GRETCHEN MORGENSON
In response to an invitation to readers, David Kocieniewski, a business reporter for The New York Times, and Gretchen Morgenson, an assistant business editor and columnist, are answering questions about their four-part series, The House Edge, which examined the challenges posed by Wall Street’s influence over markets and the prices consumers pay.
The series also explored issues including the role of Goldman Sachs in the global aluminum market and academics who have reaped financial benefitswhile defending some of the largest players in the commodities business.
Some of the questions have been edited for brevity or clarity or to provide context.
Calculating the Consumer Cost
Q.
“A Shuffle of Aluminum, but to Banks, Pure Gold” (July 21), about the involvement of financial players like Goldman Sachs in the aluminum market, says that delays at metals warehouses owned by Goldman and others have cost American consumers more than $5 billion over the last three years. How was that number computed? Why don’t suppliers of aluminum-based products find their own supply chain? — Jason, Washington
A.
The delays at Metro International, a group of Detroit-area warehouses owned by Goldman Sachs, affect prices that consumers pay across the nation because of the peculiar way that metals prices are computed. Aluminum buyers pay a spot-market price plus a premium, based on the cost of storing and transporting the metal. During the first three years Goldman owned the warehouses, the delays at Metro International increased from an average of six weeks to more than 16 months, and as a result inflated the premium. According to former Metro International employees, delays were intentionally lengthened by Metro International to increase the daily rent it collects from metal owners.
That premium is added to the spot price of virtually all aluminum sold in the United States, even if the metal was never stored in a warehouse, so users who buy metal directly from manufacturers still pay for the delays. After the delays grew at the Detroit warehouses, queues at major aluminum storage facilities in Europe began to lengthen, too, inflating the premium and prices overseas.
Estimating how much this costs consumers was a complex and, admittedly, inexact calculation. We consulted with more than a dozen aluminum industry experts to discern how much the delays added to the cost of a ton of aluminum, and how that was likely to affect what consumers paid at the checkout counter. We arrived at the estimate of about one-tenth of a cent per can, and a total of more than $5 billion since Goldman bought the warehouses in 2010. In testimony before Congress, industry experts from the Beer Institute later put the figure even higher — $3 billion a year — but either amount indicates that the warehouse delays have a sizable impact. — David Kocieniewski
Banks’ Investments in Commodities
Q.
Goldman and other major banks are playing big time in the commodities market. Goldman is buying up all the farm ground in the Midwest, and they can’t lose because of the farm welfare. It was the same thing as suitcase farmers in the ’30s who played havoc with the wheat prices and brought down the worst of the Great Depression. Are we heading the same way? — Basine, Idaho
What other commodities are the Big Guys involved in? I wonder if this helps explain the real increase in price of so many products. For instance, cloth has become very thin. This means clothes will wear out much sooner. There is less product, but the same price. Same with many food items, cereals in particular; the incredible shrinking boxes. Since I’m getting old and remember long-term trends and terms, the word monopoly has fallen out of use. Monopoly used to be a big concern of government and the general public. Why does it seem to no longer be of concern? — Sharon Reagan, Williams, Ore.
A.
During the past decade, large banks and hedge funds have made huge investments in commodities markets in a number of ways. And while the commodities markets have cooled over the past few years, they still generate about $6 billion a year in revenues for major banks, about half the total in 2008, according to the London-based research firm Coalition.
Big banks steered hundreds of billions in new investment into commodities after deregulation, much of it in the form of commodities index funds, a relatively new class of assets that generate high fees for the banks that manage them.
Banks have made their own investments in everything from oil and grain to cotton, livestock and coffee. Those holdings are estimated at more than $35 billion in 2012. They have also bought up the infrastructure used to store and ship commodities. In addition to the metals warehouses owned by Goldman and JPMorgan Chase, big banks own pipelines and refineries, shipping lines, power plants and ports.
Banks say that their liquidity brings efficiency to the markets, often lowering prices. But there have been abuses. In recent years, banks like JPMorgan, Barclays and Deutsche Bank have been fined for manipulating electricity prices and, in some cases, costing consumers hundreds of millions of dollars. The Justice Department and the Commodities Futures Trading Commission began investigating Goldman’s aluminum warehouse operations last summer, and several class-action lawsuits were filed accusing the company of unfair practices.
Some in Congress are pushing the Federal Reserve to end the special exemptions that allow banks to own commodity-related infrastructure, arguing that the risks involved in the business pose a danger to the banking system. The additional regulatory scrutiny, coupled with lower profit margins in commodities, have prompted some financial giants to state publicly that they might sell their commodities businesses. But the Fed has yet to make any major policy changes, so it is unclear whether changes will take place. — David Kocieniewski
Speculation and Market Forces
Q.
“Academics Who Defend Wall St. Reap Reward” (Dec. 27) disclosed the financial ties between a University of Houston professor and proponents of unfettered speculation in the commodities markets. My question is very simple: Does commodities speculation ultimately cost the end users more for a given product than the laws of supply and demand would dictate? — JDKJJK, New York
A.
The academic debate about what role, if any, the surge of financial speculation played in the run-up of commodity prices during the past decade remains unresolved.
It is generally accepted that the price increases were in large part caused by market fundamentals – increasing demand in China and other developing countries, currency fluctuations, the diversion of grains to biofuels. Numerous studies by economists find little evidence that speculation played a major role. Studies by other economists find that price increases and volatility were fueled, to a significant degree, by the vast amount of speculative money that has entered the market since the rise of investment funds — particularly index funds — that track commodities.
The task of definitively answering the question is complicated by the murkiness of the data. Most trading data is considered proprietary and is therefore not released to the public or researchers. The information released by federal regulators and the exchanges is often difficult to work with because it is aggregated in ways that make it tricky to separate investors speculating on where prices will go from those simply trying to hedge their risks.
When the Commodity Futures Trading Commission gave researchers from Princeton and the University of Michigan access to actual trade data, the resulting study found evidence suggesting that financial speculation had played a role in price swings during certain time periods. But before more studies could be done to test their findings, the C.F.T.C. research program was shut down because the Chicago Mercantile Exchange complained that asubsequent study, which was critical of high frequency trading, had improperly released confidential details about its clients.
Outside of academia, many commodities traders, financial institutions and oil industry executives have asserted in recent years that speculation is a major factor behind rising prices and market volatility.
The public policy debate has also been moving toward more regulation to prevent any possible price impact of increased speculation in the future. In the United States, restrictions on speculation were included in the Dodd-Frank package of financial reforms in 2010. While those rules were blocked by a court challenge funded by the financial-services giants, the C.F.T.C. in November approved a new set of position limits that would curtail Wall Street speculation. — David Kocieniewski
Industry Influence on Academia
Q.
“Academics Who Defend Wall St. Reap Reward” came across as suggesting there are a few bad apples, when I think it is much more pervasive. Typically the connections are less direct, but there is a lot of “sponsorship” of business schools or funding of research. What do you think ordinary people can do to change the system (or pressure those in power to do so)? — Jonathan, New York
A.
Since the 2008 financial crisis, there has been widespread concern about the way Wall Street has used academia to influence the public debate about regulation and economic policy. Traders, banks and hedge funds have funded favorable research and promoted research by those with friendly viewpoints at conferences and seminars, as well as on websites likeopenmarkets.com (run by the Chicago Mercantile Exchange) andcommodityfact org (the International Swaps and Derivatives Association) and heartland.org (funded by Exxon Mobil, the American Petroleum Institute and Charles G. Koch of Koch Industries, among others). In some cases, they have paid academics who present themselves publicly as impartial scholars without revealing their financial ties to businesses with a stake in their research.
As a result, the American Economic Association enacted stricter financial disclosure guidelines in 2012. The purpose of those rules is to provide enough information to allow policymakers and members of the public to take a researcher’s financial involvements into consideration when evaluating his or her assertions.
There have been an assortment of media reports about the issue. Our article cited the conflicts of interest revealed by the film “Inside Job,” an academic paper published by researchers at the University of Massachusetts Amherstand an article in The Nation magazine. And there have been reports by others, including Reuters and The Boston Globe.
Because The House Edge focused on banks’ role in commodities, we looked into the financial involvement of academics who do research on those markets and found that two of the most outspoken academics in the debate had previously unreported financial ties to speculators. — David Kocieniewski
Questions on Two Professors
Q.
Concerning “Academics Who Defend Wall St. Reap Reward,” I would love Mr. Kocieniewski to respond to criticisms of his piece by myself, Craig Pirrong and others, including, but not limited to:
Why does Mr. Kocieniewski believe that the money flowing to the University of Illinois business school is a reward for research by Scott Irwin, when Mr. Irwin doesn’t teach at the business school?
Does Mr. Kocieniewski believe that Irwin has violated the A.E.A. code of ethics? If not, does he believe that the A.E.A. code of ethics doesn’t go far enough? What would he like it to say?
Does Mr. Kocieniewski believe that Mr. Pirrong is anything other than a straight shooter when it comes to his own opinions? Does he believe that Mr. Pirrong’s opinions are shaped by the money he’s getting from consulting contracts?
Mr. Kocieniewski says that “major financial companies have funded magazines and websites to promote academics with friendly points of view.” Which companies? Which magazines? Which websites?
Would Mr. Kocieniewski agree with Mr. Pirrong that most of Mr. Pirrong’s consulting engagements “have been adverse to commodity traders and banks?”
Mr. Kocieniewski says that Mr. Pirrong has written “a flurry of influential letters to federal agencies.” How many is a flurry?
More generally, does Mr. Kocieniewski believe that Mr. Irwin and Mr. Pirrong are especially worthy of being singled out in this article and in this manner? Or was this just a case of finding a couple of professors at public universities which could be FOIAed? — Felix Salmon, Reuters columnist, New York
A.
Despite the disclosure requirements of the American Economic Association and the University of Houston, Mr. Pirrong did not release details of his paid consulting work with 11 different clients until The New York Times filed repeated requests under the Freedom of Information Act. Among the businesses paying him were the world’s largest commodities exchange, the Chicago Mercantile Exchange, and one of the largest commodity trading houses, Trafigura.
Mr. Pirrong was also a paid consultant of a Wall Street group, the International Swaps and Derivatives Association, which is funded by Goldman Sachs, Morgan Stanley and other major traders, at the time the association was quoting his research extensively in a lawsuit that for two years blocked attempts to regulate speculation.
Mr. Pirrong declined to answer questions about how much he was paid or the nature of some of his consulting work. The article nonetheless cited one instance in which his findings went against the interests of the Wall Street affiliated group that had funded his research.
Mr. Irwin, as the article notes, did report his financial ties in his disclosure form with the University of Illinois. In describing the Chicago Mercantile Exchange’s dealings with the University of Illinois, the article also pointed out that Mr. Irwin’s only direct request for money from the C.M.E. was denied.
Emails obtained under the Freedom of Information Act nonetheless show a close relationship between the exchange’s public relations and research departments and the university’s academics — helping Mr. Irwin get his opinion pieces placed in newspapers, trying to schedule him to testify at congressional hearings and, when that failed, using his research to shape its executives’ testimony.
The university development office was also involved in scheduling Mr. Irwin to speak at the C.M.E. at the same time its fund-raisers were soliciting donations from the exchange for the business school, the emails show. Last fall, the C.M.E. also named Mr. Irwin to its Agricultural Markets Advisory Council, the emails show. Mr. Irwin subsequently said that he, like other academics on the committee, is paid a $10,000 annual stipend.
Finally, while friends and colleagues of Mr. Pirrong and Mr. Irwin may complain that they are being singled out for scrutiny, public records show just the opposite. Since this debate began more than five years ago, there have been many media references to the financial ties of those who have argued that speculation is responsible for price increases — whether they were academics performing industry funded research or hedge fund managers whose holdings in autos and airlines would benefit from regulation that might reduce oil prices. By reporting where the financial interests of Mr. Pirrong, Mr. Irwin and the universities that employ them intersect with those of speculators, the article gives readers additional information that they may wish to consider when weighing the professors’ public statements. — David Kocieniewski
Carbon Taxes vs. Ethanol Credits
Q.
Regarding “Wall Street Exploits Ethanol Credits, and Prices Spike” (Sept. 15): A primary argument for mandating ethanol addition to gasoline is environmental, based on the fact that ethanol is at least partly renewable and, on balance, contributes less heat-trapping carbon dioxide to the atmosphere. The abuse of the ethanol credits market by big banks ultimately acts like a tax on the final product, with the revenue flowing to banks as a profit on the ethanol credits. Could you discuss and compare the merits of a flat (and revenue-neutral) fee per ton for use of fossil-based carbon? Would this have less potential for market abuse than the current regulatory approach employing trading of ethanol credits? Would consumers and taxpayers stand to benefit from a carbon tax-and-dividend vs. the current regulatory mandate? — Wharton, Chicago
A.
It is hard to imagine a market more open to potential abuse than the market in trading of ethanol credits, or RINS. It is unregulated, shrouded in secrecy and consisting solely of bilateral transactions. It is overseen by the Environmental Protection Agency, which has no experience policing markets for manipulation or other malfeasance.
The rocketing price of RINS earlier this year definitely added to costs for refiners who had to buy the credits to meet their federal mandates. To the degree the refiners were able to pass those costs on to consumers at the pump, an effect of the trading was something of a tax on the end-user. — Gretchen Morgenson
The Legislative Outlook
Q.
Do you think that the level of access and degree of impediment that the financial industry achieved regarding the Dodd-Frank financial overhaul was strenuously enough resisted by Congress and regulators? Were they granted too many “reasonable” opportunities to participate in the process, thus leaving us with a less-than-fulsome reform?
My personal belief is that until we return to the separation of retail banking and lending from investment banking/financial management/market making/proprietary investments, as we had with the Glass-Steagall Act of 1933, or at least limit the absolute size of institutions, we will continue to be beholden to their self-interest. Do you see any chance for or merit to this? — Aschaffer4
A.
Excellent questions. Large financial institutions had many opportunities to affect the outcome of the Dodd-Frank legislation. Their first opportunity arose as the law was being written; their second came when the regulators such as the Commodities Futures Trading Commission, the Securities and Exchange Commission and the Federal Reserve wrote the rules that were required under the law. This meant that these institutions were deeply involved in the entire reform process.
One comparison I like to make about the Dodd-Frank law is to point out that it is roughly 1,500 pages long. Glass-Steagall, by contrast, which protected our society from dubious banking practices for almost 70 years, consisted of approximately 34 pages.
There are several advocates in Washington for breaking up large banks and making them less of a bailout threat for taxpayers. Senator Sherrod Brown, Democrat of Ohio, and Senator David Vitter, Republican of Louisiana, have put forward a bill that would require much larger capital cushions among the largest institutions. And Richard Fisher, president of the Federal Reserve Bank of Dallas, and Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corporation, have been advocating a break-up of big banks. But these people are up against a well-financed lobbying machine, so it is unclear what will come of their arguments. — Gretchen Morgenson
Barring Companies From Business
Q.
A long time ago, when I was working in the health care industry, there would occasionally be a corporation barred from doing business with the government because of repeated fraudulent practices. I don’t know if this was a health care law or more general law. But it sure seems like a good and sufficient practice for the current environment in the financial industry.
Simply looking at a listing of successful litigation by governmental agencies tells us that the major financial institutions are not feeling sufficient reasons to halt fraud against the government and the public. So the question remains: Why are we continuing to do business with them and to insure them if laws are already on the books to allow us to not do business with them? — KalamaMike, Kalama, Wash.
A.
It would be highly unusual for a financial company charged with misconduct to be barred from doing business with the government. Nowadays fines are the typical punishment meted out to institutions found to have wronged consumers or investors. Keep in mind, however, that these fines are usually paid by companies’ shareholders, not by the people who engaged in the misconduct. Sometimes the fines seem large — in the billions — but they can often be tax deductible to the institutions paying them. To some executives, fines are viewed as a cost of doing business.
Holding individuals involved in creating the financial crisis to account has also been difficult for the government. For those of us on the outside looking in, this is hard to explain, but as long as people and institutions are not held accountable for dubious practices, it is hard to imagine that behavior will change. — Gretchen Morgenson
The Financial Sector’s Mission
Q.
What portion of the rewards of making markets still achieves the original purpose of encouraging useful enterprise? What portion has now been reduced to activities that serve no useful economic purpose whatsoever? I submit that if we were to just pare away anything that cannot show a direct connection to the production of desired goods and services we would have no more than 20 percent of the financial services industries remaining. — Michael O’Neill, Bandon, Ore.
A.
Weighing the financial industry’s purpose — whether it adds or destroys value in our society — is one of the most compelling questions of our time. And it has only grown in importance as the industry has ballooned in size and dominance in recent years: Finance income now accounts for over 8 percent of gross domestic product, more than double the level of the 1950s, according to work by Thomas Philippon at New York University. With this growth, the potential damage posed to our economy by financial institutions has increased as well. For this reason alone, it is worth discussing whether the financial industry is constructive or destructive.
Before the crisis, for example, regulators routinely argued that financial innovations, such as credit default swaps, had reduced risks to the broader economy. But in fact, some of these instruments amplified the crisis. Exotic mortgages that carried low initial rates only to explode a few years later were at the heart of many foreclosures across the country. And the creation and sale of collateralized debt obligations filled with toxic mortgages that made them likely to fail brought new meaning to the concept of financial innovation.
Professor Philippon has done terrific work assessing the costs borne by users of financial products and asking why they have not fallen. Another academic who has questioned the increasing role of finance in our society is Luigi Zingales, professor of entrepreneurship and finance at the University of Chicago. In his 2012 book, “A Capitalism for the People,” he writes about how the financial sector, “thanks to its resources and cleverness, has increasingly been able to rig the rules to its own advantage.” Historically, our nation was able to keep the financial sector in check, he writes, “but as the financial system gained strength, it also gained political influence.”
At its best, the financial industry should help businesses raise capital to create jobs and help investors save for retirement. But as Wall Street has expanded its focus away from these important goals — owning commodities storage operations, for example, that were off limits for decades — more of its activities seem designed to serve these institutions’ own interests rather than those of their customers. — Gretchen Morgenson
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