Sen. Joseph Lieberman (D-Conn.), chairman of the Senate Homeland Security and Governmental Affairs Committee, said at a hearing May 20 that he will be considering drafting an “outline” of legislation that would limit the role of institutional investors in commodities markets and close what he termed a “loophole” that allows large investors to circumvent commodity position limits.

The move would endorse recommendations made by a witness at the hearing, Michael Masters, who is a managing member and portfolio manager for Masters Capital Management, a hedge fund. Masters told the committee that institutional investors--specifically, those that park money in passively managed commodity indexes--are “one of, if not the primary, factors affecting commodities prices today.”

Masters said such investors, which he termed “index speculators,” “provide no benefit to the futures markets, and they inflict tremendous cost upon society.” While he acknowledged that such investors--which include pension funds, endowments, and sovereign wealth funds--are acting legally and with no malicious intent, “collectively, their impact reaches into the wallets of every American consumer.”

Masters, who said he is not “currently involved” in trading on commodity futures markets, also cited what he called a “swaps loophole” that he said affords institutional investors an exemption from speculative position limits when they hedge “over-the-counter” swaps transactions. “This has effectively opened an unlimited loophole for speculation,” he testified.

Close Loophole, Change ERISA.

Besides closing the so-called swaps loophole, Masters recommended that Congress modify Employee Retirement Income Security Act regulations to prohibit commodity index investing strategies as unsuitable because of the damage they can inflict on the economy as a whole. He also recommended that the Commodity Futures Trading Commission reclassify all the positions in the “commercial trader” category of its Commitments of Traders Reports to distinguish between positions held by “bona fide physical hedgers” and more passive institutional investors.

Several senators on the committee seemed compelled by Masters' testimony, most importantly Lieberman, who directed his staff to work with him in considering legislation.

CFTC Action.

Meanwhile, CFTC Chief Economist Jeffrey Harris told the committee that the agency hoped to announce several new initiatives to deal with rising agriculture commodities prices “fairly shortly.” At the same time, Harris, as he did the previous week in front of a House subcommittee, denied that institutional investors were responsible for rising commodities prices, or that excessive speculation exists in those markets (40 SRLR 807, 5/19/08).

In his testimony, Harris said that “all the data we have analyzed indicates that little economic evidence exists that demonstrates futures prices are being systematically driven by the speculators in the [agriculture] and energy markets.” Harris cited statistics showing that prices in commodities with no futures markets or with little to no institutional money have risen alongside the others.

In his written testimony, the chief economist acknowledged that “others have asserted that historically high futures price levels have been driven by speculative traders. However, our comprehensive analysis of the actual position data of these traders fails to support this contention.”

Instead, he said prices are being driven “by powerful, economic fundamental forces and the laws of supply and demand.” Specifically, he noted, these include increased demand, a decreased supply, as well as the weakened U.S. dollar. “Together these fundamental factors have formed the perfect storm that is causing significant upward price pressure on futures across the board,” Harris said.

Asked what recommendations he would have for Congress in combating the rise in commodity prices, Harris urged lawmakers to “focus on broad economic policies rather than trying to pinpoint behavior in the marketplace.”

Many members of the committee, however, seemed far more intrigued with Masters' conclusions than Harris'. Committee ranking member Susan Collins (R-Maine), who said she went into the hearing with an open mind, told Masters, “I find your basic premise to be compelling. It seems to me that when you have this massive influx of [index speculation] that that would drive up the cost beyond which you would otherwise see.” Collins, however, said she foresaw a possible conflict inherent in Masters' call to limit pension investing, saying it would put the interest of pension investors for a high return on their funds at odds with the desire of pension recipients to keep commodities prices manageable.

For his part, Lieberman said at the end of the hearing he has concluded that “index speculators are responsible for a significant part of commodity price increases that are really hurting a lot of individuals [and] a lot of businesses, and we ought to see if we can do something about that.”

Meanwhile, other members of the committee criticized Harris for everything from ignoring the role they have concluded that speculators and institutional investors are playing in spiking commodities prices, to being indifferent to the plight of Americans suffering from the extraordinary rise in prices.

Pitchforks.

Sen. Claire McCaskill (D-Mo.) told Harris that “the people of America are about to take up pitchforks, and we are feeling the heat here in Congress. … [But] it does not appear that our cop on the beat,” the CFTC, “feels the heat.” She continued: “I know that part of [the regulator's] job is to be careful and cautious and modulated, but I think we are all frustrated because it appears you are saying, 'Hey, no harm, no foul.' … I think it's time to muscle up.”

Sen. Carl Levin (D-Mich.) spoke for several minutes, took issue with Harris' notion that there was no link between speculation and rising energy commodity prices. “You're supposed to be the cop on the beat regulating excessive speculation, and I don't think you even recognize its existence,” Levin said. When Harris responded that the commission indeed had been engaged in studying the role of speculators for years, Levin interrupted him. “Engaged? I don't mean studying, I mean doing something about it.”

Later in the same exchange, Levin said, “You monitor, you update, you study--you don't do a darn thing about it. You're supposed to be the cop; you're our regulator. … We want a cop on the beat, [but] you don't see the problem. You don't act against that incredible, dramatic increase in speculation as far as I can tell. You don't even recognize it. Your studies show you can't even find a relationship. … To me, unless the CFTC is willing to act against speculation, we don't have a cop on the beat.”

Monetary Issues.

Meanwhile, another witness, Benn Steil, director of international economics at the Council on Foreign Relations, told the committee that there was “little evidence” that speculation was having a manipulative effect on futures markets. “Low and declining levels of inventory for major food crops, for example, indicate no potentially manipulative hoarding going on in that sector” he testified.

For crude oil, he said evidence indicates that speculative money follows the actions of commercial traders, “so that commercial rather than speculative position changes are driving price changes.” That determination coincides with the position the CFTC has taken since at least 2005, when it released a report drawing the same conclusions about the interplay between commercial hedgers and speculators (37 SRLR 833, 5/9/05). Steil also agreed with Harris that fundamental factors related to supply and demand can account for “a goodly portion of the run-up in prices in recent years.”

Steil, who Lieberman called a foremost expert on monetary policy, said the United States is at the end of what he termed a “currency bubble” of the last 25 years and that “the correlation between dollar depreciation and commodities prices has become dramatically more pronounced since 2007.” He urged the government to study the subsidies and taxes used to balance consumption and investment in commodities futures, as well as to intervene to help revive credit markets.”

By Richard Hill

Copyright 2008, The Bureau of National Affairs, Inc.