In 1992, during the final months of President George H.W. Bush's administration, Wendy Lee Gramm, was the head of the U.S. Commodities Futures Trading Commission (CFTC). The CFTC oversees the commodities market and applies the regulations set forth under the 1936 Commodities Exchange Act (CEA), a measure enacted by Congress to prevent another collapse on the scale of the 1929 crash. One of Wendy Gramm's final acts as chairwoman in January 1993 was to create an exemption that allowed companies - like Enron - to trade energy futures contracts (agreements to deliver energy commodities at a set price in the future) and to hide these trades from the CFTC itself.
Gramm left the CFTC, and five weeks after creating this exemption, she became a board member of - you guessed it - Enron. In return for her work deregulating the market for Enron to exploit, she racked up millions as an Enron board member prior to the company's collapse. The company would also donate hundreds of thousands to the campaigns of her husband, former Senator Phil Gramm of Texas.
The Gramms were just getting warmed up.
Eight years later, at the end of President Bill Clinton's second term and the waning days of the 106th Congress, Senator Gramm dusted off an old bill and attached it as an amendment to an 11,000-page appropriations bill. As a rider to a much larger bill, the Commodities Futures Modernization Act was no longer subject to the normal vetting process in Congress that a stand-alone bill would receive. Lawmakers, undoubtedly feeling the pressure of the holidays and lacking the time to thoroughly review the voluminous document, quickly approved the bill for the president's signature.
On Dec. 21, 2000, the appropriations bill was signed by President Clinton. Gramm's amendment came to life and deregulated all energy futures trading. In recent years, that amendment has been commonly referred to as the "Enron loophole." The trading power that it unleashed would ultimately lead to Enron's demise. But it would take another six years, another President Bush and a new Congress to open the floodgates of rampant speculation.
The easiest way to think about commodities is that they are physical things that can be measured in size, quantity or volume. Fruit. Oil. Grains. Metals. Currency. All these have unique characteristics and trade against one another on commodities exchanges throughout the world. It is a complicated system that's not for the faint of heart. Commodities traders are highly specialized in their fields, and their discipline is so narrow that it's largely misunderstood.
An important aspect to the commodities market is that there has always been a ceiling to the transactions, and every investment made in the United States must be overseen by the CFTC. This market cap and transparency kept the commodities market in relative obscurity against its much bigger counterparts, the stock market and the bond market. Federally regulated markets, like the New York Mercantile Exchange (NYMEX), tracks the transactions of commodities, and limits were enacted under the Commodities Exchange Act to keep any one investor, or group of investors, from overwhelming the exchange and flooding it with money.
But the Enron loophole essentially permitted the trading of energy futures on over-the-counter markets, thereby allowing a new set of investors - hedge funds and investment banks - to trade energy futures. Still, the U.S. exchanges saw relatively little activity as compared to their European counterparts, where the oversight was far more lax. Because commodities trade in real time and U.S.-based companies have the most money to invest, the investment banks and hedge funds were still slow to drive great sums of capital into the market. What they needed to really make this thing soar was the ability to invest serious capital within the United States, like their counterparts could on the London Exchange, for example.
In 2000, Goldman Sachs, Morgan Stanley and British Petroleum became the primary founders of a little-known exchange based in Atlanta, the Intercontinental Exchange (ICE). A year later, it purchased the London-based International Petroleum Exchange (IPE) and was renamed ICE Futures. It was an acquisition that was fairly straightforward - until 2006, when the CFTC, seemingly out of nowhere, officially recognized the ICE as a foreign-based exchange because it had purchased the IPE.
So even though the ICE is based in Atlanta, backed by U.S. banks and now traded publicly on the New York Stock Exchange, the CFTC decided to treat it as if it were based in London and therefore no longer subject to federal trading regulations. Now the investment banks could trade every type of commodity, especially crude oil, without any spending limits or federal oversight.
It was here that the wheels began to fall off the commodities market. John Mack, the chairman and CEO of Morgan Stanley, has had an illustrious career, holding some of the most lucrative and prestigious positions on Wall Street. Nicknamed "Mack the Knife" because of his hard-edged, no-nonsense approach and hardcore cost-cutting measures, Mack ran Morgan Stanley through the '90s before accepting the job as co-CEO of Credit Suisse First Boston, a leading investment bank, in 2001. Mack left CSFB in 2004 and was wooed back to run Morgan Stanley in '05. Upon his return, Morgan Stanley went on an aggressive oil-buying spree - but not necessarily the kind you might expect.
On May 24, 2006, Morgan oil analyst Douglas Terreson announced that integrated oil equities were "15 percent undervalued." In a research report, he wrote that, "Independent refining and marketing remains the largest sector bet in the global model energy portfolio." Soon after, on June 18, 2006, Morgan Stanley acquired TransMontaigne Inc. and its subsidiaries - a half-billion dollar group of companies operating in the refined petroleum business.
How convenient. After its oil analyst decides that this portion of the industry is looking up, Morgan Stanley gets into the oil business. This type of freewheeling environment, with little separation between the proprietary desks at the banks and their investment analysts, was unorthodox. "[There must be] a verifiable and hardened wall between analysts and the investment entities," because it's the only way to maintain integrity, says former CFTC employee Michael Greenberger. But this separation is essentially what the CFTC was dismantling, right under everyone's noses.
Morgan's investments in the oil business continued aggressively over the next year into the far corners of the industry. In short order it closed the circle of the supply chain by acquiring Heidmar, a shipping company, and various stakes in foreign-based energy supply companies. It even snagged a contract from the U.S. Department of Energy to store 750,000 barrels of home heating oil at its corporately owned terminal in New Haven, Connecticut. Morgan Stanley, which was at the time the largest trader in oil futures, was now a serious international oil company.
Douglas Terreson was Morgan Stanley's chief oil analyst. The award-winning, nationally recognized Terreson had fielded questions in relation to oil prices and futures since the mid-1990s. On March 14 of this year, he said that oil would settle in at around $95 per barrel for the remainder of 2008. Moreover, Terreson also concluded that oil would retreat to around $83 per barrel for 2009.
This would be Terreson's last forecast for Morgan Stanley.
Two months later, Dow Jones Newswires reported that Terreson had been ousted in a round of layoffs. Two weeks after that, Richard Berner, Morgan Stanley co-head of global economics and chief U.S. economist, issued a statement saying that crude oil could easily reach $150 a barrel. This set off a round of speculative fervor never before seen in the market. Goldman Sachs immediately followed suit by forecasting oil to roar beyond $150, saying it could hit $200 a barrel in the near future. Oil prices were off to the races, with the investment banks in full lobbying mode - while citing rising demand in China and India as the cause.
So, where did this $150 number come from?
A spokesperson for Morgan Stanley says that Richard Berner "doesn't do interviews on oil stuff." In fact, "he doesn't deal in oil" at all, says his assistant matter-of-factly. That's because for more than a decade this had been the exclusive domain of Terreson.
A month after the report that Terreson had been laid off, Morgan Stanley issued a statement claiming that Terreson voluntarily left his position at Morgan for the promise of higher pay from a hedge fund. Not so, according to a Morgan Stanley employee familiar with the circumstances surrounding Terreson's departure, who asked not to be identified. "I knew they had a rightsizing, but he said he was retiring. He was getting ready to head off into the sunset."
Reached at his present residence in Alabama, Terreson said, "I'm retired. I'm not with Morgan anymore and can't talk about any of this." When asked for a brief comment on current oil prices, he responded, "I don't feel comfortable talking about it," and hung up the phone. In May, Michael Masters, the managing member of Masters Capital Management LLC, a hedge fund that invests in private equity, testified before the Senate's Committee on Homeland Security and Governmental Affairs. His testimony brought speculation into the light and sent shockwaves through the halls of Congress.
Masters was able to simplify the exchange and put the issues in a context that lawmakers could grasp. One of the telling examples he gives is that "Index speculators [companies such as Morgan Stanley] have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States has added to the Strategic Petroleum Reserve over the last five years."
This essentially squashed the claims of that investment banks had been making, that demand from China and India was solely responsible for the increase in oil futures prices.
"The way [the price of oil] ran up had all the earmarks of manipulation," says Gary Aguirre, a former staff lawyer and investigator for the Securities and Exchange Commission (SEC) and authority on financial markets. "It looked like somebody was playing a game. I don't know what the game was or how they did it but that was … the smell drifting my way." In 2005, Aguirre headed up an investigation into an insider trading claim involving Mack and a hedge fund named Pequot Capital Management. There were allegations of insider trading, but just when the investigation seemed to be gaining momentum, Aguirre was told to back off by his bosses at the SEC. After a glowing review from his superior, Aguirre went on vacation. When he returned, he got a pink slip.
Aguirre insists that his own experience is merely part of a larger and much scarier problem running rampant on Wall Street.
"What we have are the markets highly leveraged, highly speculative and without any regulation, effectively, of the abuses," he explains. "In short, it's not much different than it was just before the crash in 1929." The cozy relationship between oil companies and the U.S. government is nothing new. Aguirre explains the "you scratch my back" culture in monetary terms by saying, "These people are sponsored by the industry. [U.S. Treasury Secretary Henry] Paulson's straight out of Goldman [he was chairman until June 2006]. We have the fox guarding the henhouse." "Double Jeopardy: Responding to High Food and Fuel Prices," a report issued by the World Bank in July, estimates that "up to 105 million people could become poor due to rising food prices alone," with "30 million additional persons falling into poverty in Africa alone."
The report links the effect of high food prices directly to rising energy and oil costs - but stops short of blaming speculators, claiming that commodity investors and hedge fund activity appear to have played only a "minor role" in the increase of food and fuel prices. The report's source for this assertion: The CFTC.
But the eye-opening testimony from Masters in May was a scathing indictment of the CFTC's thinking. He claimed: "The current wheat futures stockpile of Index Speculators is enough to supply every American citizen with all the bread, pasta and baked goods they can eat for the next two years."
As far as the much maligned "corn for ethanol" program that has environmentalists and lobbyists alike backing away, Masters contends that, "Index Speculators have stockpiled enough corn futures to potentially fuel the entire United States ethanol industry at full capacity for a year."
At least high oil prices have us thinking about alternative energy, right? According to James Howard Kunstler, author of The Long Emergency and creator of the popular blog Clusterfuck Nation, it's a case of too little, too late: "No amount of alternative fuels is going to allow us to run the stuff we're running the way we're running it, and we have to get hip to that. We're not going to run the interstate highway system and Wal-Mart and Walt Disney World on any combination of ethanol, solar, wind, nuclear or chicken fat. We're going to have to make other arrangements for daily life, and it's the one thing we're not talking about."
Kunstler has very little faith that we can afford the new technology, let alone old fossil-fuel technology. "The 'whoosh' that you hear in the background is the sound of capital leaving the system," he muses. On this, most everyone agrees: Kunstler, Greenberger, Aguirre and Masters all come from diverse backgrounds, but all point out that our financial system seems to be hanging by a thread and that the corrupt regulatory system is mostly to blame. Why drive oil prices beyond practical limits? The better question: Was it dumb luck that this speculation occurred at a time when the major investment banks were reporting record losses and write downs? The worst part is, it was all legal.
The federal government, beginning with Wendy and Phil Gramm, cleared the way for tremendous systematic abuse in the financial markets to fatten the Gramm family bank account with blood money - Wendy Gramm's multimillion-dollar take as an Enron board member and Phil Gramm raking in more than $335,000 in campaign contributions from the securities and investment industries.
Instead of being punished for these now well-documented actions, Wendy Gramm is still influencing Capitol Hill as a distinguished senior scholar of the conservative think tank Mercatus Center at George Mason University, in Virginia. Phil Gramm has been advising Republican presidential candidate John McCain (and attracted unwanted attention a few months back for referring to Americans who are fearful over the economy as "whiners"). People are beginning to contemplate dwindling oil supplies and imagine that while the world may have flattened out for a while, it's getting a whole lot rounder again. Kunstler proclaims, "Globalism was a product of a certain time and place and special circumstances, namely, a period of very cheap oil and relative peace between the great powers." It's what he calls the "end of the happy motoring era."
Still, one can't help but think about how quickly the end of this era may be arriving and for what reason. The "demand shock" that Masters spoke of also created a hunger shock that reverberated around the globe. Perhaps the analysts and speculators were acting to save their own banks in the short run. But it seems awfully easy to manipulate the markets when you control so many pieces of the puzzle.
Congress has the ability to seize control of these markets even before the upcoming presidential election. The new president will decide whether we drill or not, but that decision has nothing to do with restoring the oversight and stability that existed in the commodities arena from 1936 until 2006. If it weren't for federal oversight and regulation, Morgan Stanley - which was created in 1935 from the ashes of the 1929 crash - wouldn't even exist. But history is often forgotten, or ignored, by greedy corporate raiders who are therefore destined to repeat it. A longer version of this article first appeared in Long Island Press.