The Sunday Washington Post carried a front page story on the “slight oversight” of energy trading. Here’s the lede:
One year ago, a 32-year-old trader at a giant hedge fund named Amaranth held huge sway over the price the country paid for natural gas. Trading on unregulated commodity exchanges, he made risky bets that led to the fund’s collapse — and, according to a congressional investigation, higher gas bills for homeowners.
But as another winter approaches, lawmakers and federal regulators have yet to set up a system to prevent another big fund from cornering a vital commodity market. Called by some insiders the Wild West of Wall Street, commodity trading is a world where many goods that are key to national security or public consumption, such as oil, pork bellies or uranium, are traded with almost no oversight.
Had I world enough, and time, the article would get the fisking it deserves. It begins with the somewhat imprecise “one year ago … Amaranth held huge sway over the price the country paid for natural gas.” Actually, one year ago Amaranth had already suspended operations and hired Fortress Investment Group to help liquidate Amaranth’s remaining assets. That “huge sway” was somewhat earlier in the year, during which time Amaranth made money for a while and then lost much more.
Sentence two blames the losses on trading on “unregulated commodity exchanges” — presumably they mean the IntercontinentalExchange, but I think Amaranth was pretty equal-opportunity here, losing money both at ICE and the regulated NYMEX. Reporter David Cho correctly indicates that a congressional report claimed that Amaranth’s trading led to higher consumer gas bills, but the congressional claim is suspect. My conclusion upon reading the report: “Despite the report’s bulk, the evidence for various assertions seems thin.”
Given the scale of Amaranth’s participation in the gas futures market, I’m sure that some prices were higher and other prices lower than they otherwise would have been. Amaranth was doing a lot of calender spread betting, going long in one month and short in the next. As it accumulated positions, all else being equal, the price of the contracts in the long position would tend to go up, and the price of the short position would tend down. Depending on which gas consumers consumed in which month, and when they entered the market to lock in a price, the price paid may have been higher or lower than it otherwise would have been. Given the trading practices, it was unlikely to have been a one-sided effect.
(Some economic theory suggests that increased volatility of prices will itself lead futures prices to increase, because the value of holding a hedge increases as volatility increases. Generally, hedging trades like Amaranth conducted should tend to reduce volatility, but given the large scale that Amaranth operated on perhaps not. The congressional report referred to above ran for 135 pages and included another 345 pages in appendices. I don’t recall a single chart documenting the claimed effects of Amaranth on volatility, or for that matter an estimate of the effects on commodity gas prices.)
While the article says “lawmakers and federal regulators have yet to set up a system to prevent another big fund from cornering a vital commodity market,” such a system is already in place in the form of position limits on the regulated commodity exchanges.
As Cho tells the story, “part of the problem” is that the government regulator can’t keep up with the fast-growing, ever evolving trading business — “CFTC’s staffing has dropped to its lowest level in the agency’s 33-year history. Its computer systems that monitor trades are outdated. Its leadership has seen frequent turnover.” Once you define the problem as inadequate government oversight, only one reasonable solution seems possible.
My views remain the same now, just before the House Agriculture Committee meetings, as they were in June and July, when the Senate Permanent Subcommittee on Investigations released its report and held a pair of meetings on the subject. In July I wrote:
The more basic question is whether the current state of regulation is really resulting in public policy problems for which the best solution is the extension of government oversight. I don’t think the Amaranth Advisors blow up constitutes much evidence of a need for more regulation. Advocates of more regulation seem concerned that when Amaranth was told to reduce holdings on NYMEX, it moved it positions to ICE rather than simply unwinding them, but I must have missed the explanation of the harm to the public created by that switch.
Increased disclosure might improve the energy markets in some ways, said Michael Cosgrove, president of the Houston-based energy brokerage Amerex, a wholly owned division of derivatives broker GFI Group (GFIG). However, the markets tend to regulate themselves when it comes to issues of prudence, such as the size of a position an entity should take in a market, Cosgrove said.
“Regulators aren’t there to keep people from blowing themselves up,” Cosgrove said. “They’re there to ensure that the marketplaces are fair. Amaranth’s position was not too big for the market, it was too big for Amaranth.”
Just so. A problem for Amaranth’s investors certainly, but not a matter for expansion of government authority.
[Inset quote from a Dow Jones news story.]