From the 2009 News Archive
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Prof. Greenberger: Limit Commodities Speculation

Federal regulators are exploring limits to the role speculators play in commodities markets. That has incensed staunch supporters of deregulation, amid applause from experts who say wild price swings in everyday goods, like oil, have become unmoored from the fundamentals of supply and demand.

The U.S. Commodity Futures Trading Commission (CFTC) held a series of hearings on the issue in recent weeks with a focus on whether setting position limits in energy markets would bring the price of oil and natural gas back under control. Professor Michael Greenberger, who testified at the last of those hearings on Aug. 5, supports setting position limits to curb excessive speculation.

"Speculators' motivations do not include ensuring fair prices," said Greenberger, a professor at the University of Maryland School of Law and a former director of the Division of Trading and Markets at the CFTC.

Greenberger noted that speculators do play a necessary role in futures markets by providing the liquidity needed to expedite contract trading. But he, along with lawmakers, regulators, and other financial experts, believes speculators have exploited lax oversight and reaped windfall profits in return.

"[Speculators] are simply betting on the direction of the market and their sole interest is that the markets go as high or as low as possible in support of their betting strategy," Greenberger said in written testimony submitted to the CFTC.

Speculators can be large financial institutions, hedge funds, wealthy investors - anyone without a commercial interest in the actual commodity that is traded. Airlines, for example, have a commercial interest in entering into oil futures contracts to hedge their risk against fuel price volatility. An investment bank, however, might trade oil contracts to hedge against exposure to other financial risks - but the fluctuation of oil prices does not inherently affect that investment bank's day-to-day business.

Gas prices were front and center at the hearing as commissioners and witnesses referenced the record swing in oil prices last year, a particularly contentious topic because industry insiders point to their own figures that show $4-plus per gallon gasoline was the direct result of supply and demand. Crude oil reached its peak of $147 a barrel in July 2008, only to freefall back to $30 by December. Supporters of position limits say there's no doubt speculation shoulders most of blame.

"Over 90 percent of trading in oil futures involves speculators trading with each other," said Michael Masters, a hedge fund manager who testified along with Greenberger. "When speculative euphoria takes over, speculators can and will drive prices to levels that do not reflect actual supply and demand conditions."

Greenberger echoes those concerns.

"The recent run up in crude oil and gasoline prices while the country is attempting to recover from the worst financial crisis since the Great Depression presents a dire threat that the financial back of the American consumer will yet be broken by further price spikes in everyday necessities," said Greenberger. "That will doubtless weigh down any potential economic recovery, leading to further and more sustained economic hardship."

Position limits could prevent a similar market dysfunction in the future capping the number of contracts speculative traders may take in for a certain commodity, thus controlling excessive speculation. Currently, the CFTC imposes position limits on only a few agricultural commodities, and exchanges like the New York Mercantile Exchange and the Chicago Mercantile Exchange (CME) voluntarily set position limits on other commodities. Greenberger gave kudos to CME for its acknowledgment of the need for tougher position limits.

If the CFTC asserted aggregate position limits, those limits would apply to across the board to commodity trading on all U.S. exchanges. It is unclear when the CFTC will rule on position limits and what that ruling will be.

Posted by Nick Alexopolous

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Copyright © 2015, University of Maryland Francis King Carey School of Law. All Rights Reserved