Whether it comes to fruition is to be determined, but taken at face value, Connecticut senator Joseph Lieberman’s proposal to bar institutional investors such as pension and index funds from investing in commodities is a Nixon-goes-to-China moment, a significant indicator of Wall Street’s fallen standing.
Lieberman has been a staunch defender of the securities industry and repeatedly stymied the efforts of the last pro-enforcement SEC chairman, Arthur Levitt. But now he’s not simply willing to support legislation that will put a crimp in the financial services money machine, he’s leading a charge.
Now this move could be deeply cynical. Opponents may argue that this will simply drive investing in commodities overseas. Perhaps, but funds regulated under the Investment Company Act of 1940 (most US fund managers) don’t have that sort of latitude, and ERISA investments could similarly be reined in quite easily. And it’s US investors, plagued by (until recently) an ever falling dollar who have had particularly strong reasons to look to a hedge like commodities.
As a move to drive any speculative froth out of commodities, this one isn’t bad (but one wonders how all those commodities index funds get unwound). Although some have called for increases on margins at commodities exchanges, that hurts commercial actors as well as speculators. A move like this focuses on the underlying issue more directly.
Goldman in particular would suffer, since as the biggest manager of commodities funds based on its index, GSCI, it not only earns fees, but as we have discussed elsewhere, earns even more from an unsavory but hugely profitable practice called “date rape” around the monthly futures contract roll.
Now before the wealth-holding class howls that they’ve just been done a dirty by being deprived of inflation protection, there is an asset class that, unlike commodities, supports productive investment. and provides inflation protection, namely, infrastructure investments. The cash flow from infrastructure projects (toll roads, airports) goes up over time, as do the payouts, so they have fairly secure cash flow that increases over time. Although there is some debate about how to view them, they seem closest to an inflation-indexed bond (although any investor would need to study the ability of the enterprise to increase charges versus the drivers of operating expenses).
Overseas. investor allocations to infrastructure are often as high as 10%, while in the US, they are less than 1/5 that level.
From the New York Times:
A prominent Washington lawmaker said Wednesday that he would propose next week to ban large institutional investors, including index funds, from the nation’s booming commodity markets.The idea is one of several outlined by Senator Joseph I. Lieberman, independent of Connecticut, who is chairman of the Senate Homeland Security and Governmental Affairs Committee. That committee will hold a hearing on June 24 to continue examining whether financial speculation is affecting the prices of crops and fuel.
“There is excessive speculation in the commodity markets that is driving up the cost of food and energy,” the senator said in an interview. “The question is, do large institutional investors play a positive role?” His concern, he said, is that they do not….
One steady source of money has been the growing number of new funds that mirror specific commodity indexes, like the Standard & Poor’s Goldman Sachs Commodity Index. More recently, exchange-traded funds — popular new investment vehicles that trade on stock exchanges but track commodity prices — have followed the index funds into the market….
Besides what he called the “aggressive” idea of banning institutional investors from the commodity markets, Senator Lieberman said he would also put forward other ideas for discussion at the hearing on June 24.
One less-sweeping proposal would be to strengthen existing regulatory limits on the size of the stake that each speculative investor can hold in a given market, called speculative position limits.
And he plans to propose barring investment banks from using the regulated futures markets to hedge speculative bets their clients are making in the vast unregulated global swaps market — what he called “the swaps loophole.”
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It’s ironic that regulators want to get involved at market tops. I understand why they do, of course, but still, their timing is impeccable at marking inflection points.
Whether such a move would lower oil prices is not as interesting a question, since the trade is to short oil at these levels (or, since that’s extremely risky given the potential upside explosion before the very top, getting long the dollar as a proxy).
The question is whether legislative solutions, the kind proposed by Senator Lieberman or other proposals, will hurt us competitively in the future, after oil prices have crashed to “reasonable” levels. (Reasonable means maybe around 60 – 70 dollars.)
Attempting to fight the market, which is forward looking, with political solutions, which always “prepare for the last war,” (apologies for the lazy metaphor) seems difficult, to say the least. A timing mismatch.