The Federal Reserve may curtail Wall Street commodity businesses after lawmakers said banks’ role in energy, power and metals markets spurred unfair trading advantages and could threaten financial stability.
At a Senate hearing today, Fed Governor Daniel Tarullo said curbs under consideration include ownership limits, restricting how much revenue can be derived from commodities and requiring Wall Street firms to boost capital. He said the new rules, to be proposed early next year, could restrict banks from investing in oil tankers, coal mines and other businesses involved in physical commodities.
“We are focusing on the risk to safety and soundness presented by specific activities and on whether those risks can be appropriately and adequately mitigated,” Tarullo said at the hearing held by the Senate Permanent Subcommittee on Investigations.
This week, the Senate panel released findings from a two-year investigation that said Wall Street’s role in owning commodities provided undue influence over prices and could threaten the economy if a bank-controlled business suffered an industrial catastrophe. The findings put pressure on the Fed to stiffen rules that have allowed lenders to erode what was once a strict line separating banking from commercial activities.
At a separate Senate hearing today, New York Federal Reserve President William C. Dudley questioned whether banks should be involved in commodities at all. The Fed is looking at the issue “intently,” he told lawmakers on the Senate Banking Committee.
The Fed has drawn criticism from senators who allege it engaged in weak oversight over the last decade as banks expanded into new businesses involving aluminum warehouses, coal mines and trading in electricity and uranium.
Tarullo said the central bank plans to propose new rules in next year’s first quarter, a move U.S. Senator Carl Levin called “long overdue.”
“The separation between banking and commerce has served markets and our economy quite well for decades,” said Levin, a Michigan Democrat who chairs the investigative panel. “The erosion of that barrier is clearly doing harm today.”
Levin faulted banks for stockpiling commodities at the same time they were engaging in “massive” transactions to buy and sell them and trade derivatives tied to oils and metals. The situation “raises concerns” about market manipulation and unfair trading, he said.
Goldman Aluminum Deals
The Senate Permanent Subcommittee on Investigations’ 400-page report said the Fed has “a current lack of effective regulatory standards” and an “uncoordinated, incoherent patchwork” of limits on banks.
At a hearing yesterday, Levin sparred with Goldman Sachs Group Inc. executives for more than two hours over aluminum trading contracts between a bank warehouse subsidiary and clients. Levin said the deals led to long wait times for customers to get their aluminum out of warehouses, leading to consumers paying higher prices for the metal.
Jacques Gabillon, head of Goldman Sachs’s global commodities principal investments group, rejected the accusation.
“When everything is said and done, you can say there is no correlation” between wait times and price, Gabillon said.
Levin responded that the executives were “in a very different mathematical world” if they wouldn’t acknowledge the connection.
The Senate report referenced a 2012 Fed study of four banks that found each had capital and insurance shortfalls for commodity units of as much as $15 billion. That meant that if each bank experienced a catastrophe on the scale of BP Plc’s 2010 oil spill in the Gulf of Mexico, they couldn’t cover the losses, the report said.
Banks have moved to sell commodities units amid the scrutiny and revenue from the businesses has tumbled by two-thirds from peak years.
Goldman Sachs produced $1 billion of revenue from its commodities unit and investments in commodity businesses in 2012, down from $3.4 billion in 2009, according to the Senate report, while Morgan Stanley’s commodity revenue fell for four straight years, from $3 billion in 2008 to $912 million in 2012.
Goldman Sachs said it is looking to sell the warehouse subsidiary and will wind down an uranium-trading unit after the bank didn’t receive acceptable bids when it put the business up for sale. The bank is also considering selling coal mines in Colombia, according to the report. Meanwhile, JPMorgan has been selling off large portions of its physical commodities business.