"Please Listen Carefully, Some Menu Options Have Changed"

Speech of Commissioner Bart Chilton, Trade Tech 2012, New York, NY

March 8, 2012

Introduction—It’s Complex

Good morning. I’m raring to go and categorically excited to be with you. Although, I’ll admit sometimes (not today) it does take me a little bit to get my motor running in the morning. Yesterday, at 5 a.m., I was ordering coffee at the McDonald’s drive-thru and said, “A large coffee, to go.” Of course it was to go, numbskull. That’s why they call it a drive-thru!

Sometimes we just aren’t firing on all cylinders. We aren’t focused, and life can certainly get hectic at times. Given the fast pace and complexities of our multifaceted personal and business lives, now and then it seems amazing that we can simply put all the myriad pieces together to arrive where we are needed each morning. In today’s world, to keep up, it is sort of like those recorded message phone trees, we need to listen carefully, because menu options may be changing. So, I’m pleased we are all here at the Javits Center today. Remember Colonel John “Hannibal” Smith, the character from The A-Team who said, “I love it when a plan comes together.” Well, I too love it when a plan comes together.

The Financial World

It is amazing if you think about the elaborate, intricate and inter-related global financial markets of gargantuan size and breadth—churning, burning, millisecond-splitting, markets operating nearly every day all day. It is amazing that it all works so well. But then again, it hasn’t always done so, right?

We have banks and other institutions (think AIG) which were so large that just a few years ago when they were toppling, or about to topple, we—all of us—had to fork over hundreds-of-billions of dollars in a hideous, budget-busting bailout. There isn't much doubt about the causes of the economic crash, and complexity had a whole lot to do with it.

The Financial Crisis Inquiry Commission (FCIC) was established to look at what happened (always a good thing to do after you spend hundreds of billions of dollars. Hey, why did we have to spend that loot?). FCIC concluded the Troubled Asset Relief Program or TARP was needed due to two culprits to the crisis.

• One culprit: regulators. People like me. You see, in 1999, Congress and the President deregulated banks. 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. And, roll they did. They rolled 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 rules and regulations, they devised all sorts of creative, exotic and, yes-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.

Here’s an example. Exhibit A: Credit Default Swaps (CDSs)—bizarre bets upon bets that certain things would actually fail. And these CDSs were sold and resold around the Street to the point that nobody really understood what they had and how much it was worth. It was all way too complicated. The value of CDSs was in the eye of the beholder. Folks were over-leveraged if their books called for it to be so. Make it so Number One.

A case in point would be Lehman Brothers. They were leveraged 30 to 1, according to the last annual financial statement. That data showed the firm held $691 billion in assets divided by only $22 billion in actual shareholder equity.

If all those mind-altering financial products weren’t enough to fuel-inject the festivities, as a special bonus to the traders, it was completely and unreservedly unregulated. “Party on Garth.”

CDSs were part and parcel to creating this humongous dark market with no oversight by regulators. When I say humongous, I mean it. We at the CFTC currently oversee roughly $5 trillion in annualized trading on regulated exchanges, but the over-the-counter (OTC) market is roughly—wait for it—$708 trillion. In fact, there are well over 160 million financial transactions taking place each day. Like I said, it is humongous.

Bottom line: the 2008 economic disaster was created due to (1) crappy 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 Rubik a migraine.

The Fixers: Dodd-Frank

As a result of the monstrous economic mess, a mess of which we are still crawling out, in 2010, Congress passed and President Obama signed into law the Wall Street Reform and Consumer Protection Act—otherwise known as Dodd-Frank. 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). To fix a complex problem, sometimes there isn’t an easy fix, and that has been the case with financial reform. It isn’t that Members of Congress had voices in their heads telling them to legislate. Nope, their action was a detailed response to the economic crisis. For those that say Dodd-Frank should be repealed, I guess I don’t understand why they’d want to go back to the set of circumstances that led to the ultimate demise of our economy. I just don’t get that.

Dodd-Frank generally imposed a 360-day deadline for approval of all the regulations, and while we’ve obviously missed that, we’re working hard to get the regulations in place.  A few times we proposed a rule, yet when we received the comments, realized we had totally missed the target and we had to re-propose. For those that follow every move we make, every breath we take, this is all part of the process: getting the rules right and ensuring they are balanced. But I understand that people have to be diligent to keep up here. I have a lot of sympathy. This is very complex. Like I said, people may want to listen carefully, some menu options may have changed.

So far, the CFTC has issued 28 final rules, and it’s my hope and expectation that we will meet our Congressional mandate within the next few months and finish the 21 additional final rules that we are required to write.

Certain “T’

However, just because I expect us to finish all the rules, that doesn’t tell people when they will be implemented, or when compliance is necessary. Aside from complexity and changing menu options, one of the worst things for our industry, from anyone’s perspective, is uncertainty. Regulators don’t like it. Market participants don’t like it. Members of Congress don’t like it, and the public certainly doesn’t like it.  When we aren’t clear about exactly what we’re doing, when rules are to go into effect, and when people have to comply with those rules, that creates uncertainty with a capital “T.” Let me explain.

One of the refrains we keep hearing is that we need to identify what “T” is.  In other words, we’ve said that we will give folks time to comply with our rules—T+90 days, T+180 days, T+270. The legitimate question is: what the heck is T?

Just like the robotic phone tree, people have pushed an options button, and they keep getting an answer, but it either isn’t the answer they want or it’s not the fulsome answer they need. They may be pushing one for English and then saying “agent” or “operator” but they never get to something or someone who can actually help them out. We all know that feeling, and it can be maddening. So now, it’s time we provide another “menu option,” and answer this timing question. We hear folks, and here’s a way to get there.

• First, we need to get the review of swaps for mandatory clearing rule done.
• Second, we need to finalize the implementation timetable rule. This will give all of us—market participants, regulators, Congress, the public—firm compliance dates and it will all seem a lot less complex.
• We should give folks a visual of what we are doing and update that as menu options change. I have seen some firms that have these. I’ve urged that we simply put all these expected rule dates on a chart so that people can see them in concert with each other. When is the rule expected to be completed? What might be the implementation timetable? It seems like a fairly modest thing to do, yet we haven’t done so yet. I mean, “Got rudimentary technology?” Does anyone have PowerPoint in the house?

Uncertainty is not just an irritation. It’s bad government, and it’s time we make sure everyone gets the certain “T” with a capital “T” they need, and firm answers when they “push the button.”

Position Limits—The Time is Now

One of the rules that has been very difficult to get a visual upon is position limits. Remember when I said that most of the rules were to be completed within 360 days? That would have been last July. Well, there were just a few exceptions to that, and position limits was one. Congress wanted limits done sooner, and told us very specifically so in the law. We were supposed to start implementing them a year ago January. But guess what? On one of these charts that a firm showed me a few weeks ago, position limits were actually the last regulation to be implemented. I think their chart was actually wrong. I hope it was wrong, but I can understand why they might think limits would be delayed.

The Commission passed a final position limits rule in October, but it has yet to be implemented. We are actually waiting, of all things, for a joint rule with the SEC on definitions to be approved before the implementation clock—the T—starts ticking.

The problem is this: we need these limits now. I’ve been calling for them since 2008. We have needed them for years. If you’ve been to the gas station lately or watched the news, you know people are experiencing a lot of pump price pain.

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 they are fair.

If we look back to 2008 when there was relatively stable supply and demand for crude oil, we saw prices ride a rough-and-tumble roller coaster—going from below a hundred dollars-a-barrel early in the year to nearly $150 in June, then moving all the way down to just over $30-a-barrel in December. There was no justification for such a price swing based upon the fundamentals of supply and demand. The only good explanation is what many researchers and prominent economists and others have said about the link to excessive speculation.

And guess what? We are seeing something similar this year. The supply of oil and gasoline is greater today than it was in 2008 and demand for oil in the U.S. is at its lowest level since April of 1997 (so, says the Energy Information Administration).  Yet, we see what is happening to prices. They are once again rising sharply.

The increased cost of fuel can also dampen the economic recovery. Data confirms the economy is on the mend, but there is no question the recovery is still fragile. According to the International Monetary Fund, for every $10 increase in the price of a barrel of crude oil, the entire U.S. GDP is reduced by a half percent.

We all know fuel prices have a direct impact upon individuals, but think about the enormous drain on businesses large and small. The airlines, for example, will spend billions more this year than they had anticipated due to higher fuel costs. A few days ago, I spoke with Delta Air Lines executives Ben Hirst (the General Counsel) and Jon Ruggles (the Vice President for fuel). They tell me that each incremental dollar per barrel of crude impacts their fuel prices by $96 million per year. They are now expecting to spend at least $1 billion more in 2012 than initially budgeted. Do they believe speculators are having an impact on rising prices? You bet they do, and they are not alone. In fact, the association that represents all of the major air carriers has been urging us to impose positions limits for years. They urged even more restrictive limit levels that the Commission approved.

And by the way, federal, state and local governments are also impacted very directly by fuel costs, so this is a drain on taxpayers not just with regard to their family budget but because it increases the costs of government. Here is an example: the U.S. Department of Defense spent $17.3 billion on fuel in 2011.

Now, before some of you who have an opposing view about speculation get too worked up, let me say unequivocally that markets 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 an unfair price.

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?” Well, good question Grasshopper.

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 1. 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 suggesting that 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 push prices to levels that may be uneconomic—certainly not tied directly to supply and demand—and the prices 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. And remember, it’s pretty early in the year for gas prices to be this high. It was even higher last year and not just a little higher. From June of 2008 until January of last year, speculation in energy markets had increased by 64 percent. In the metals and agricultural complexes, it had increased by roughly 20 percent.

Is that speculation excessive speculation and is it impacting prices? I think so and so do many members of the U.S. House and Senate. In fact, in the last two weeks, we have received numerous letters from dozens of members of the House and Senate—those that actually voted for the reform law—telling us to get with it and implement position limits. Earlier this week, 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, last week President Obama said, “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. There are many who don’t. I can continue to explain all this to people, but I can’t comprehend it for them.

Nonetheless, let me lay one more piece of research on you with regard to speculation. This one doesn’t come from some lefty progressive group. It comes from one of the big Wall Street banks. In fact, I met with them again yesterday. Their 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, driving 120,000 miles per year at 6 miles per gallon. The annual cost to the trucking industry: $29.1 billion. For the airline industry: $9.8 billion.

Our position limits rule is one of the only tools regulators have in our utility belt to combat unfair prices. We need to use it. We need to implement the rule as soon as possible and I’m working to do just that. But there is another fly in the ointment on this, and a lot of you know about it. Certain Wall Street interests are suing the government in an effort to stop the rule from going into effect. They contend, among other things, that we didn’t do an appropriate Cost Benefit Analysis—a CBA. I suppose they want the ability to speculate with no limits whatsoever. That’s not good for markets, for the economy or for businesses or consumers.

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

A More Perfect Regulation?

We live in not only a complex, but a litigious society. Sure people have the right to go to court and challenge things. But regulators need to keep our eye on the ball and not be scared into making rules and regulations weak or ineffective because we are overly concerned about what we call “litigation risk.”

This is an issue that has troubled me for a while, and I’m going to use this forum as an occasion to talk a little about something that is significant. Bear with me a little here. In the preamble to the Constitution of the United States, there is this wonderful aspirational language:

We the people of the United States, in order to form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity, do ordain and establish this Constitution for the United States of America.

“In order to form a more perfect union.”   Those words, “in order to”—they meant that our forefathers were working toward, hoping, aspiring, to form a more perfect union.  It wasn’t perfect, and it might not reach perfection, but they were trying to get there.

So, here’s something to think about:  those wonderful “planks” toward making that “more perfect union”—establishing justice, insuring domestic tranquility, promoting the general welfare—each one of those distinct factors didn’t in and of itself create the more perfect union. Rather, each facet was a building block that the Founding Fathers intended to use to “get there,” to become that more perfect union.   In other words, “providing for the common defense,” wasn’t the be all and end all, but instead it was one of the important pieces used to get to the ultimate goal:  a more perfect union.

Now I’m going to take what you may think is an odd turn.  In a similar fashion, Cost Benefit Analyses, like the CBA I mentioned a moment ago with regard to the position limits lawsuit, in regulatory rulemaking are analogous to those discrete building block factors in the Constitution’s preamble.  A CBA is not the ultimate goal of rulemaking, although if you listen to some you might think it so. A CBA is an important piece of reaching the ultimate goal:  a “more perfect regulation.” Like the framers of our Constitution, regulators aspire to reach objectives that protect the commonweal.  That’s our job.  In the recent past, however, our jobs have been made significantly more difficult by a contortion—but I’ll call it as I see it: a bastardization—it is a bastardization of the conduct and use of CBAs in regulatory rulemaking.

This by no means is a new phenomenon. It has cropped up over the years, time and again, as a convenient tool to scuttle regulatory initiatives. Its use at this moment in history is, however, particularly galling to me, given the focus of the regulations that are being decelerated and the harm that was caused to the public as a result of the economic crisis of 2008.

There are those who bellow about the “costs” of regulation.  To those catcalls, I would simply ask, what were the “costs” of that multi-hundred billion dollar taxpayer-funded bailout?  What are the “costs” of families losing their homes?  What are the “costs” to our economy of skyrocketing oil and gas prices, fueled by unbridled excessive speculative activity?

CBAs are being used as a Sword of Damocles over regulatory agencies. Some regulators live in constant fear and are virtually paralyzed by the threat—or, indeed, the actuality—of lawsuits brought (spuriously, in my opinion) on the bases of allegedly poor CBAs.  When this happens, rulemaking activity slows, or grinds to a halt—and that is the precise intent of some who threaten, design, and bring, these lawsuits. And at the same time, American consumers and taxpayers continue to pay more at the pump for a gallon of gas. The airlines will pay billions more. Our Department of Defense and state and local governments will pay more. We will continue to see the devaluation of homes, and continue to face high unemployment rates. How do we measure those “costs?”

It’s time to put some sense (and cents) back into CBAs, and to criticisms of rules.  By that I mean, I’d like to see reasonable, accurate, and well-supported analyses, and those who criticize our CBAs should be required to provide, not “masked data,” with no clear or hard figures, but real, verifiable dollars and cents to rebut our analyses.  For example, we put out a proposal, ask for comments and ask what the costs might be. Then we either aren’t provided with costs of the regulation, or what we get from the commenters isn’t very helpful. We develop the rule and do the best job we can with all the data we have and go final. Then, opponents of the rules say, “Hey, you didn’t do an adequate CBA.” Give me a break. Then, some talk about or take the government to court. People have a right to go to court, but there is a point at which it seems to me some might be taking advantage of the system.

If we are all held to the same reasonable standards on providing and developing good thoughtful data, and not just throwing mud to try and slow the process down, CBAs might actually be a whole lot more useful—as they were intended:  as a factor in forming “more perfect regulations.”

Ah, good. That feels better.

Helen, Mike and MF Global

Finally, I don’t want to leave here without discussing a little bit about MF Global and the mysterious missing millions. Let’s be clear: this was a fresh slap-in-the-face reminder that we need appropriate regulations in place now. MF Global is the new poster child for why thoughtful financial regulation is needed more than ever.

No matter how I talk about this horrific set of circumstances with regard to MF Global, I can’t express what a sorry situation this has caused for many MF Global customers. I have a one paragraph letter I received in January and I want to share it with you. It said:

“I am 75 years old and my husband is 76 years old. We take care of our brain injured son who is 55 years old. All of our money—over $900 thousand—was invested in commodities with MF Global. We have no income except for a small Social Security check for both of us and some for my son. We will be losing our home we have lived in for 30 years if these funds aren’t returned to us soon. We really made a mistake by trusting too much. We are too old to work anymore. All of our strength we have goes to caring for our son. Can someone please help? We are desperate!”

I’m not going to use their last name or tell you where they are from because I didn’t check with them, but I have it right here and I’ve been carrying it around for the last few days to remind me that the MF Global matter isn’t some esoteric policy issue. It is a real and dire matter for thousands of people like Helen and Mike.

For us, job one is always—no excuses—to ensure that customer funds are held sacrosanct in what are called “segregated accounts,” and that they are safe and secure. In this case, those funds were not secure. Hundreds of millions of dollars isn’t where it should have been. Aside from trying to find and claw back all the funds and conducting our investigation and going after anyone who broke the law, we also need to ensure that we do all we can to avoid this happening in the future.

In that regard I have suggested several things that can be done, although there are others:

• One, we need to engage in regular and robust deep data dives. By that I mean we need to regularly ensure that customer funds are where they are supposed to be. Rather than taking a firm’s word at face value that the money is where it is supposed to be, we need to do the Jerry Maguire and insist that they “show us the money.”
• Two, we should allow customers a choice of how or if their funds in segregated accounts are used. People make choices about the types of investment that can be made with their money in their pension funds. They should be able to do the same with segregated funds. They should also be able to say: “My money sits there as margin and nothing can be done with it.” By the way, customer choice is something that is already done in the United Kingdom, so we should look to them for guidance on how best to formulate such a plan, and;
• Three, Congress should approve legislation to establish an insurance fund to serve as a backstop for customers like Helen and Mike should there be a loss in the future. The securities world has such an insurance fund. We all know the banking world has the Federal Deposit Insurance Corporation. We need such an insurance fund in the futures world.

Conclusion—Some Menu Options

I am grateful for your attention. We live in a complex world and these are all complicated issues. Here is what I know: we are in a rapidly changing environment. Markets are morphing. Laws from less than two years ago don’t even mention things—like high frequency traders—that are clearly issues for regulators today—something we didn’t have time to discuss. It is all moving and changing fast, fast, fast.

We can’t do the job we need to do as regulators without the serious and thoughtful help of people involved in these markets. We need to know what you think. That is why I’ll be very pleased to take your comments and questions if there is time. If we have gotten something wrong, you need to tell us. If something needs changed, shout it out. Here is my personal promise to you: I will listen carefully, because I understand that some menu options may have changed.

Thank you.

Last Updated: March 8, 2012