Fed to Review Grandfather Laws that Allow Banks into Commodities

Michael Teague |

In the wake of a late-July New York Times' article that offered compelling evidence that Goldman Sachs’ (GS) was leveraging its ownership of storage facilities in the metropolitan Chicago area in order to drive up the price of Aluminum, the Commodities Futures Trading Commission made some noises about an investigation.

The resulting furor led to a categorical denial on the part of Goldman, but perhaps it was no coincidence that only two weeks later, Morgan Stanley (MS)  sold off its own commodities business.

Now, however, the Federal Reserve is said to be stepping in with its own review of the physical commodities operations of the nation’s “too-big-to-fail” class of investment banks, according to an anonymous source close to the matter.

Fed Could Clamp Down

Indeed, the Fed is rumored to be undertaking an inspection of the legal and regulatory frameworks that originally permitted the aforementioned banks to be involved in commodities markets in the first place. The potential consequences of the Fed’s review could be quite far reaching, and could lead to the central bank rescinding a 2003 decision to make exceptions for certain lenders interested in basic materials.

According to “grandfather” laws passed as part of financial reform laws passed in the waning months of the Clinton Administration in 1999, any commodities operations held by banks prior to October 1997 would be “grandfathered,” in other words not subject to the new set of requirements and restrictions.

According to Karen Shaw Petrou, co-manager of the Washington-based Federal Financial Analytics policy research firm, the Fed is considering measures “to clear up grandfathering and how it fits merchant banking. While such banks have long traded derivatives tied to all manner of commodities, there has been a growing trend among these financial institutions of becoming involved to various degrees with the actual physical commodity itself, such as Goldman’s aluminum storage racket.

Should Big Banks Play a Role?

While some businesses and industry groups such as Boeing Co. (BA) and the Chamber of Commerce have contended that banks play an essential role in managing the risk that inevitably accompanies basic materials, critics say that under the current circumstances, it is simply too easy for these financial institutions to manipulate commodities markets to their own advantage.

Neither Goldman nor Morgan Stanley’s stocks were affected by the news, but either way Wednesday’s news is just one more item in a growing list that would seem to indicated the Federal Government is becoming far more serious about regulating the excesses of the industry.

 

 

[Image Courtesy of Wikimedia Commons]

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