CFTC COMMISSIONER CHILTON'S SPEECH TO THE AMCOT 2013 BUSINESS CONFERENCE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION

“Cowboy Company”

Speech of Commissioner Bart Chilton to the Amcot 2013 Business Conference, Lake Tahoe, California

August 5, 2013

Hey Yeah, Hold Your Horses!

Hey yeah! Much obliged for the introduction. It sure is a fine thing to spend a spell with all you good folks in this pretty part of the American West. I always get a little “giddy-up” when dealing with cooperatives, so it’s a great treat to be with each of you.

When people think of Tahoe, they may ponder “Tahoe, oh—skiing, the Lake, maybe golf or gambling. Heck, let’s go.” But today, well, let’s switch it up and talk about the Old West and Tahoe aglow, back in the day. This is a fitting place to do just that. The Ponderosa Ranch, from Bonanza, was just over yonder, on the Nevada side of the Lake. Remember the Cartwright’s? There was Ben who survived three wives, but begets a son from each one: Adam, Hoss, and Little Joe. And just a few miles from here, they hold the Genoa Cowboy Festival at the site of the first ranch in Nevada. (Not the Mustang Ranch—that’s 15 minutes east of Reno. Hey, you at the door, where ya going?) The first ranch in Nevada was Trimmer Ranch No. 1. Let’s assume there were others. The oldest saloon in Nevada is also in Genoa. A portion of the original bar from the 1800’s is still in use. And, the local phone book lists at least 25 places to “get your boots on” and get a pair.

Right about now, some of you might be thinking, “Whoa, hold your horses there, long hair.” Isn’t this supposed to be about financial regulation or commodity markets or something?” Yeah, Sundance, it is. We’re just going to kick up the dust a bit as we “tumble along with the tumbling tumbleweeds” and have our cordial conversationalizing. After all, like George Strait sings, “I ain’t here for a long time. I’m here for a good time.” So, let’s get to it and talk some about the Old West and our financial markets today.

Has anybody seen the new Lone Ranger movie? Ooh, not too many, eh? It received some rough reviews, although I found a few good ones. It tanked on opening weekend. As of a few days ago, the film had made $85 million in the U.S., and $164 million worldwide. The production budget was $215 million. So, not good, Kemosabe. The whole thing has the good folks at Disney cogitating some on that one. But, I’ll come clean: I’m partial to it. In fact, I really liked it! Yessiree, Bob. (Jarral asked me to refer to Bob Norris as “sir.” Yessiree, Bob. Was that okay, Jarral?) In fact my wife and I saw The Lone Ranger twice. Heck, he’s an American legend. Plus, I’m a patsy for Westerns and the William Tell Overture. Can’tcha just hear that tune? Hi-Yo Silver, away! It really gets you going. You can envision Silver rearing up then taking off like wildfire and galloping along. Lots and lots of action—ooh, ooh yeah!

Well, there’s a lot of action in financial markets too. How smooth was that? But it’s true. The William Tell Overture might as well be the theme music for our work, sun-up to sun-down these days.

Blue Jean Baby & Prospectors

So, let’s travel back those golden days of yesteryear, to the mid-1800’s. The Gold Rush was going strong here in California. Prospectors came to make their fortunes. Some did. Some didn’t. In addition to those gold prospectors, some folks that assisted them also found their fortunes. Think Levi Strauss, who switched very early on from canvas to twilled cotton cloth to make his now-famous pants. He later co-patented, with a Reno tailor, the pants with rivets to make them stronger. It was the birth of blue jeans. “Blue jean baby . . . L.A. lady, seamstress for the band” (sorry). But, it was the birth of blue jeans, if you will. There was also Henry Wells and William Fargo of stagecoach and now banking renown. One of the prospectors, Charles Bowles, had a side job. He robbed Wells Fargo stagecoaches of their strongboxes ‘round these parts. He committed 28 such robberies in Northern California in eight years and became better known as Black Bart. Gotta love the name.

At the same time, a group of market prospectors in Chicago started what would become the Chicago Board of Trade. Commodity prices were in disarray with extreme volatility that didn’t do anyone any good. These market prospectors sought to fix that. Cotton wasn’t one of the original products traded, but soon, it would be.

Here we are, all these years later, and like the Western gold prospectors who changed the way they looked for gold over the years, the market prospectors—in particular the speculators—have also changed, or morphed. The question I ask as a regulator, and I know some of you ask as well, is this: Are markets still performing the purposes envisioned by those folks back in the day? There are a couple of areas, actually some new types of traders and activities, which make me wha wha wha wonder.

The Massive Passive Gang

First, we have seen a “financialization” of commodity markets by a band of traders called Massive Passives—the Massive Passive Gang (they are a “gang” for today). Investors looking to diversify their present-day strongbox portfolios sought out the derivatives world and dumped roughly $200 billion into U.S. regulated futures markets as they were “coming round the mountain” between 2005 and 2008.

Say a pension fund wanted to diversify into commodities—there’s nothing wrong with that from my perspective. They aren’t Desperados. Nevertheless, the type of trading activity they undertake is different from what speculators have typically done. Instead of getting in and out of markets, maybe based upon a drought or other natural disaster, this gang of very large funds, pension funds, some hedge funds, exchange traded funds (ETFs), and the like buy and hold their market positions. They bury them, only to come back a few years later. They are both massive in size, and fairly passive in their trading strategy—the Massive Passive Gang.

Here’s the worrisome part, pardners: too much concentration in markets by too many of the Massive Passive Gang can influence and contribute to price abnormalities. Heck, just one large massive passive can impact price if they are large enough.

Take 2008, when crude went from right around $99 at the beginning of the year to more than $145 in July, then all the way back to $31 in December. All of that took place without much change in supply or demand. Convince me the Massive Passive Gang had no role in that market distortion and I’ll wear chaps and a fringe coat to your next meeting.

On cotton futures markets, absent a few exceptions (uh hum, 2008, pardon me…frog in my throat) since their inception more than 120 years ago, things have been comparatively stable. There are lots of commercial traders, like many of you and other end-user-related traders. Of course, we still have the market speculators. We need the speculators, want ‘em, gotta have ‘em, or we have no markets.

One thing that has changed is the length of the trading day. The markets run nearly 24-7-365. That’s actually caused some problems in cotton, by the way. Also back in 2008, we saw 14 days in about a six week period where markets went lock-limit, 11 of which were before sun-up in New York—ya know, back in the Old States. There was sparse liquidity, and traders in China in the markets, and what would normally not be huge trades pushed prices to the limits. Heck, the markets were locked before folks here had their eggs and bacon.

In response to what was going on in 2008 with the Massive Passive Gang, Congress and President Obama instructed us (as part of the Dodd-Frank financial reform law in 2010) to put in place speculative position limits. Those limits would ensure that regulators have the firepower to run excessive speculation outta these markets. To date, the limits aren’t in place. There’s fierce opposition out there, but we’re fix’n to pony up and fix that soon. In September I expect we’ll get back in the saddle again and put out a proposal on position limits. And, I believe the final limits rule will be in place come January of 2014. This rule, I assure you, won’t be able to be shot down (in a blaze of glory or otherwise).

So, that’s the Massive Passive Gang. Let’s go, daylights burning and we’ve got ground to cover.

The Fastest Gunslingers

There is a lot of debate about who actually was the fastest gun in the West. Some say Doc Holliday or Johnny Ringo deserve the designation. Others suggest Bat Masterson (born Bartholomew, by the way—what’s it about those dandy Western names?). How about Billy the Kid? The Kid thought he was the one, “I’m Billy the Kid,” he said, “…the fastest draw. It’s not arrogance. It’s the truth.” Maybe Wyatt Earp? Nah, he held that, “Fast is fine, but accuracy is everything.” Annie Oakley and Calamity Jane, the renowned sharpshooters, would agree with Sherriff Earp. Some suggest the fastest gun was John Wesley Hardin, also known as “Little Arkansaw.” He claimed to have killed 42 men.

Let’s talk about some other fast guns—market gunslingers. They’re a rough bunch of young guns, and a Wild West breed all their own. Not a horse, like the Lone Ranger’s “Silver,” or a cow, coyote or rattlesnake, but a cheetah. That’s right, a cheetah. Not a card cheater who sits in the gunfighter’s chair in the corner saloon, but a cheetah as in the fastest land animal. Those cats are the fastest trading guns. Sometimes you just gotta mix it up.

Now, I’m asking you to envision a cheetah with a hat (let’s say a ten-gallon hat, just for the hell of it), tooled boots with silver spurs, and a low-slung gun belt on those slim cheetah hips. That cheetah gunslinger is eyeballing us from 40 paces. Will we be fast enough to take him? In truth, nah, probably not. They usually win, those cheetahs, with their fancy spurs. Who do they think they are?

The thing is, those cheetahs gunslingers are always so hell-bent for leather when they trade that they are impacting the ability of you guys, and other end-users, to do what you need to do, to hedge. I mean, pardon you guys to pieces for simply trying to hedge your legitimate business risks. For crying out loud, you aren’t looking for a gunfight. You just wanna do what those original prospectors set in motion all those years ago. Yet, here you are, staring down the barrel of a gun. And . . . that gun is held by a damn cat, with a hat . . . at that!

How Fast is Fast?

How fast are these cheetah gunslingers? Well, it’s about a thousand miles from New York to Chicago. A recent article in the Financial Times pointed out that communications cables laid between the two cities meant that a message could be delivered in 14.5 milliseconds—70 round trips per second. Now that’s fast—cheetah gunslinger fast. But not fast enough for some who use those cables to trade commodities. It’s been reported that at least one company has cut that time down to 13.1 milliseconds and that microwave capability could get it under 10 milliseconds. Holy smokes!

Let me give you some of our own data: over the last year, we analyzed 20 million trading seconds. Of those 20 million, we pinpointed 189,000 seconds, primarily around the open and close of markets. In those 189,000 seconds we found something astounding: cheetahs traded at rates of 100-500 trades per second in a major commodity market! Trading 100 to 500 times per second, as a gang, in one commodity contract? That’s pretty hard to wrap your head around. Heck, it’s easier to imagine our cheetah friends in their gunfighter get-up.

Why this need for speed? It’s not the need to stay alive like an Old West gunfighter, of course not. It’s about the dinero, the loot. A study late last year, which was conducted in conjunction with the CFTC, said in essence that cheetah trading imposes quantifiable costs. Aggressive cheetahs make a lot of money, and they make their biggest paydays when they trade with small, traditional traders. A cheetah trading with a fundamental trader—like a lot of you—makes $1.92 on a $50,000 trade, but if that same trade is made with a small trader, the number goes up to $3.49. This could end up pushing smaller, slow-shooters out of markets and it doesn’t help the fundamental traders either.

But that’s not the only issue with the cheetahs, no sirree.

Ghost Town Liquidity

The name “Tahoe” actually came from the name “Washoe,” which is the name of the Native Americas that inhabited this area for something like 6,000 years. In fact, Washoe City is located just south of Reno. In the 1860’s it was booming with a sawmill for lumber used in Virginia City (ya know, where the Cartwright clan went when they went to town—da ta da da da, da da da, ta da da, da da da daa). Washoe City was even the county seat of Washoe County (it’s now Reno). But today, you can’t even visit Washoe City. It’s all fenced off. Washoe City is an Old West ghost town.

That brings us to another problem area with the cheetah gang. I told you it was like the William Tell Overture—lots going on. In fact, this ghost town thing is sort of a dirty little secret. It involves “wash” trading, where cheetahs (and sometimes others) trade with themselves. They make a bid or offer and they hit it themselves. Putting a price out and hitting it yourself, you take no risk, yet create the impression that a legitimate trade has occurred. That entices others—easy prey—to get into markets. But the liquidity isn’t real. It’s ghost town liquidity. If this was only for a few trades, it wouldn’t make much difference. However, there is a lot of ghost town liquidity. I mean a whole lot. “Voluminous” is the word I’ve used. And if this ghost town trading amounts to wash trading, it’s not only wrong, but based upon the facts and circumstances, it is illegal. That’s because wash trading is clearly unfair to other traders, and it can impact price discovery which is unfair to consumers.

Wash Blockers—20-Mule Team Borax!

One might think the exchanges would put in place what are called “wash blockers.” That sounds like a commercial: “Wash blockers—for cleaner markets!” Remember Death Valley Days? “Brought to you by 20-Mule Team Borax.” The show was Ronald Reagan’s last acting gig before he went into politics.

Wash blocker technology is available and exchanges are starting to put more of an emphasis on it. In my view, traders shouldn’t be able to just opt-in to the technology requirements if they want to. It needs to be mandatory that they utilize wash blocker technology. Otherwise, we’ll still have ghost town liquidity and markets that aren’t necessarily fair and effective.

So, that’s the cheetah gang and we did the Massive Passive Gang. Let’s head down the trail to our last topics.

Bank Ownership

When we think about how the West was won, it had a lot to do with the railroads. As the Iron Horses moved from east to west, towns along the line grew. But towns could never ever have amounted to much without banks. The banks helped build the towns. They made loans to individuals and businesses. They helped fuel economic development. They built communities. Some refer to the Winchester rifle as “The gun that won the West.” But I’ll tell ya, a good case could be made that banks won the West.

However, just like markets have morphed with the Massive Passive Gang, with non-stop trading, with our cheetah gunslingers and their “gee whiz” technology, so too have the banks changed. And it seems some have lost sight of those noble endeavors for which they are known as the country moved west.

A decade ago, in the shifting climate to allow banks more freedom, several policy changes took place. One such change was approved by the Federal Reserve. It allowed the ownership of totally unrelated businesses. The idea was that it was a good thing for the banks to be diversified. It was okay to get away from their sweet spot—ya know . . . banking. Like folks do when they see an opening, the banks got into all sorts of other businesses—businesses which include physical commodities like agriculture, energy or metals. It also includes owing the storage or warehousing facilities of commodities, and/or the delivery mechanisms of commodities—like pipelines, shipping, rail or other transportation interests.

Bank Ownership: The Data

You might wonder, “What it is they actually do own?” Well, let me tell you a story. A couple of weeks ago we rounded up a posse to look and see what actually is owned by the banks. I’m a financial regulator; you’d think it would be a piece of pie to find a list of what they own, right? I mean, it would be understandable if there were certain business reasons why a few particulars of the ownership information might not be available to the public. Nevertheless, you’d think I could get it. After all, banks own commercial interests that can impact prices, and at the same time their trading desks are all over the very same markets. There are obvious conflicts of interest. I’m not saying there have been any violations of the law, but how would we even know?

Our little posse did find that Morgan Stanley has ownership stakes in oil tankers and a fuel distributor. And, of course, they also trade crude oil and other energy contracts. Parts of Citigroup, Goldman Sachs and Bank of America own or have owned power plants. They also trade energy contracts. And, everybody’s been talking about Goldman Sachs holding onto aluminum at warehouses they own. Some say that’s consequently driving the up the price of beer and soda, while the bank collects storage fees. And, they trade aluminum. JP Morgan also owns similar warehouses, although they said last week they may get out of commodities. We’ll see. Oh, and by the way, Barclays and JP Morgan are putting out hundreds of millions of dollars in restitution for getting caught rigging electricity prices. There is that.

But, getting other information on ownership of the banks has been super difficult, at best. Maybe we need a “WANTED” poster:

W A N T E D

Information leading to the apprehension of ownership data related to large investment banks, including but not limited to businesses related to commodities, the storage and warehousing of commodities, and/or the delivery mechanisms of commodities.

This might be a little amusing if it weren’t such a serious thing that the information isn’t readily available. In fact, its sorta deja-oohish in that it’s reminiscent of that period of time, just before the financial crisis, when folks were asking questions about the valuation of credit default swaps (CDSs). Nobody could turn up much of anything. We all know how that troubled tale of tragedy ended . . . in tragedy and economic catastrophe. So, this is a big deal.

Tracking down this information should be an immediate responsibility of regulators. It’s gonna require more bodies and more horses, and maybe that “WANTED” poster, but we need to find out specifically—and comprehensively—what banks own relating to physical commodities. Furthermore, the basic ownership information should be transparent, certainly to regulators. And public information should be easily accessible on the Federal Reserve’s website or someplace where people can view it without needing a bloodhound to track it down.

Bank Ownership: The Work-Around (Volcker & Limits)

There is also a related issue with ownership of commodities by banks. If the banks own the physical commodities, warehousing or delivery mechanisms, they may then contend that their “legitimate business interests” should allow them to hedge those risks, in addition to hedging their financial proprietary risks.

This approach could amount to yet another work-around the Volcker Rule. Recall the Volcker Rule? It’s a provision of Dodd –Frank that requires that banks no longer be able to conduct speculative trading. They may only hedge their legitimate business risk. But, if they own the physical, then it muddies up what is their business risk.

I’ve written to Chairman Bernanke about this issue (and am discussing it for the first time today). In the letter, I urge that the final Volcker Rule be written in a precise and surefooted fashion that allows only for appropriate hedging of banks proprietary risks, but firmly prohibits speculation. I even provided rule text language for his consideration. I won’t vote for a final Volcker Rule unless this language, or something substantially similar, is included in the final text.

Incidentally, owning the physical could also be used as a way around speculative position limits. (I’m working on that one.) We’d be fools to think the bank lawyers aren’t thinking about these work-around end runs.

Bank Ownership: Reverse the Policy!

One easy way to stop the work-around is to simply have the Federal Reserve’s ownership policy reversed. Why can’t the banks, just can’t get back to banking? That’s my preferred policy. I don’t want a bank owning an electric service, or cotton, corn or feedlots. I don’t want banks owning warehouses, whether they have aluminum, gold, silver, or anything else in them. Get back (Jo Jo) to making loans to individuals and businesses to help get our economy on track. We don’t want Cowboy Companies out there. We don’t want a Wild West anymore when it comes to our economy. Do what you did when the West was won, when you helped to build the frontier. That is such an honorable, worthy, noble and essential endeavor. Plus, you were so very good at accomplishing so much!

I hope the Federal Reserve, which announced last week that the policy was being reviewed, actually reverses it. They can and should reverse it. Sure, if they have to grandfather some of the bank ownership in for a time-certain, I get that. The banks shouldn’t be required to take a loss due to the policy change. But the policy should, in fact, change, and soon. And, if the Fed doesn’t do so, I expect there will be efforts in Congress, and I hope there are, to prohibit such ownership by changing the law.

Cowboy Ethics

Our trail has come to an end. However, I’d like to leave you with this: there’s a book out by a gentleman named James P. Owen who’s a cowboy and western lover and who also happens to be a 40-year veteran of Wall Street. The book’s called Cowboy Ethics. It is sort of a coffee table book with a message—great photography, too. Owen opines that businesses today, especially the behemoth banks on Wall Street, need to live less by the “greed is good” mantra and more like the Code of the West. “When you make a promise, keep it.” “Remember that some things aren’t for sale.” “Know where to draw the line.” Do those sound like mantras for Wall Street? Unfortunately—not so much. You folks can recall the horrific headlines of malfeasance as well as anyone. A recent study queried 250 financial service industry insiders and 23 percent said they had “observed or had firsthand knowledge of wrongdoing in the workplace.”

For a while now, I’ve been saying that there needs to be a culture shift in the financial sector. How about the responsibility to customers, to society and the economy? Maybe the Code of the West is just the thing.

Conclusion—Shut Up

There’s a scene near the end of The Lone Ranger where, as the sun is setting, the masked man rears up on Silver, and says the famous “Hi-Yo Silver, away!”—only time in the movie he actually says it. And Johnny Depp, as Tonto, says, “Don’t ever do that again.” Well, I’m not going to stop working on these issues. I’m going to remember the Old West and how and why these markets began. I’m going to talk about them and work on them again and again. Even if the William Tell Overture remains our theme song.

However, there’s another old cowboy adage, “Never miss a good chance to shut up.” So, for now I’ll just say . . . thanks, Kemosabes.

CFTC COMMISSION CHILTON SPEAKS AT NATION GRAIN AND FEED ASSOCIATION'S ANNUAL CONVENTION

Photo:  Food.  Credit:  National Institue Of Health.

FROM: U.S COMMODITY FUTURES TRADING COMMISSION
"The New Prospectors"
Speech of Commissioner Bart Chilton to the National Grain and Feed Association’s, 117th Annual Convention, San Francisco, California
March 18, 2013
Introduction: The Gold Rush

Hi-ya! Thanks to Todd Kemp for the invitation to be with you in San Francisco, the great Dianne Feinstein's city. Nancy Pelosi's town. And a state that boasts many superb government servants like Senator Barbara Boxer and your earlier speaker Congressman Jim Costa.

It is hard to believe this is NGFA’s 117th convention. That’s way back. Your first was held in 1894. Wow!

I'm going to ask you to go with me now, to take a little trip, even further back—back to 1848.

It was a time of adventure and gambling on the future in a lawless land. That's when James Marshall discovered gold, about 140 miles from here. Not many people knew about the discovery. One fellow who had the ability to publicize the discovery, actually waited to do so. Samuel Brannan was the publisher of the San Francisco Star. Before touting the discovery, he set up a store to cater to gold prospectors. Then, he publicized the discovery. And he ran around San Francisco with a jar of gold in his clutches saying something like, "Gold, it's gold I tell ya!" And he made a fortune.

Brannan, and there's a street named after him, was the original business prospector who made it big on the Gold Rush. But there were many business prospectors who never picked up a pan or a pick themselves. Levi Strauss, whose company is still headquartered here, first profited in dry goods and then with those first-ever, blue jean baby queen, riveted, denim work pants. Henry Wells and William Fargo formed Wells Fargo with those iconic stage coaches transporting people and money. They focus on the money now, with $1.42 trillion—one of the largest banks out there. And there was John Studebaker who traveled from Pennsylvania to prospect in his own way. He made and sold wheel barrows and did extremely well. With his profits, he headed to Indiana where he started that famous Studebaker company. First they built wagons, then years later they built those wonderful cars—cars like the Silver Hawk, with those fins. My father owned one and let me drive it when I was 16. "Be safe, Bart. Two hands on the wheel at all times, 10 and 2, 10 and 2."

The Chicago Prospectors: CBOT

In that same year, 1848, roughly 2,100 miles to the east, in Chicago, there was yet another group of business prospectors. These guys had nothing to do with the Gold Rush, but were trying to figure out a way to solve an immense problem in grain markets. You know the story: farm prices were whipsawed with wild boom and bust cycles. When farmers harvested, the cash markets usually tanked. Then, some months later, when the supply bottomed out, processors and consumers would pay profoundly for the commodities

This assemblage of 25 business prospectors, in addition to grain merchants and a banker, included a druggist, bookseller and a tanner. They met above a feed store on Water Street, and they started the Chicago Board of Trade (CBOT).

CBOT was a place to gather ‘round and haggle, and it worked. It helped even out prices and provided for some risk transfer. What this commodity cadre created was to markets what the Gold Rush was to California

With regard to markets, there remain commercial producers (farmers and processors, etc.), and speculators. The speculators, prospecting, mining and digging their way through these markets for their own riches, continue to gamble that they can make money from a futures contract by selling it later if prices change. While some things are still the same, commercials and speculators, a lot has transformed since 1848. We’ve come a long way, baby.

Morphing Market Prospectors

So here we are 164 years later, and like the gold prospectors who changed the way they ventured for gold, the markets prospectors—in particular the speculators—have also changed, or morphed. The question I ask as a regulator is this: Are markets still performing the purposes envisioned by those 25 imaginative market prospectors who met above that feed store on Water Street in Chicago?

Today, we have two new types of market prospectors, speculating in markets.

Massive Passives

First, we have seen a "financialization" of commodity markets by a class of traders I call Massive Passives. Let me explain. Investors looking to diversify their holdings sought out the derivatives world. Between 2005 and 2008 we saw roughly $200 billion come into the regulated futures markets in the U.S.—there was even more that we don’t know about in the previously unregulated swaps world.

Say a pension fund wanted to diversify into commodities. There’s nothing wrong with that from my perspective (although I know some Members of Congress who disagree), but the type of trading that they do is different than what speculators have typically done. Instead of getting in and out of markets, maybe based upon a drought or other natural disaster, or in the energy markets getting in or out related to the driving season, these very large funds, pension funds and others like exchange traded funds (ETFs) bought and held their market positions. They invested in futures markets more like they invest in security markets. They are both massive in size, and fairly passive in their trading strategy. They are fairly price insensitive. They don’t get in or out of the market because prices change a little here or there. They are in it for the longer term.

I’m not suggesting the Massive Passives shouldn’t be allowed to do this, but it is different and it has impacted markets. It has helped push prices up at times, and when we have seen large price movements, we have then witnessed some reciprocal downturns. There are many studies that document this phenomenon.

Here’s the worrisome part: too much concentration in markets can influence prices and these Massive Passive traders, have contributed to price abnormalities.

Now, many people would say that any liquidity is good liquidity. But, are we sure? There are times when there is so much Massive Passive liquidity on the buy side—those going long and staying long—that prices cannot be based on the fundamentals of supply and demand. We’ve seen it.

Take 2008, when crude went from right around $99.62 at the beginning of the year to $145.29 in July, then all the way back to $31.41 in December. For those that claim the Massive Passives had no role in that market distortion, explain how it happened. I’ve asked hundreds of times and there have been no efforts to enlighten us.

Now, if some of you think, as I do, that the Massive Passive influx was problematic in 2008, what’s happened since then? We’ve seen well over the amount of speculation we had in 2008 at various times since then. With such large concentrations of market participants being these new speculative prospectors, it continues to raise the concern about how prices can be distorted and contorted. That’s not good for the traditional market participants like many of you. It’s not good for consumers and it isn’t good for our economy.

In response to what was going on in 2008, Congress instructed us (as part of the Dodd-Frank financial reform law in 2010) to put in place what are called speculative position limits. To date, they’re not in place. There’s fierce opposition from the largest speculative prospectors on earth. However, we are working to get them in place and we will do so. Word!

We need to have our hands firmly on the wheel to ensure markets are safe—10 and 2, 10 and 2.

Cheetahs

In addition to the Massive Passives, we have some new prospectors speculating in markets with the most advanced computer technology. High frequency traders (HFTs), "cheetahs" I call them, due to their incredible speed, are out there 24/7/365 prospecting for micro dollars in milliseconds. That’s how speedily they trade.

If you divide a second into 1000 parts, they trade in those teeny tiny fractions of a second. If you’re going 100 miles an hour, a millisecond is the time it takes you to go two inches. I know that’s true because it’s on the Internet. You can’t put anything on the Internet that isn’t true. (I’m a French model, bonjour!)

There are some noble things about these high frequency trading cheetahs. They are, admittedly, very innovative prospectors in their own right. Some use complex algorithms that boggle the mind. The cheetahs also add some liquidity to markets. However, it is "fleeting liquidity" and at times "fantasy liquidity." Let’s think on this a bit more, shall we?

Fleeting Liquidity: These cheetah traders want to get in and outta markets in a hurry. In fact, they don’t want to hold any risk for very long—for sure they don’t want to carry it overnight. So, when we think back to those original market prospectors in 1848, a speculator might hold a farmer’s risk for many months. Not today. If you want to off-load your wheat, bean or corn crop risk for 5 seconds, I have just the cats for you. This liquidity is, at best, fleeting liquidity, and that is different. Do the cheetahs help fulfill the vision of those original Chicago prospectors—those guys above the feed store? I’m not sayin’ what the cheetahs are doing in this regard is bad. I’m just sayin’.

Fantasy Liquidity: Then, there is the appearance of liquidity that is, in numerous instances, really an illusion—fantasy liquidity

The Commodity Exchange Act (CEA or Act) is our regulatory bible. Section 4c of the CEA says that it is: "unlawful for any person to offer to enter into, or confirm the execution of a transaction involving the purchase or sale of any commodity for future delivery … if the transaction … (i) is, of the character of, or is commonly known to the trade as, a ‘‘wash sale’’ or ‘‘accommodation trade."

And there are exchange rules out there that say, "No person shall place or accept buy and sell orders in the same product and expiration month … where the person knows or reasonably should know that the … transaction(s) [is a] wash sale(s). Buy and sell orders for different accounts with common beneficial ownership that are entered with the intent to negate market risk or price competition shall also be deemed to violate the prohibition on wash trades."

Another exchange rule says, "No Market Participant shall … c. make or report any wash trade...."

So, wash sales are clearly against the law, and against exchange rules. However, in voluminous instances these cheetahs are engaged in this activity. When they do so, it might appear to be liquidity, but it is not. It isn’t really there. It’s fantasy liquidity. The cheetahs are essentially singing that old Billy Idol tune:

"Oh dancing with myself

Well there’s nothing to lose

And there’s nothing to prove

I’ll be dancing with myself."

Well, they have nothing to lose or prove because they aren’t taking on any risk whatsoever—zero, zippo, nada. They aren’t providing liquidity when they wash whatsoever.

Why would the cheetahs do that? Why would any exchange allow that? There are algorithms out there to stop cheetah trading programs from washing. They call this wash blocker technology. Why don’t all the cheetahs use it? We should require that they do so. Well, those are good questions which deserve more review. We need to ensure that we have the correct policies and procedures in place.

Oh, one final point: these HFT cheetahs aren’t even mentioned in Dodd-Frank. These traders were part and parcel to the Flash Crash on May 6th, 2010 when the markets dropped precipitously in 20 minutes time. However, Dodd-Frank was nearly finished and no new language was added. So I think Congress needs to act to give us some fairly basic regulatory tools to assist in our efforts to somewhat cage the cheetahs. During the Gold Rush, prior to California becoming a state, it was a lawless wild west. They set up Vigilante Committees that took the law into their hands. Well, I’m not suggesting that, but here are just some of the things that I’ve called on Congress to consider.

One: Cheetahs need to be registered. As crazy as it sounds, they don’t have to be registered now. Once they are registered, it provides us with authority to examine their books and records, among other things, which is a key to our oversight and enforcement duties.

Two: They should be required to test their programs before they are put into the live production environment. Some do that already, but it’s sort of on the honor system. Markets are too important to leave this matter to chance.

Three: These cheetah programs also need to have built-in kill switches that shut them down, should they become feral. After all, a runaway automated trading system is actually what instigated the Flash Crash. Yup, didn’t have both hands on the wheel and it caused a crash.

Four: Our penalty levels have become antiquated. In many cases, we are currently limited to $140,000 in civil monetary penalties per violation. That needs to go up—and not just for HFTs—but for all market participants, both individuals and entities, who break the rules.

With these changes, and potentially some others, we can have safer markets, 10 and 2.

Conclusion

When we look back at those prospectors in 1848, in California and in Chicago, they really set the stage for some unbelievable development on the coast and in markets, respectively. Both were monumental undertakings—spanning all those miles—and impact us still.

And while futures markets have worked exceedingly well since that time, we are seeing some of the new prospectors having an influence which can be problematic. Both the Massive Passives and the cheetahs raise a lot of concerns. The question, as with most things in government and life, is balance. How do we protect the good parts of what is going on while avoiding potential obstacles that can limit the important functions of these markets from the beginning? What we don’t want is another tragic story of gaming and adventure in a lawless land

What would those guys above that feed store on Water Street say? And here’s why asking that question is so important: those guys established the Chicago Board of Trade for purposes of price discovery. When markets work well, they are good for folks involved in the commercial business of the underlying commodity. It works for the prospecting speculators—be they Massive Passives or cheetahs or others, and it works for consumers. So we have a responsibility to ensure these markets are efficient and effective and that we have steady hands on the wheel—10 and 2, 10 and 2.

Thank you.