Chip and Thread,
I'm wondering if any here are familiar with the Commodity Futures Modernization Act of 2000, and would care to comment upon its implications for the volatility of the markets.
I was surprised to run across this item in a column by Molly Ivins at the Ft. Worth Star-Telegram:
star-telegram.com
Just before it left town last week, Congress passed a little horror called the Commodity Futures Modernization Act of 2000, brought to us courtesy of heavy lobbying by Wall Street banks and investment brokers.
Frank Portnoy, writing in `The New York Times,' describes the bill...... (see editorial below).....
Note the cunning timing of this odious piece of special-interest legislation. The Nasdaq is tanking and the Dow's not healthy, while our merry brethren on Wall Street are cashing in their usual obscene Christmas bonuses. As all you happy capitalists know, you now have to pony up half the purchase price of stock before buying; you can only borrow double what you put up from a broker. This is known as buying on margin, and some experts believe it's already too generous.
You will recall that the proximate cause of the Great Crash of '29 was too many buying on wide margins. Under this new law, you can buy stock futures with almost nothing up front, borrowing more than 10 times your own investment. Think how much that will do for the stability of the stock market.
Notice, too, that we have just been informed by the Securities and Exchange Commission that an earlier piece of Wall Street special-interest lobbying has been a windfall for Wall Street and done zip for consumers. The recent SEC report says that brokerage firms have pocketed millions of dollars from the new competitive arrangement in the trading of stock options while passing on almost none of the money to customers. Does this remind you of Lucy and the football in `Peanuts'?
"The commission found that from November 1999 through September 2000 the options specialists paid $33 million to retail brokerage firms for directing their orders, with one brokerage firm collecting $6 million and six others getting more than $2 million each. None of the large recipients passed those payments on to customers, either through reduced commissions or rebates," the `Times' reported.
Why does this not amaze us?
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The Frank Partnoy editorial: nytimes.com
December 21, 2000
Stock Gambling on the Cheap
By FRANK PARTNOY
AN DIEGO -- At the eleventh hour last Friday night, Congress passed a measure that will benefit Wall Street at the expense of the average investor. This bill should raise a few eyebrows this holiday season, when investment bankers and brokers are cashing hefty bonus checks just as the holdings of many small investors are entering free fall.
The bill, the Commodity Futures Modernization Act of 2000, which passed after an intense push by Wall Street lobbyists, changes the financial markets in two ways. First, it lifts a longstanding ban on futures trading in individual stocks, thus allowing investors to buy shares through brokers with very little money down. Second, it protects a lucrative business for bankers — the private financial contracts known as swaps — from being regulated, for the most part. Investors are affected by swaps because they are used by many mutual funds and publicly traded companies. (In a swap, one party bets that an economic variable — interest rates, for instance — will go up, while the other bets on its going down.)
The first change — trading in single-stock futures — might sound like a cheap way for investors to have fun. Under existing federal rules, you are required to ante up at least half of the purchase price when you buy a stock. For example, if you want to buy $2,000 worth of Yahoo (just to pick on a company that lost about $100 billion in value this year), you could pay just $1,000, with your broker lending you the extra money. Of course, if the stock drops too much, you get a "margin call" from your broker, demanding repayment. Under the new provisions, you can buy stock futures with very little cash up front. For $1,000, you might buy $10,000 worth of stock futures, or even more.
It's not surprising that Wall Street lobbied for the new rules. The major banks and investment houses, chock- full of investment bankers, brokers and traders, will earn big commissions and trading profits on single- stock futures contracts. As always, they will make money regardless of whether their customers do.
But the new single-stock futures bill could be dangerous — for the market as well as for individual investors. As the vast literature on behavioral economics shows, people aren't all that rational when it comes to financial risk. And there's the danger that investors who bet wrong will simultaneously dump their portfolios to pay their debts to brokers, causing stocks to crash.
Earlier this year, when many day traders received margin calls, they sold in unison, and the markets dropped precipitously. If the new rules had been in effect then, their debts would have been larger and their selling might have caused a market meltdown. Think of the 1920's, when investors borrowed heavily to speculate — their collective debt 10 times the value of their collective down payments. We all know what happened after that.
The new bill's second impact, in the swaps market, is less direct but still worrisome. The act ends an argument about whether swaps qualify for regulation by making it clear that they are not regulated if a participating company or individual has $10 million in assets. That means that the swaps activities of most companies and mutual funds are not regulated.
Yet few investors know what swaps are. And there's almost no publicly available information about specific trades in this market, now bigger than many stock or bond markets. By contrast, futures trading takes place on exchanges; an investor can find closing quotes for futures in a newspaper's financial section.
To be sure, a company's swaps activity can benefit investors. Most major airlines enter into swap contracts with banks to lock in their jet fuel costs, their biggest expense after labor. They agree to pay money if fuel prices go down and to receive money if fuel prices go up. If the price of fuel rises, an airline can offset its higher costs with money it makes on swap contracts. Southwest Airlines uses swaps this way, and its stock doubled this year (and its fares have stayed low) even as fuel costs increased.
However, if the price of fuel decreases next year, the airline will be locked into paying the higher cost. The problem is that investors have no way of knowing about that risk. Financial statements of publicly held companies provide only summary data about their swaps. And you don't find the day's jet-fuel swaps listed in the financial pages.
Lawsuits over losses on swaps contracts, meanwhile, tend to be settled quietly and privately; investors have little chance to recapture their losses and may not even know about a loss.
Before last week, there was ambiguity about whether swap contracts were covered by Commodity Futures Trading Commission rules. Enough ambiguity to draw Wall Street's top lobbyists to Capitol Hill. Wall Street makes much more money from these unregulated transactions than it does from futures trading, and the pressure on legislators intensified in Congress's waning hours. At a minimum, the question of swaps regulation deserved more scrutiny by lawmakers.
As for the question of single-stock futures trading, next year, you can expect more calls from your broker, who may try to sell you on what Oscar Wilde once said: "The only way to overcome a temptation is to yield to it."
Frank Partnoy is a professor at the University of San Diego School of Law and author of ``F.I.A.S.C.O.: Blood in the Water on Wall Street.''
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Here's what a search at SI has turned up:
Message 13918064
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To my simple mind, it seems that this might well be a big bad deal for those who, like me, have the delusional thought that maybe a little less volatility in the markets could be a good thing.
Comments Welcomed!
Best, Ray
PS: Ward, this one's for you: amazon.com |
