Banks such as JPMorgan Chase & Co. may have adopted the model for commodity trading used by Enron Corp., adding “more and more risk” to the financial system, U.S. Senator Elizabeth Warren said.
JPMorgan, Morgan Stanley and Goldman Sachs Group Inc. are among lenders whose commodity trading is in jeopardy as the Federal Reserve reconsiders letting banks ship crude oil and run warehouses for industrial metals. Warren, a Massachusetts Democrat, spoke today at a Senate subcommittee hearing on bank ownership of metal and energy assets. Enron, once the world’s biggest trader of power and natural gas, collapsed in 2001.
Moves by banks at the start of the last decade into broader areas of physical commodity trading and assets “suggests this movie won’t end well,” Warren said during a question-and-answer session at the hearing.
Banks and regulators probably will be called to testify at a second hearing on their role in the commodity industry, and the Federal Reserve will need to be “more forthcoming” on plans to rein in banks, Senator Sherrod Brown, an Ohio Democrat and the subcommittee chairman, said at the hearing.
Saule T. Omarova, a law professor with the University of North Carolina at Chapel Hill, said at the hearing that Enron may have established the template for banks to expand in physical raw materials. She called for a public debate on commodity holdings of banks, which have “sprawling enterprises” too difficult to monitor and regulate.
“It stretches regulatory capacity beyond its limits,” Omarova said in an interview before the hearing. “No regulator in the financial world can realistically, effectively manage all the risks of an enterprise of financial activities, but also the marketing of gas, oil, electricity and metals. How can one banking regulator develop the expertise to know what’s going on?”
At the hearing, Warren cited “dangers” posed by banks trading in commodities because of “systemic risk” similar to the financial meltdown in 2008 triggers by bad bets by lenders in mortgage debt.
Enron’s traders used strategies with names like “Fat Boy” and “Get Shorty” to create phantom congestion and artificially raise prices in California’s energy markets. The manipulation helped trigger the state’s electricity crisis of 2000 and 2001 that sent retail power prices to record highs and cut power to millions of customers in the most populous U.S. state.
A federal investigation found that Enron made large-volume, rapid-fire trades on its own electronic platform to trigger price moves that all traders could see without knowing the cause. The transactions made through EnronOnline influenced daily price indexes used in physical gas contracts and for settling financial derivatives such as swaps.
The company filed for bankruptcy in 2001 following revelations that it used off-balance-sheet vehicles to hide billions of dollars in losses and inflate its stock price.
JPMorgan, the biggest U.S. bank, is near an agreement with the Federal Energy Regulatory Commission to settle allegations that the lender rigged electricity markets, the Wall Street Journal reported last week.
The commission last week ordered Barclays Plc and four former traders to pay a combined $487.9 million in fines and penalties for engaging in what the agency said was a scheme to manipulate energy markets in the western U.S. from November 2006 to December 2008. London-based Barclays said it would “vigorously” contest the penalties.