Actually the MF Global Inc. trustee’s report released earlier this month pinpointed where much of the money was stuck and the main question that needed to be asked is why is everyone still quoting the $1.2 billion figure when it simply doesn’t add up. I guess a simple math question is not as sexy as citing unnamed sources.

Perhaps the anomaly is a tale of two trustees’: one whose mission is to get customer money back, the other to preserve capital in the parent company so that creditors can claim it. So it would not be a wild stretch of the imagination to suspect that the insider suggesting fund’s vaporized came from the MF Global Holdings Ltd. side, suggesting the money is gone and the MF Global Inc. trustee can go home and customers should accept the 72¢ on the dollar they received — if they were not unfortunate enough to have money in accounts overseas or held precious metal certificates confiscated by the trustee—and go home. And that the source from the investigation saying they know where the money went is from the side looking for the money, with the goal—if not the will—to get it back. They are the ones who need to grow a backbone and go after the money at MF Global Holdings, MF Global UK and JP Morgan.

Legal entities aside, this was one company with one Chairman and CEO and the fact that it was split up for bankruptcy purposes the way it was seems a miscarriage of justice and done for no other purpose but to allow certain creditors to move in front of others. At least one court filing noted that there isn’t much use in customer priority rules if it can be rendered moot by moving funds from one legal entity to another of the same organiztion.

The Sapere motion offered a simply solution. Basically it would treat MF Global et al as one entity and apply the Commodity Exchange Act bankruptcy priority to it. It is what should have happened from the beginning but unfortunately Judge Martin Glenn ruled against Sapere earlier today. However, he did acknowledge in ruling against broad discovery that it was unneccesary because “the Justice Department, FBI, CFTC, SEC, SIPA Trustee, and Chapter 11 Trustee are all actively investigating the collapse of MFGI and MFGH.”

According to an FBI spokesman any FBI investigation is criminal, which raises the question, how does a government appointed trustee refuse to cooperate with a Federal criminal investigation? MF Global Holdings Trustee Louis Freeh (coincidently a former Director of the FBI) has withheld certain information requested by the CFTC in its investigation. We do not know if this same information was requested by the FBI but if it wasn’t that raises another question. For the judge to suggest Freeh is investigating is a bit of a stretch. The trustee for MFGH is clearly working for the interests of the Chapter 11 creditors and against the interests of customers as he even attempted to prevent the third bulk distribtuion of funds from the MFGI estate. Since we know funds were moved illegally out of segregation, any information as to where those funds went should be made public so the process of clawing those funds back can begin. Any attempt to withhold information should be viewed as obstruction of justice.

It is unlikely that the Commodity Futures Trading Commission would ever entertain such an idea for the existing futures clearinghouses but the concept might be applied to new ones set up to handle off-exchange swaps (Dodd-Frank allows private swapping more than you may have been led to believe).

Using the catchy phrase “ring-fencing,” advocates infer that they might not clear their private swaps at all if their funds might be at risk in the event of some stranger’s default.

Existing clearinghouses weathered the financial crisis (2008 – ?) without any federal bail-out. Risk mutualization is why.

Should this idea gain traction I have two suggestions. First, don’t let them be called “clearinghouses.” That would be like permitting MacDonalds outlets to call themselves “hospitals.” Second, adopt a more accurate name. The term “Titanic” comes to mind.

It was no secret that the two Republican members of the commission, Jill Sommers and Scott O’Malia, would oppose the position limit rule and Commissioner Dunn was highly skeptical of its efficacy. Speaking to me at the Futures Industry Association Expo last week, Dunn acknowledged that lack of position limits where not impactful on the financial crisis and the agency needed to concentrate its efforts on things that would make the industry safer.

In several stories he has called positions limits a sideshow and his comment from a previous hearing — “With such a lack of concrete economic evidence, my fear is that, at best, position limits are a cure for a disease that does not exist or at worst, a placebo for one that does,”  — has gone viral.  

Dunn addressed Gensler directly asking him to give assurances that the agency would examine the impact of the rules after it became effective. You almost expected Dunn to ask Gensler to put his hand on a bible before responding to direct questions on the purpose of the rule and the role of the Commission. It made you wonder why he didn’t just vote against it. Perhaps approving a rule was the easiest way to move forward.

Dunn also expressed publicly and privately his frustration that they are still waiting on further definitions of swaps, which must be set before the rule becomes active.

What was clear from Tuesday’s meeting is that there was a myriad of compromises on the initial proposal to get the measure passed. What wasn’t so clear was why it was necessary. Those who believe speculation caused the run-up in energy prices in 2007 will not be satisfied nor will those opposed who will bear the cost of compliance, which is expected to run over $100 million.

The chairman and each of the commissioners separately made the point that the Commission was not a price setting agency. In fact, that was one of the questions Dunn asked directly to Gensler and he waited for the chairman to affirm that the agency was not in the business of setting price. The problem is that those advocates who most passionately have been pushing for positions limits believe that that is the role of the Commission or at least believe that if limits were in place the price of many commodities would have been lower in recent years.  

In fact U.S. Senator Bernie Sanders (I-Vt.) may have committed a crime in his fervor to castigate speculators by leaking non-public crude oil position data to the press and a  recent United Nations report flat out recommended affirmative government action in the markets to “correct” price.

Several panelists at the recent FIA Expo in Chicago made the point that often the loudest supporters of certain reforms be it transaction taxes or position limits are the most ill informed.

So we have a rule the necessity and value of whch three commissioners are uncertain of though there seems to be certainty on the cost, at least $100 million to the industry according to the CFTC, making it a major rule.

Dunn asked Gensler, “How will this rule impact disruptive trading practices and market manipulation and the resources at the Commission’s expense to combat them.”

Gensler said, “this rule is another tool to protect price discovery and promote fair and open and competitive markets, it helps protect against parties having excessive market powers therefore protects against corners squeezes and other manipulative schemes.”

There was more regarding large position reporting, information the Commission already receives, but $100 million seems like a large burden for just another tool. The cost estimate would seem to require the Commission to make a stronger case for the necessity of this rule.

Earlier this week the answer from the Obama Administration appears to be “yes” as they decided to open up the Strategic Petroleum Reserve (SPR) along with the International Energy Agency (IEA)to make-up for lost Libyan production. The decision to release 30 million barrels of oil from the U.S. SPR over the next 30 days seems to be a stretch of the emergency role of the SPR and could be an omen of a slippery slope towards more government intervention.

As we noted in a subsequent post on the UNCTAD report, which recommended that central banks take affirmative action to roll back the effect of what it called the “financialization of commodity prices,” part of the reason for higher commodity prices is the use of agricultural commodities in creating biofuels. In the United States the ethanol industry is being subsidized by government so government action is, in part, causing some of the price dislocation the UN is  recommending be solved by more government action.

While the thrust of the UNCTAD report is that it believes speculation in these markets is to some degree the cause of higher prices — a view we do not necessarily subscribe to — it does acknowledge that more traditional fundamentals are playing a role. We continue to ask why all the prescriptions to address the so called problem focuses on the one side of the equation where there is no consensus rather than the side where there is a consensus.

As far as the Administration’s move, it is probably borne more of political considerations than an overall philosophy on markets, but we have seen that bad policy often pushes more bad policy. It is easier for politicians to create policy to address problems caused by other bad policy than simply reverse the original bad policy. This is a slippery slope towards more intervention in markets.

On the other hand, there is a civil war going on in Libya that has affected supply. Though there have been other supply disruptions that did not push us to tap the SPR.

The recent credit crisis proves that regulation is necessary, but the goal of regulation and government policy should be to allow markets to do what they do best. It should not be used to create an outcome, however beneficial that may appear to be at the time. The list of negative unintended consequences for this type of intervention are too numerous to mention.

And while my first reaction to the announcement was positive based on self interest — I am driving to the east coast this week — this doesn’t seem the type of emergency envisioned for the SPR.

Setting aside the fact that the deadline confirms Congress’ oblivion to the amount of work involved, our legislators delayed the necessary funding and, for distraction, ran a virtual shuttle service between the CFTC and various Hill hearing rooms to grill CFTC leaders relentlessly on why more was not being accomplished. Or why the CFTC was not heeding fully the wisdom of banks, hedge funds and swap users that saw Armageddon in each rule proposal.

When it became obvious many weeks ago that the July 16 drop-dead date was an impossibility, a one-line amendment to Dodd-Frank extending the deadline would have been a solution that any fifth-grade civics student might suggest. Instead, a crisis was manufactured that required the CFTC to use its own wits.

Which it has. In a twist of irony, the agency has concluded that the lack of rules means that key parts of the new law would be jibberish without, say, rules defining key terms. Why, we won’t know what a “swap” is until the CFTC finishes defining it. Implementing a registration regime for “swap dealers” without clarifying the first term, for instance, could subsume unintended targets – even the Congress itself (just let them try to deny that they swap and deal all the time!).

But muddle through we must, and will. It is a very steep climb, thanks to Congress. After all, the place is not called “the Hill” for nothing.

While the charges are sure to spur the blame speculators and impose position limit crowd into outrage (and already has), the details of the case highlight a point made here on several occasions. That is that real manipulation occurs in the physical market and rarely does it occur solely in the futures markets. Gresham Investment Management founder and veteran cash and futures trader Henry Jarecki has made that point in a profile and recent interview as has futures industry veteran Neal Kottke.

While it is hard to determine what moves markets at any given time, those that like to blame speculators and are pushing for tighter limits on derivatives refuse to distinguish between physical markets and derivatives. This case helps to point out the difference.

 The alleged perpetrators where more manipulators than speculators as they used the physical market to affect derivatives, not the other way around as many believe has been and continues to be occurring. They are not representative of those entities using the futures market to gain long exposure to commodities. They actually made a great deal of their profits in the scheme—a net of $35 million according to the CFTC—on the short side.

 As with the Hunt Brothers—thought not on as grand a scale—the alleged manipulators accumulated a large physical position while at the same time establishing a large long futures position. The firms in question: Parnon Energy Inc. of California, Arcadia Petroleum Ltd. of the United Kingdom, Arcadia Energy (Suisse) SA of Switzerland, outdid the Hunt’s allegedly, in that they attempted to profit on both ends by holding supply away from the market while long and then going short before dumping their physical supply on the market.

It is an interesting story, which we will follow but before everyone gets too carried away we should remember the time frame. This all allegedly occurred in the first four months of 2008, well before crude oil’s blow-off top and subsequent collapse.

 But as noted by many experts, the key to any manipulation scheme is the ability to manipulate physical supply.

I remember arguing with a colleague that merging the two largest U.S. stock exchanges would not be allowed. We talked about the Chicago Mercantile Exchange acquisition of the Chicago Board of Trade and how some folks thought it could be held up by antitrust concerns. I recall that the CME and CBOT’s argument was that they did not compete against each other directly as the CME’s main products were short-term interest rates, equity indexes and meats while the CBOT concentrated on long-term interest rates and grains. Obviously that is an argument that could not be made with a Nasdaq and NYSE hook-up.

But putting together a huge complex merger proposal is extremely costly and disruptive to business so there were obviously some very smart people who though it would survive such a review.

In fact ICE Chairman and CEO Jeff Sprecher suggested that their proposal would have less antitrust risk as a DB/NYSE Euronext merger would in Europe over combining its derivatives business.

And anecdotally, that process seems to have changed dramatically over the last 20 or 30 years as massive megamergers occur on a regular basis. But between the time the CME and CBOT hooked up and CME moved to acquire the New York Mercantile Exchange something appeared to be changing at DoJ. The DoJ sent a letter to Treasury questioning the futures clearing model and suggested that there were deep antitrust issues with the vertical clearing model. The letter stated, “the Department believes that the control exercised by futures exchanges over clearing services – including (a) where positions in a futures contract are held (“open interest”), and (b) whether positions may be treated as fungible or offset with positions held in contracts traded on other exchanges (“margin offsets”) – has made it difficult for exchanges to enter and compete in the trading of financial futures contracts.”

The letter raised a ruckus at the time it came out (Feb. 2008) and led people to ask why they didn’t hold up the CME/CBOT tie-up and whether it was a preemptive strike against CME Group’s acquisition of Nymex, which had been proposed but not closed. In the end the Nymex acquisition passed but the DoJ made its feelings known.

Another thing had changed. We had a global credit crisis and a great recession where we had to bailout “too big to fail” institutions. It probably has taken longer than it should have but there are folks beginning to question the era of huge megamergers and starting to raise questions regarding a perceived  Laissez Faire attitude at the DoJ and whether a lack of diligence on antitrust issues is a major contributing factor to the mess we find ourselves in. After all, how did too big to fail come about? It came about by mergers of large institutions.

In a statement  the DoJ said of a possible Nasdaq/NYSE combo, “the acquisition would have substantially eliminated competition for corporate stock listing services, opening and closing stock auction services, off-exchange stock trade reporting services and real-time proprietary equity data products.”

In defended its planned merger NYSE Euronext and DB focused on the synergies in its deal and did not discuss antitrust issues. But they have their own review to go through, which oddly will most likely come after the shareholders of each exchange vote. I suppose ICE will still be waiting in the wings with their offer for the derivatives side of the business if European regulators come to a similar conclusion regarding the two largest derivative exchanges in Europe as the DoJ delivered regarding the two largest U.S. stock exchanges.

Not sure how it will play out but it appears that regulators are starting to look more closely at larger mergers, which given what has gone on, is probably a good thing.

So why be worried when the Federal Energy Regulatory Commission (FERC) whacks a natural gas trader for $30 million based on a finding that he manipulated the price of natural gas futures (an activity assigned by Congress 40 years ago for policing EXCLUSIVELY by the Commodity Futures Trading Commission) on the New York Mercantile Exchange (also supervised EXCLUSIVELY by the CFTC)? 

FERC’s theory appears to be that, whatever the jurisdictional rules, futures markets can affect prices of the real energy product over which it has unquestioned responsibility. So, it can act to get at the source of the problem.

Congress awarded the CFTC sole authority over futures activity precisely because the FERC theory, if embraced, would have allowed other agency’s to set their own rules for futures that potentially interact with matters under their wing. Everything from corn to copper to crude oil to commercial paper to catastrophic events would have multiple regulators at the federal, state and local levels.

By my count, at least 60 agencies at the national level alone could claim a seat at the futures policy table.

And they don’t think alike. In one recent case where two agencies conducted a joint investigation looking at the self-same documents and hearing the self-same testimony, one agency found two failed attempts to violate the law while the other agency found 12 successful violations.

Who can do business under such circumstances? How does one hope to comport oneself when dozens of varied standards are applied?

Advocates of limited regulation should jump all over this development. Otherwise, even the new Yankee Stadium will be too small to host all of the regulatory wannabes.

It is astonishing to us that the CFTC has promulgated whole forests of rules related to Dodd-Frank and yet has not defined the entities and products that come under those rules. Seems backwards as noted here recently by our contributor and former CFTC Chairman Philip McBride Johnson.

We are sympathetic with the volume of work the Commission has had to undertake and realize that the definition phase is particularly cumbersome as it must be undertaken in cooperation with multiple other regulators, but it still makes no sense to save the definitions for last.

People and organizations are commenting on these myriad of rules unsure what particular bucket they and the products they offer and are accessing fall into.

A clear set of definitions as a first step could have helped streamline the whole process.

Now there is the chance that rules may be rendered meaningless as there is a real threat that Dodd-Frank could be neutered through a lack of funding. This type of uncertainly is bad for the markets. As is the prospect of defunding the regulators. Markets need clear rules or standards and their enforcement should be even, not based on a resource allocation decision within an agency.

If there are parts of the law people don’t like, work to remove them but don’t turn compliance into a voluntary exercise based on a cost benefit analysis estimating the regulators ability to monitor your activity.