Occupy the SEC (“OSEC”) has submitted a letter to the Federal Reserve Board of Governors (“Board”) regarding that agency’s advance notice of proposed rulemaking on physical commodities transactions under three provisions of the Bank Holding Company Act (“BHCA”). The Board revisits these provisions at a time when the Dodd Frank Act’s momentous changes in systematic risk regulation and recent abuses of the BHCA demand heightened prudential regulation, including heightened examination and leverage-based and risk-based capital requirements, and divestiture of existing commodities operations.
The Board now has the opportunity to reinstate the historical separation in American law between financial and commercial activities that kept banks from becoming Too Big to Fail and overwhelming the economy. It can prohibit institutions that receive federal depository insurance and implicit federal guarantees to act in a manner that threatens environmental pollution and risks systematic financial contagion. It can limit or mitigate speculation in physical commodities and derivatives markets that has created artificial scarcity in products such as wheat and oil on which billions of people—and governments—are reliant.
The BHCA, passed in 1956, was only one response to concentration in the banking industry and repeated financial crises at the turn of the 20th century that often began with speculative commodities transactions. Those crises also led to progressive citizens’ movements, and the Clayton Antitrust and the Federal Reserve Acts of 1913. These laws helped prevent banks from limiting innovation and controlling financial and commodities markets—as well as the institutions of government themselves.
The Board must implement the systematic risk provisions of the Dodd Frank Act and the Volcker Rules’ limits on proprietary trading in limiting unsafe physical commodities operations. The Board recognizes in the ANPR the risk that physical commodities operations in such fields as petroleum trading and refining pose to a still heavily leveraged and overly complex financial system. OSEC agrees that a single environmental risk involving a Bank Holding Company (“BHC”) or Systematically Important Financial Institutions (non-BHCs) under Title I of the Dodd Frank Act could suffer liability, reputational, and liquidity risk that would threaten institutional survival and could contaminate and destroy the financial system. The Deepwater Horizon disaster and the extensive operations of BHCs in fields such as energy management are excellent examples of the operations’ multi-tiered threats. As a result, the Board cannot ignore that license that Title I provides for it to institute severe leverage-based and risk-based capital requirements, reporting and disclosure requirements, and liquidity requirements, among other regulations. The merchant banking rules, with permit passive investments in companies with physical commodities trading operations, are limited under the Volcker Rule’s restrictions on private equity investments. The Board must also institute reporting and disclosure requirements, more extensive bank monitoring, and limit the duration and active management of merchant banking investments.
The ANPR does not comprehend that BHC physical commodities trading threatens more volatile core commodities prices and the growth of the economy and jobs. The Board, however, has a dual mandate to limit inflation and ensure full employment and cannot only concern itself with the stability of a jury-rigged and unreliable financial system as it threatens to malfunction and explode. OSEC contends that the physical commodities trading operations risk the productivity and safety of the entire economy and stable, dependable job growth. They also threaten to limit access to vital commodities such as wheat, soybeans, aluminum, and oil and cause increased poverty and geopolitical disruption.
OSEC contends that the Board intensified these dual crises when it failed to apply the proper criteria in its actions on the complementary, grandfathering, and merchant banking provisions of the BHCA. The Board, starting in 2003, approved such actions as petroleum trading as complementary to financial activities without properly analyzing their risks to financial system and firm safety and soundness as well as competition in the physical commodities markets. Evidence of illegal price manipulation and risky activity demands the rescission of those orders and divestiture of physical commodities operations. The Board improperly interpreted the temporary and permanent grandfathering provisions of the Act to permit new BHCs to hold onto an unlimited swath of physical commodities activities. The Act generally allows for only a three year temporary conversion period, with two extensions, and institutions such as JP Morgan and Goldman Sachs that became BHCs after Sept. 1999 can only hold onto physical commodities activities they possessed in Sept. 1997. OSEC asserts that the Board implemented merchant banking rules with few restrictions on the lengthy term they can be held or on active BHC management of subsidiaries and little role for active internal Board monitors at those institutions.
These omissions demand that the Board revisit its regulations and orders and require divestiture or at least extensive prudential limits on physical commodity operations. The recent financial crisis illustrated the limits to prudential regulation and tools such as Value at Risk for both banks and regulators when it comes to unpredictable and severe crises. We recommend that the Board adopt a precautionary approach and at least require transparent reporting and disclosure, significant leverage-based and risk-based capital requirements, liquidity requirements, and limits on the duration and intensity of BHC management of operations. Prudential regulation would mitigate but not resolve the difficulties with the current BHCA operations.
Indeed, the Board fails to recognize in its ANPR that physical commodities operations could result in massive environmental liability and that the Federal government could become responsible for initial remediation and cleanup costs. Under statutes such as Superfund (CERCLA), the possibility that the Federal government will become responsible for initial remediation costs is significant. There is a possibility of massive initial, or even permanent, social and environmental disruption even if the polluter does not evade its responsibilities under the bankruptcy or resolution procedures under Title II of the Dodd Frank Act. There is no justification for providing a further subsidy so that BHCs can engage in risky and socially unproductive activities.
The Board has also failed to recognize that the massive and cumulative physical commodities investments permitted under the complementary provisions of the BHCA require that the agency issue an Environmental Impact Statement. The National Environmental Protection Act (“NEPA”) requires that agencies make such statements before certain major agency actions, such as permitting risky petroleum drilling, to allow for a fully informed process.
The Board, finally, fails to square the explicit and implicit subsidies that BHCs receive with their negative effects on physical commodities and derivative markets as well as productivity. Since deregulation in the 1980s, physical commodities and derivative markets have increasingly resembled other speculative financial markets. Further permission for speculation will allow unfair competition with BHCs using the massive capital structures that are the product of heavy government guarantees to concentrate resources and benefit from insider information to the detriment of customers and the public. Recent Federal Energy Regulatory Commission enforcement actions against J.P. Morgan and other BHCs manipulating the energy markets illustrate the negative effects on the economy. Although certain customers could benefit from deals, they threaten the productivity and stable growth of the economy.
OSEC contends there is no justification for allowing activities that were the subject of criminal prosecution in the Enron crisis and which threaten global financial safety to continue. The Board must significantly revise its prior orders and regulations to permit a safer, more productive financial sector and a wider economy that works for the benefit of all.