Monday, September 26, 2016

Commodities: The Feds, Merchant Banks and a Famous Default

From Matt Levine at Bloomberg View:
Physical commodities.
As far as I know there are no capital requirements for trading oil. Planet Money bought and sold some oil this year, and they are a public radio show. Bloomberg's Tracy Alloway bought some last year and sold it to  Izabella Kaminska, who then defaulted on the trade. If you wanted to get into the oil business and borrowed $45 from your mom to buy your first barrel, that would be fine. There are of course lots of environmental regulations, and you'd probably need insurance to drill it up or move it around, but the basic capital structure of the oil industry -- how much of the money comes from shareholders and how much is borrowed -- is a private decision, a matter for negotiation between companies and investors and banks.

Meanwhile the Federal Reserve wants to put a 1,250 percent risk weight on some physical commodity trading at Goldman Sachs and Morgan Stanley. "The 1,250 percent risk weighting basically means about $1 in capital would be needed for every $1 in investment." So while you are free to borrow money to get into the oil business, Goldman wouldn't be: Banks would need to back their physical-commodity trades with their own money. Other physical commodity trading activities at big banks would get a 300 percent risk weight, and the proposed rules have other restrictions. The Fed says that the purpose of the proposed rules is "to help address the legal liability and reputational risks of physical commodity activities as well as the inherent uncertainty in valuing the potential damages associated with a catastrophe." Viewed as environmental regulation -- as a way to make sure that physical commodity traders have enough money to pay for any damage they cause -- it is odd, insofar as it applies only to banks. But of course it's not environmental regulation; it's banking regulation, and we're much more worried that a bank could fail than we are that an oil company could cause catastrophic environmental damage and be unable to pay to clean it up.

The core business of banking is taking deposits and making loans. It's a fine business as businesses go, but there you are, a bank, with all that money. You want to do things with it, things other than making 30-year fixed-rate mortgages....

See also:
Default, dear Brutus, is not in our stars,
But in ourselves, that we are underlings.