Oil, The Futures Markets And Manipulation

Many half-truths are told about oil trading. It doesn't take long to get right into the bias: many are out there "debunking" the idea that speculation was behind the oil price run-up. The Bush administration was against any form of regulation. Most conclusions were reached beforehand. This is the notion that the markets are "too deep" to be manipulated. We know just last week that the markets were moved $10 by a rogue trader. That's empirical evidence of manipulation.

Some say "One person's speculator is another's welcome provider of market liquidity." The "liquidity" argument has been repeatedly debunked by the work of Eric Oberg on RealMoney.com, who has often talked about how excessive speculation has led to a diminution of liquidity. You get real players frightened out of the market. We know this from the asides of many of the major oil producers who simply believe these markets are rigged -- correct assumption -- and can't be used.

Some say that the CFTC's Gensler wants to "re-examine the rule that exempts traders from position limits when they are hedging actual deliveries of a commodity. If that exemption was removed, those who took a purely financial interest in a commodity - through, say, derivatives that settle for cash -- would face constraints." To which I say, why not? Why shouldn't there be some constraints? Given the imperative of having a functioning oil market, some financial institutions that demonstrated no success or big losses speculating or investing in mortgages or private equity shouldn't be trusted to do the right thing in this market. So why not have some constraints? Where does it say that markets are free for everyone who hangs a banking or brokerage shingle on the wall?

More: "this could throw a big wrench in the market. Say a bank sold fuel hedges to an airline. The bank could trade energy futures freely, but if it tried to lay off its own exposure to the airline using cash-settled instruments, its trading partners might face limits." Here goes the slippery slope: If one can't do it, the other can't do it. But I question the chain. Why do we care what happens if a bank makes this trade? Maybe it shouldn't. Maybe it's too risky. Maybe they should be more cautious.

The imperative is a fair market that doesn't create huge economic uncertainty. We got that uncertainty when oil went to $140 on what we now know was not economic demand, or terrorist premium, or a lack of supply, but simply the ease with which you could keep this market higher with very little capital in order to have gains, gains so outsized that you forced airlines to hedge when they didn't need to. And hedging isn't free or foolproof. The idea of creating something artificially that needs hedging is such circular reasoning as to be laughable.

To analogize to stocks, which, again, are not nearly as important for the future of the consumer, the commercial enterprises or the nation, and national and economic security for that matter, why can't we think about limits? It's a disclosable event to go over 5% for an institution. Some entities, such as banks, require a halt at 9.9% of investment by any one account because of fears of manipulation.

Some out there are still refusing to acknowledge the proposition that rules were even enforced. They weren't, because of ideology. The resources are there. The ideology is based on the pattern that runs through the article: Markets should be free and unfettered because they "work." It also presumes that nothing even went wrong, yet a run from $70 to $140 when there wasn't economic demand for the product, or a run from $30 to $72 which occurred when there was reduced demand and booming inventories, seem to be simple cases for the rules not working and the enforcement being nil. It also presumes that there is an inalienable right to hedge, when there isn't and has never been.

In fact we all have to admit that the oil market worked much better pre-futures. It also presumes that all futures are good futures and that all leverage is good leverage. We have seen the hazards of excessive leverage in other businesses. How about here, in the 10-to1 model? How about some recognition that the self-enforcing nature of these exchanges is nil, because the imperative, the real imperative, is to have more trading and therefore more fees, regardless of the cost to society?

We all agree there is too much leverage in the system. That's the great lesson of the near collapse of the financial world. We also agree that there has been an endless slippery slope toward it, as per the amazing 3-to1 leveraged products in ETF land, that specifically go around the feds' ability to regulate margin. We accept that any trading -- no matter how unfair -- is fine. How about supporting insider trading? Hey, maybe it's good for trading and provides liquidity for those who might be dumping the stock -- yeah, it can be extrapolated that easily.

Here's the bottom line: This market has gotten out of control. This time, the self-regulation has failed. Because of that, the government has had to get involved. Gary Gensler of the CFTC wants to change things in a way that protects national interests and wants to stop the endless backfiring that is occurring right now. How can that be "harmful" when the current system is egregiously harmful? What will his hearings do, allow oil to go to $170 or $200 when it should be at $60 or $50?

All that said, these scurrilous and insidious arguments will prevail, I believe, because the traders have enough money to fight any serious regulation. Gensler is smart, the administration is smart, but as Stalin says, how many divisions do they have? The anti-regulators have so much congressional mind-share courtesy of ignorance and contributions that is suspect this kind of chicanery will be with us for some time. At least we have to be able to analyze the argument for the gossamer reasoning that pervades them.