“It Takes a Pillage—Financial Fiascos, Frauds and Fixes”

Speech by Commissioner Bart Chilton to the Hot Springs Village Democratic Club, Hot Springs Village, AR

March 23, 2012

Introduction

Thank you. It’s good to be with you today. I really appreciate the invitation from your President, Joe Stuart. I also appreciate your activism and work for your community, state and country.

We are well aware that this is an election year, but this isn’t going to be a partisan speech, although facts are facts and you will have to judge for yourselves who or whom is responsible for some of the things we will be discussing. You see, I’ve worked in government for 26 years, on Capitol Hill and for three Administrations. But the nice thing has been, I worked mostly on agricultural issues and the Ag Committees on both sides of the Capitol are about the least partisan of the bunch. Sure, there’s bickering but it’s mostly confined to the Members of Congress who represent rice and cotton farmers as opposed to those who come from corn and wheat areas.

Likewise, my job now isn’t particularly partisan. We currently have three Democrat and two Republican Commissioners at CFTC. I like all of them. Sure we disagree on some things, but we all love our country and are doing what we think is best.

Ginormously Humongous Markets

So today, I want to spend a few minutes talking about something that affects us all. They are non-partisan. They take no prisoners. They are our amazing global financial markets.

Just think about the incredibly elaborate, intricate and inter-related markets of gargantuan size and breadth—churning, burning, millisecond-splitting, markets operating nearly every day all day.

It really is amazing that it all works so well.  But then again, we know there have been, and continue to be, issues where markets do strange things, where the financial players don't do what they are supposed to do, and where technology doesn't work like we thought it would, could, or should.

We have banks and other institutions (like AIG, the American International Group insurance company) which were so large that just a few years ago when they were about to topple, we—all of us—had to provide hundreds-of-billions of dollars in a hideous, budget-busting bailout. It was a gigantic financial fiasco for our nation, and much of the world. Folks looked at the impact on their savings, their retirements, their home values and many felt as if there had been a pillage.

The Financial Crisis Inquiry Commission (FCIC) was established to look at what happened. It concluded the Troubled Asset Relief Program or TARP was needed due to two culprits to the pillage.

• ▪One culprit: regulators and regulation.  You see, in 1999, Congress and the president deregulated banks—and by the way, it was a bipartisan effort.  Banks were no longer bound by that pesky Depression-era Glass-Steagall Act that cramped their style and limited what they could do with the money in their institutions.  With the repeal of Glass-Steagall, regulators got the message to let the free markets roll.  They put a “do not disturb” sign on their door and said, “Move along folks. ‘Nothin to see here.” The markets rocked and rolled. And, roll they did—right over the American people.
• ▪The second culprit:  The captains of Wall Street.  FCIC concluded that since they were allowed to do so much more without those annoying rules and regulations, they devised all sorts of creative, exotic and complex financial products.  Some of these things were so multifaceted hardly anyone knew what was going on or how to place a value upon them.

Take for example, Credit Default Swaps (CDSs). These we're bets upon bets that certain things would actually fail.  And these CDSs were sold and resold around the Street to the point that few understood what they had and how much they were worth.  The value of CDSs was in the eye of the beholder.  Folks were over-leveraged if their books called for it to be so.

CDSs were a significant component of creating this ginormously humongous dark market with no oversight by regulators.  When I say ginormously humongous, that's a technical term. You see, we at the CFTC currently oversee roughly $5 trillion in annualized trading on regulated exchanges, but the global over-the-counter (OTC) market is roughly—here it comes—$708 trillion.  If you Google ginormously humongous, it should say, "See OTC markets."

So, the bottom line on who or what was responsible for the pillage: (1) weak or non-existent oversight and regulation; and (2) Wall Street creativity and a penchant for the exotic that created financial products so complex they would give Einstein a migraine. It was a financial pillage of epic proportions.

Along Comes Dodd-Frank

When Congress saw the pillage and the enormous economic mess, a mess of which we are still crawling out, it sought a fix. So in 2010, it passed and President Obama signed into law the Wall Street Reform and Consumer Protection Act—otherwise known as Dodd-Frank.

The most important thing the act brings to markets is transparency. That $700 trillion plus over-the-counter market has operated in the dark, under the regulatory radar.

The Act is over 2,000 pages long, and has over 300 provisions requiring rulemakings, 80% of which are to be promulgated by the SEC, the CFTC, the Fed, and the CFPB (Consumer Financial Protection Bureau).

Position Limits

I want to talk about just one of those rules today and that’s honestly because I think it’s one of the most critical rules we’ve written. Here’s why: how many of you have noticed that gas prices are a little high? Well, there are a few reasons for that but one of them is troublesome: rampant Wall Street speculation in oil with no limits on positions. By that I mean there is no limit to the amount that any one trader may control in a market. Crazy, right? That’s why I’ve been calling for speculative position limits since 2008.

Not only do I think position limits are important, Congress did too. Congress instructed us to implement these limits before almost all of the other rules. Of the over 50 rules that our Agency was to complete, only a few—less than six—were to be done sooner than a year. Position limits was one of those. That is how pressing Congress thought it was that we put limits in place.

In the wake of 2008 when crude neared $150 a barrel and gas prices reached their highest ever at $4.10 a gallon on average nationwide, Congress got very serious about the need to impose position limits. By the way, there is nothing in the fundamentals of supply and demand that would link that roller coaster ride on prices. Congress was clear, the CFTC was to implement limits a year ago January.  But guess what?  Not only have we not done it, but there is already one lawsuit against the government to stop us from doing so.

The problem is this:  we need these limits now.  We have needed them for years.  You’ve already said you’re feeling a lot of pump price pain.  Some folks are making decisions between food and fuel. If prices were fairly discovered, then it might just be tough luck, but prices are being impacted by excessive speculation and that isn’t right. It isn’t good for markets, for consumers or for the economic engine of our democracy. For every $10 increase in the cost of a barrel of crude oil, it slows our gross domestic product by a half-a-percent. When an economy grows at perhaps two percent, a half-of-a-percent means a lot. And given where we have been in crawling out of the economic hole created in 2008, we need all the help we can get with the economy. I didn’t blame President Bush for gas prices in 2008 and I‘m certainly not blaming President Obama. Oil and gas prices are determined by a myriad of variables. That said, our Agency has influence over speculation and one of the things we can and should do—because, I don’t know, it is the law—is to ensure that these position limits go into place.

Now, there may be some of you who have an opposing view about speculation. Don’t get too worked up, let me say two things: (1) The CFTC is not a price-setting agency.  That isn’t our job.  However, we do have a mission to ensure that the price discovery process is fair. Position limits can assist in ensuring prices are fair; and (2) I know we need speculators.  There are no markets without them.  Speculators are good.  But like a lot of good things, too much can be problematic.  Therefore, it is the excessive speculation that can cause problems, contort markets, and result in consumers and businesses paying unfair prices and negatively impacting our economy.

Some people say:  “Well these markets have worked pretty well over the years.  How can you really tag speculation with being a problem in 2008 and is it more than just a guess that excessive speculation is a problem today?”

Between 2005 and 2008 we saw over $200 billion come into futures markets from non-traditional investors.  I call them “Massive Passives.”  They are the likes of pension funds, index funds, hedge funds and mutual funds. These funds are very large—massive—and have a fairly price-insensitive, passive trading strategy.  When I say this, I’m talking generally.  I realize that all these traders aren’t passive all the time, but we do see a pattern.  In fact, new CFTC data says that massive passive long speculators have shorts outnumbered 12 to one. Like a rising tide lifts all boats, when we see this unprecedented increase in speculation, it has an impact.

I’m not suggesting that the Massive Passives, or speculators in general, are actually driving prices.  Let me be clear.  I’m not proposing they were all in cahoots and decided to raise oil prices.  What I am saying is that they contribute to price swings, and have a proportional impact in markets based upon their size as a whole, and certainly individual traders can push prices around if they have a large enough concentration.  When prices are on the rise, like now, and the Massive Passives and others get into markets, they can push prices to levels that may be uneconomic—certainly not tied directly to supply and demand—and the prices may stay higher longer than they normally would.

By the way, although it isn’t as interesting to the media and others, the same takes place when speculators exit markets.  That’s why prices shot down so far in 2008 by the end of the year.  Every trader was bailing from the markets because of the bottom falling out of the economy and prices for a lot of things tumbled.

Now, if people believe there was a lot of speculation with that $200 billion infusion back in 2008, guess what?   It is even higher this year.  In energy markets, it’s 43 percent higher than in June of 2008.  Is that excessive speculation and is it impacting prices?  I think so and so do many members of the U.S. House and Senate.  Just a couple weeks ago, we received a letter from 23 Senators and 45 Members of the House.  They were clear:  get on with position limits already.  We gave you that tool.  Use it now.  Also, President Obama has recently been saying, “When uncertainty increases, speculative trading on Wall Street can drive up prices even more.”

But you don’t have to take it from me, from Senators or U.S. Representatives, or from the President of the United States.  In fact, you don’t have to take it at all. Nonetheless, let me lay one more piece of research on you with regard to speculation.  This one doesn’t come from some lefty activist group.  It comes from one of the big Wall Street banks.  Its researchers said that each million barrels of net speculative length adds as much as 10 cents to the price of a barrel of crude oil.  The speculative length is a known quantity.  With a little math, you can determine that the “speculative premium” on oil these days is around $23 a barrel—and that translates into about an extra 56 cents for a gallon of gas.

What that means is this:  if you drive a Honda Civic, the speculative premium costs $7.39 every time you filler-up.  If you drive a Ford Explorer or F-150, the total is $10.41 and $14.56, respectively.  I don’t know how often you fill up, but over the course of a year we’re talking real money—hundreds of dollars.  Imagine a trucker who pays a speculative premium of $112 more to fill up a Freightliner with two standard 100 gallon diesel tanks. And if you extrapolate those numbers to the trucking industry as a whole, the annual cost is $29.1 billion.  For the airline industry:  $9.8 billion.

Our position limits rule is one of the only tools regulators have in our regulatory shed to combat unfair prices.  We need to use it and we need to do so immediately.

Will position limits take us back to the days of $1.00-per-gallon gasoline? Oh, heck no.  Limits will, however, if we can survive the court challenges and implementing delays—help reduce the pump price pain.

A Colossal Fraud

So, that’s just one of 300 rules called for under Dodd-Frank. But, that’s OK. Dodd-Frank is a good law that will put some teeth back in regulation and harness some of Wall Street’s greediest gamblers. The problem is it took that financial fiasco to get Congress to do what was needed. I suppose sometimes, it takes a pillage.

This entire economic mess unearthed yet another major problem. The ugly head of it I can describe it in two words: Bernie Madoff. Ole Bernie traded in his Manhattan penthouse for a cell in the big house, but not before he ripped off billions-of-dollars from innocent folks in the biggest Ponzi scam in history—a colossal fraud.

You see, when the markets and the economy are tanking, some people pull money from investments just to live upon. Others just don’t want to lose more money, so they pull it out and put it someplace else—like under their mattress maybe. In the Madoff case, though, and dozens of others like it, the money wasn’t there. So you see, sometimes it also takes a pillage to realize you’ve been ripped off.

Ponzimonium—How Scam Artists are Ripping Off America

Even though Bernie’s was the biggest, there are mini-Madoff Ponzi scams going on all the time. Did you know that in fiscal year 2011, our agency investigated more Ponzi scams than at any time in history? So did other regulators. The FBI had more than 1,000 such cases. So, it’s still Ponzimonium out there.

In that vein, I’ve tried to bring attention to these scams. I released a book about some of them in November: Ponzimonium—How Scam Artists are Ripping Off America. This is a government publication and neither I, nor my Agency, make anything from it. The book, tells the tales of 10 such Ponzi scams that took place in 2009, in the wake of Madoff.  These are real cases, real fraudsters, with unfortunately, very real victims. I also capture, in words and pictures, a behind-the-scenes look at the lifestyles of the schemers. It is amazing what these jerks did with other peoples’ money.

One con artist purchased a fleet of luxury vehicles in colors like lime green and “blue & cream,” including multiple Ferraris, Lamborghinis, Porsches, a Bentley, a Maserati, a Lincoln Limousine, and a metallic burnt orange Hummer golf cart.  That guy took hard-working peoples’ money and used it for a mansion, nearly 20 plasma televisions, sports and rock and roll memorabilia, and a contingent of body guards. These crooks have no shame. Another fraudster bought a 269-acre ranch, a fleet of classic sports cars, two airplanes and massive diamonds for ladies he was wooing in New York, Toronto and St. Louis.

What We Know

Here is what we know; many of the fraudsters are preying upon people through the use of “affinity fraud,” where they use personal contacts to swindle family, friends, coworkers or even fellow church parishioners.  For example, and this is a recent case, not in the book, From May 1, 2010 to May 3, 2011, when the CFTC filed its complaint, Jeffery L. Groendyke, allegedly fraudulently solicited and accepted at least $953,000 from at least 54 individuals. He allegedly misappropriated at least $600,000 of that by transferring the funds to earlier victims, falsely characterizing such payments as “returns.” Our CFTC complaint alleges that he solicited and accepted funds primarily from individuals he knows through his church—his church! We are still in litigation on this case in Michigan, so I can’t say much more, but man-oh-man-oh-man, his church. So, that’s affinity fraud.

I write about another affinity fraud Ponzi in the book. This one fellow, Marvin Cooper, is deaf. So, you guessed it, his victims were deaf people.

Here is another one that’s more recent and not in the book. In late October, we obtained a federal court order against Queen Shoals and the owners, the Hansons. The Hansons, Sidney and Charlotte, are husband and wife.  The amount allegedly solicited was $24 million, and the amount allegedly misappropriated was $22 million. This is a particular concern because of the fact that they targeted older citizens, and convinced them to invest retirement funds held in self-directed IRAs. We say the Hansons defrauded customers and misappropriated millions of dollars in this foreign currency (forex) Ponzi scheme.  Of the funds solicited, only a small amount were used to trade forex, and nearly all of the money deposited into the Hanson’s various bank accounts, and later used to pay “quarterly interest payments” to existing customers, came from deposits of IRA rollovers from new customers.  We also contend that the Hansons used the stolen funds for luxury resort vacations, private plane rentals, daily living expenses, and to purchase multiple parcels of real property.  What a disgrace.

The consequences for the investors-turned-victims can be pretty horrific—people losing money for their kids’ college funds, for needed health care expenses, or for their own retirement.  Some lose their entire life savings, and others invest for family members, acting as a custodian, thinking they are doing them a favor.  It is a tremendous shame because in almost every instance, it was preventable with a little education and some due diligence fact checking.

Education and Red Flags of Fraud

That’s why in Ponzimonium, I’ve included a chapter containing the “Red Flags of Fraud” to help people avoid being scammed.  The Red Flags are tips like checking to make sure a company is legitimately registered and other due diligence “to do” items before an investment is made.

Here are a just few of those Red Flags:

1. If it sounds too good to be true, it is.

2. The investment promises little or no risk of loss or promises you won't lose money.

3. Profits or rates of return on an investment are guaranteed regardless of the direction of markets.

4. The investment is difficult to understand or incomprehensible, and

5. There is a need for secrecy.  Not being able to get written information about a potential investment should raise suspicions.

The bottom line is this: be super suspicious and exceptionally careful. It is your hard-earned money. Oh, and by the way, you can get Ponzimonium at Amazon.Com, Barnes&Noble.Com or GPO.Gov

Lucky Fellow

Ponzi scams aren’t the only way to get ripped off as you know. In fact, according to emails I received recently, you’d think I’m one very lucky fellow.  You see, I’m told a large inheritance from a distant relative, I didn't even know I had, is coming my way.  Also, my email address won a lottery worth several million (although I've not entered any contest).  All I’ve got to do is give them my bank account number, and presto, the money will be wired to me. And, it’s a good thing I’ll be getting all that cash because a woman wrote about her botched surgery in Peru. She is in tremendous pain, poor thing, and needs money to have another surgery and get healthy.  She says she will be forever indebted to me once I help out. So that sounds fair.

Then there’s a scam a police friend tells me happens right here. Yeah, right here in Hot Springs Village. This one preys on seniors. You pick up the phone one day and the voice on the other end tells you he’s a friend of your grandson who’s either in jail, been in an accident, or some other bad circumstance. He needs money and the caller is eager to give you instructions on where to wire it. After all, it’s your grandson. Unfortunately, people fall for these. And, they’re not stupid people. Heck, 21 banks, many universities and foundations and Kevin Bacon and Steven Spielberg were among those ripped off by Madoff.

The very day we released the book, I got an email from somebody I actually know. He said he was in Spain, had been robbed, lost all his money, credit cards and his passport. He needed money to get a new passport and get home. Since I knew the guy’s name, I really thought it was him. I wrote back and asked, “Is this really you?” He assured me it was. Here was the author of a book about scams about to get ripped off! Then, I smelled a rat, so I called his office. He wasn’t there but he certainly wasn’t out of the country. Sheesh. This was one sophisticated scam artist.

Conclusion—Her Beloved

Well, as you can see, I could talk all day about this stuff: about the economic pillage and how I think we need to be fighting for financial reforms to safeguard not only markets and traders, but more importantly consumers, and the economic engine of our democracy. And, as you can see, I get pretty wound up about it, so I’ll stop before I go too far around the bend.  I've got to run here anyway.  Another email just arrived.  It appears a rich princess is in distress and needs my assistance. She seems nice and calls me “Dear Beloved.”

It’s been a pleasure to be with you. Thanks very much.

Last Updated: March 23, 2012