Metro in 2013, after the Times article, according to the Senate report. Goldman has been trying to sell Metro International, even though it has stayed in other commodities markets.
The exchange told the subcommittee that the practices described in The Times article were "inconsistent with the 'spirit' of the relevant requirements" even if they did not "violate the 'letter' of those requirements." The exchange did not reveal the status of its investigation to the subcommittee.
The report also raised concerns about the flow of information between Metro and Goldman’s trading desks, which are supposed to be strictly separated. The Senate investigators found that important information about Metro's inventories, which could inform trading strategies, were distributed at various times to dozens of employees at Goldman, including the head of Goldman's commodities trading business.
A Goldman report on the Senate investigation says that it has not found that any improper information was passed along.
"Regular audits, including by Goldman Sachs' Compliance Department and third-party auditors, have identified no instances in which Metro's confidential information has been disseminated improperly to Goldman Sachs' sales or trading personnel," the report said.
Until about 20 years ago, regulated banks faced tight constraints that barred them from owning physical commodities and limited them to trading in financial contracts that were linked to the prices of commodities. But a substantial relaxation of the rules allowed the banks to own actual commodities themselves -- known as "physical assets" on Wall Street.
The banks' hunger for commodities profits even led them to acquire the plants that produce and transport commodities, like coal mines and power stations. The banks still face some restrictions, though, and the report argues that Wall Street firms have moved to exploit those gray areas.
Federal Reserve rules mandate that bank holding companies cannot hold physical commodity assets that exceed 5 percent of their capital.
But the report says that JPMorgan Chase held physical commodities assets in 2012 that were equivalent to 12 percent of a measure of the bank's capital. The bank justified this by assigning those commodities to its bank, rather than the larger bank holding company.
JPMorgan said on Wednesday that it had never gone beyond the Fed's 5 percent limit.
One notable flashpoint occurred in 2011 when JPMorgan carried out a huge trade in aluminum that caused it to surpass a regulatory limit established by the Office of the Comptroller of the Currency.
The bank responded by shifting some of the position to an affiliate. The report asserts that the incident caused the Federal Reserve to realize for the first time that JPMorgan was not counting assets at its bank as part of the assets with the bank holding company, the entity the Fed regulates.
The Fed has been reconsidering its rules on how commodities are reported, but it so far has not objected to JPMorgan's approach.
The Senate committee recommended some changes in its report. In particular, it said that regulators should reconsider the banking rules that relate to holding physical commodities.
The committee called on the regulators to clarify the limits on the amount of physical commodities that banks can hold. It also said action was needed to close loopholes and prevent firms from using information gained from physical commodities activities to benefit their trading in financial products.
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