The headlines are attention-grabbing and the investigations are substantive. Goldman Sachs is reported to be slow-walking aluminum out of warehouses that it controls. JPMorgan Chase is settling accusations that it manipulated energy prices and may also face pressure to get out of the metals and oil business more broadly. Big companies that buy aluminum, like MillerCoors, are not happy with the way banks have been operating, and these nonfinancial companies have an important political voice also. The political changes afoot may also affect Morgan Stanley and Barclays, which both have significant involvement in commodities.
Senator Sherrod Brown, Democrat of Ohio and a leader among those who want a safer and better run financial system, asked recently, “What do we want our banks to do, make small-business loans or refine and transport oil? Issue mortgages or corner the metals market?”
Banks have not always been allowed so many tentacles. Go back, for example, to the political deal behind the founding of the Federal Reserve System in 1913. After the crisis of 1907, there had been wide-ranging arguments on whether the United States should have a central bank, along the lines that already existed in some parts of Western Europe.
One major and legitimate concern expressed by some of Senator Brown’s predecessors (including Louis Brandeis, then a prominent skeptic of banking practices and later a Supreme Court justice) was that providing bankers with a government backstop would enable some of them – particularly those already running large financial institutions in New York – to become even more powerful.
This concern was shared by others, more to the right of the political spectrum, who worried that anyone who could borrow from the Fed would gain an unfair advantage in nonfinancial activities. The financier J.P. Morgan was seen as a dominant force in sectors like railroads and steel, and there was a great deal of broader concern about what was regarded as the “money trust.”
The ultimate quid pro quo was, not unreasonably, that while the newly created Fed would act as a lender of last resort to banks, it would also help to constrain the activities in which these banks could engage. The consensus was that the United States needed a stable banking system for intermediation (from savers to borrowers) and to run the payments system. Outside of that, a freer market – without downside protection provided by the Fed – was the choice.
In part, the restrictions on banks’ activities were about limiting risk, but these constraints were also very much about commercial fairness. The Fed was not offering any kind of backstop to manufacturing or transportation companies, and if banks were to enter those activities, they would presumably have an unfair advantage.
In recent decades, unfortunately, this picture changed drastically. In part, firms known as “investment banks” (which were not banks in a legal sense) were allowed to become more like regular Federal Reserve System banks, becoming larger and financing themselves with short-term liabilities (including what are known as repo transactions).
As Thomas Hoenig, the vice chairman of the Federal Deposit Insurance Corporation, put it recently about the financial crisis of 2008,
The facts are, however, whether the institutions were called a “commercial bank,” “investment bank” or “shadow bank,” it was by the time of the crisis a distinction without a difference.When the crisis hit, Goldman Sachs and Morgan Stanley were allowed to become bank-holding companies, with access to funds from the Federal Reserve. They were not, however, required to divest their commodities activities (or anything else that we can discern).
At the same time, existing large banks were allowed to add a wide range of commodities-related activities. Citigroup was allowed to expand into commodities after 2003, and its competitors followed suit. A great deal of JPMorgan Chase’s expansion into commodities actually took place after the financial crisis, with the acquisition of Bear Stearns as a key step in that direction. (See this 2010 profile of Blythe Masters, a key executive.)
When you allow any companies both cheap government-backed financing and carte blanche to take over other sectors, what would you expect to happen? And if you allow any kind of unfair market power to develop, surely it would be a shock if this did not result in higher prices or less good service – or even some kind of manipulation.
All of the above was on the table at a recent Senate hearing conducted by Senator Brown. For details on the history and policy choices, see the testimony of Joshua Rosner, an executive at Graham Fisher & Company. For a view that is more supportive of the banks’ current structure, read this column by Gregory Meyer. I also recommend this definitive essay, “The Merchants of Wall Street: Banking, Commerce, and Commodities,” by Saule Omarova.
In my assessment, there is no case for banks to own physical commodities, let alone crucial parts of the nation’s infrastructure. This is an unacceptable concentration of power that has led to abuses – and will again.
Big banks are not even good at running financial services – remember the crisis of 2007-8 and the never-ending run of scandals since. Why would anyone think he can do a better job running any aspect of the commodity business?
As for diversifying their risks, if that is your goal for big banks, why not allow them to go into the production of cellphones, trash removal or operating hospitals? Seriously, once you let banks acquire assets in any sector, that Federal Reserve backstop will carry them a long way.
Who in private business wants to go head-to-head with JPMorgan Chase or Goldman Sachs in any nonfinancial sector? Unless you are seriously considering offering Fed support to Apple or U.P.S. or Wal-Mart or all commodity traders, get the banks out of the nonfinancial sector.
Camden R. Fine, head of the Independent Community Bankers of America, puts it well in a recent blog post:
The bottom line is that these huge financial firms have grown so large and become so interconnected in our economy that they are demonstrating classic signs of monopoly power: collusive and anticompetitive behavior that pushes prices up and reduces the social surplus provided by free markets. Not only are these institutions driving up consumer costs, they are doing so with the insurance of a taxpayer-funded backstop if their businesses ever sour. And make no mistake about it, the time will come again.Don’t rely on the banks to pick and choose which parts of the commodity business they would like to keep. As Bart Chilton of the Commodity Futures Trading Commission said this week, the Federal Reserve “can and should reverse” the policy that lets banks own and trade physical commodities.
“I don’t want a bank owning an electric service, or cotton, corn or feedlots,” he said. “I don’t want banks owning warehouses, whether they have aluminum, gold, silver or anything else in them.”