Repost (May 11): Derivatives and Food Security

Bernie Sanders’ provision requiring an audit of the Fed (see our May 3 post, Audit the Fed) appears to have been approved by the Senate, 96-0, which is very good news.

The next task will be to get Congress to pass Blanche Lincoln’s provision that would require banks to spin off derivative trading or lose FDIC protection. Here’s what Mary Bottari of Bankster had to say (plus an “action alert”):

Late in the game, Senator Blanche Lincoln (D-Ark.), Chair of the Senate Agriculture Committee, demanded that provisions be put into the bill that would force the biggest banks to spin off their swaps (or derivatives) desks into a separate entity. That entity can remain part of the bank holding company, but it no longer has access to the Federal Reserve’s flow of funds, FDIC insurance and the taxpayer guarantee. In one fell swoop, her measure effectively forces banks to spin off their destructive gambling arm, protects the taxpayers and downsizes the behemoth banks. What’s not to love? The howls from Wall Street could be heard in Wisconsin. Senator Judd Gregg is offering an amendment to strip this language from the bill, and Senator Chambliss will offer other weakening amendments.

Please make a quick call to your Senators now. Call (202) 224-3121. Tell them to support Blanche Lincoln’s efforts to force banks to spin off their swaps desk, and reject any amendments that weaken the derivatives section of the bill.

You can find an article on the topic by Mary Bottari on Common Dreams. And here is part of a HuffPo article from the SAFER economists on the Lincoln provision:

Banks Must Be Barred from Dealing Derivatives: It’s NOT a Normal Part of the Business of Banking
Jane D’Arista and Gerald Epstein
Political Economy Research Institute (PERI), University of Massachusetts, Amherst
and Coordinators of SAFER

The furor over the inclusion of Senate Agriculture Chairwoman Blanche Lincoln’s amendment in the Senate bill is becoming somewhat ludicrous. Good, knowledgeable people such as FDIC Chairman Sheila Bair and former Federal Reserve Chairman Paul Volcker have stepped up – no doubt at the Fed’s and Treasury’s bidding – to strew misinformation in the path of what, to date, is the most powerful structural change in the bill in terms of both mitigating risk and preventing future bailouts. The controversial part of the amendment – section 716 – would ban Federal Reserve assistance through a credit facility or the discount window or loan or debt guarantees by the FDIC to any dealer in swap contracts. This would mean that banks that are insured by the FDIC – including the large banks that now dominate the market – would have to spin off their derivatives desks. Like the Volcker rule itself, the intent is to remove risky activities from the core banking functions that are essential to the economy and to ensure that those risky activities will not trigger the need for a bail out to prevent systemic collapse in the future as they did in the 2008 crisis.

Chairman Bair’s concern was that forcing derivatives dealers out of banks would move the business into less regulated and more leveraged entities. While saying that banks should not engage in speculative activities, she argued that banks have an important role in creating markets for their customers while needing to hedge interest rate risks related to their core lending business. Chairman Volcker, too, took the position that providing derivatives is a normal part of a banking relationship with a customer and should not be prohibited.

These are assertions that need to be questioned. First, if banks’ role in selling derivatives is so important and if it is part of the usual course of a banking relationship, why is it that only five banks – J.P. Morgan Chase, Citibank, Bank of America, Goldman Sachs and Morgan Stanley – account for 90 percent of the market? Surely that kind of oligopolistic domination of the market makes clear that it is not an activity normally undertaken by banks. Moreover, the level of concentration among swaps dealers is, in itself, systemically risky in addition to being anti-competitive.

Second, separating swap dealing operations from the business of banking does not mean that banks will be unable to hedge their banking risks. They will become end users with an interest in seeing that the dealers from whom they buy derivatives are well managed, well regulated and well capitalized. In addition, the largest dealers will be able to retain what, for them has been a major profit center by moving their swaps desks into subsidiaries under the bank’s holding company. Their only loss will be the inability to sell and trade without disclosing the prices they charge since most of their business will be conducted through clearing houses and exchanges and subject to requirements for disclosure and reporting that off-balance sheet, over-the-counter markets are designed to evade.

But, third, and perhaps most important, the assumption that taking derivatives desks out of banks will make the business less regulated and more leveraged is simply wrong. For one thing, the requirements for prudential oversight under Title VII of the bill will apply standards for capital adequacy, transparency, anti-fraud and anti-manipulation to stand-alone derivatives dealers. But the equally important point is that they couldn’t possibly be less regulated and less well capitalized than the bank dealers are now.

D&S blog reader LF has reminded us of the connection between this and food security, and the need to curb speculative activity in commodity markets. For starters, here’s part of an article by C.P. Chandrasekhar and Jayati Ghosh, from the excellent IDEAS website:

Are we Heading for Another Global Primary Commodity Price Surge?
C.P. Chandrasekhar and Jayati Ghosh

Well before the financial crisis broke out so violently in the US and caused ripple effects all over the world, most people in developing countries were already reeling under the effects of dramatic volatility in global food and fuel markets. In 2007 and 2008 prices of most primary commodities first increased very rapidly, to a degree that was completely unwarranted by actual changes in global demand and supply. Then they collapsed, from peaks in May-June 2008, at even more rapid rates than their previous increases. But in many countries the fall in global prices was not associated with a fall in prices paid by consumers, while the actual producers (such as farmers) rarely benefited from the price increases.

It is now quite widely accepted that financial activity – specifically the involvement of index investors – was strongly associated with these dramatic price movements. Commodities emerged as an attractive alternate investment avenue for financial investors from around 2006, when the US housing market showed the initial signs of its ultimate collapse. This was aided by financial deregulation that allowed purely financial agents to enter such markets without requirements of holding physical commodities. This generated a bubble, beginning in futures markets that transmitted to spot markets as well.

Thereafter – even before the collapse of Lehman Brothers signalled the global financial crisis – commodity prices started falling as such index investors started to withdraw. The global recession that was evident from mid 2008 led to perceptions that commodity prices would not firm up any time soon. While this contributed to fears of deflation in the context of liquidity trap conditions, this was even seen to be an advantage especially for food and fuel importing developing countries, whose import bills would be reduced accordingly.

But while the collapse in commodity prices after the recent peak was sharp, it proved to be quite short-lived. Most important commodity prices – especially food and oil prices – have been rising from early 2009, even before there was any real evidence of global ”recovery”.

Read the rest of the article.

And from the (apparently new) website Stop Gambling on Hunger, there’s this video explaining the connections between global finance and food (in)security:
[youtube=http://www.youtube.com/watch?v=suJlyZDnKYU&hl=en&fs=1&]

There’s other good material at that website.

Last but not least, there’s a two-part interview with Jayati Ghosh at the Real News Network, entitled Global Food Bubble on the Way?.