Saturday, December 28, 2013

The Shadows Remain in Shadow Banking

"The basic point is that there has been, and remains, a strong public interest in providing a “safety net” –in particular, deposit insurance and the provision of liquidity in emergencies – for commercial banks carrying out essential services. There is not, however, a similar rationale for public funds - taxpayer funds - protecting and supporting essentially proprietary and speculative activities. Hedge funds, private equity funds, and trading activities unrelated to customer needs and continuing banking relationships should stand on their own, without the subsidies implied by public support for depository institutions."
2010 Testimony of Paul Volcker to U.S. Senate Committee on Banking, Housing and Urban Affairs. 

Politicians of all stripes have rushed to have themselves photographed with the wise, grandfatherly oracle who is Paul Volcker.  But, what do we have after all the delay from 2010 until now?  We have a "rule" of over 1,000 pages which is full of contradictions and definitional lacunae.  A prime example would the prohibition against proprietary trading, or investment banks, who make much of their money from making markets, being enjoined from hedging 100 percent of their portfolios.  I didn't make it through much of the 1,000 pages, but after the champagne has been drunk will come the 2014 hangover when regulators wake up to the need for "tweaks."  Enough said here.

But, a seemingly unrelated story got my attention in regard to Paul Volcker's philosophical first principle that appears underlined in his testimony above.  It is the WSJ story about millions of tons of aluminum, copper, nickel and zinc which are hidden in "shadow warehouses." An owner of a shadow warehouse can, according to this story, have a stash of unreported material on one side of a fence from an LME regulated stash of the same material on the other side.  Material on the LME side goes into published statistics which drive market participant behavior and have impacts on prices.  

"It's a real concern for anyone in the industry that metal can be sucked away into a nonreporting location with no expectation or date as to when it's going to be available again," said Nick Madden, senior vice president and chief supply-chain officer with Atlanta-based Novelis Inc., an aluminum-products maker that is among the world's biggest buyers of the metal."

Guess what kind of entities are involved in this unregulated, speculative activity?  "Until 2010, most warehouses were owned by logistics firms like Netherlands-based C. Steinweg Group. But as metal-financing trades became more popular, C. Steinweg was joined by units of Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. as well as commodity traders Glencore Xstrata PLC of the U.K. and Switzerland and Trafigura Beheer BV of the Netherlands."  

Morgan and Goldman?  Here we go again.  

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