Banks and commodities: the full story

The New York Times has a well-researched article on how banks have been entering commodity markets (like aluminum); it makes the case that Goldman has been profiting by restricting the supply of aluminum, while consumers have paid extra, to the tune of like $5 billion. Not all of that $5 billion has gone into Goldman’s pocket–other aluminum sellers have benefited as well–but still, this article is damning, and in a sane world the Justice Department would be screwing Goldman to the wall for anticompetitive practices; this is a “conspiracy in restraint of trade” if I ever saw one.

And it’s not even the worst part.

The article also mentions that Goldman can use its insider knowledge of the aluminum markets in its derivatives operations (derivatives are essentially bets). So Goldman can, knowing that aluminum stocks are low, bet that the price will go up. Goldman makes money on what is more or less a sure thing. This sort of insider trading is illegal in the stock market, but in the derivatives market anything goes.

And that’s not even the worst part.

Here’s the worst part, and what the article doesn’t mention: Since Goldman influences the price of aluminum, it can explicitly manipulate the aluminum market so that its bets in the derivative market pay off.

And if it can, you can bet that it is.

That may seem paranoid, but that assumption is the only rational one to make since the LIBOR scandal.

For those who need a refresher, here’s the LIBOR scandal in brief: many big, old, respected banks reported an interest rate called the LIBOR, which was the basis of all sorts of other contracts–like how Americans’ credit card interest or mortgage is tied to the prime rate. It turned out that these banks were manipulating the LIBOR. The thing was, the manipulation wasn’t just of the “oh, shit, we’re in trouble, let’s lie about how much trouble we’re in” kind (although that happened). That would be kind of understandable. But banks also manipulated the LIBOR constantly, routinely, to make sure that the bets that they’d made on the LIBOR paid off. So, you’d take a bet that the LIBOR would go down in three months, and then three months later you’d lower the LIBOR.

And the gains in question were often tiny–barely a blip on these banks’ balance sheets.

That’s like the difference between finding that some judges occasionally take bribes for $100,000 or more, and finding that judges routinely change verdicts for five bucks and a 40-oz bottle of Colt 45. The one is bad, but the other means that the entire system is so deeply fucked up that the very assumptions behind it (like the assumption that most judges can be trusted most of the time) have to go.

The thing is, the LIBOR was easy to manipulate because it was set more or less by the honor system–banks self-reported the interest they were paying. And that’s the point. Banks’ honor was at stake, and they themselves valued it at nothing. And so must we.

Now: Even before the LIBOR scandal I thought it was obvious, in the words of one of my own posts, that financiers are dangerous idiots who need to be watched every minute. But after LIBOR there’s no way that anyone with a brain should think anything except: If banks have the opportunity to cheat, they’re going to cheat. Period.

Goldman has the opportunity to manipulate commodity prices to make sure its own bets pay off. It will. It is. Period.

So: What’s the solution? Well, as so often happens, this problem was the result of deregulation–banks were once forbidden to enter the commodities market–and the obvious solution is re-regulation.

Banks somehow managed to do business when they weren’t allowed to fuck around with commodities. They would find a way to do so again. Hey, maybe by, you know, making loans at interest to businesses and individuals. Nah, that’s crazy.