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Debate over the Wall Street Reform and Consumer Protection Act, signed into law by President Obama on July 21, has focused on the creation of the Consumer Financial Protection Bureau that will bring notable improvements for U.S. consumers. But the more obscure derivatives section of the law contains reforms that will help stabilize global food and energy prices–changes that will especially benefit the poorest communities around the world.

Commodity markets for goods like corn, wheat, soybeans, crude oil, natural gas, copper, and aluminum had worked fairly well since 1936 when Congress passed the Commodity Exchange Act. The Act established well-structured commodity futures markets with common-sense rules that allowed producers and consumers of commodities (like farmers, mills, oil dealers, etc.) to “hedge their risk”, or establish an agreed-upon price for a future sale.

This meant that farmers and businesses could plan ahead without worrying about sudden changes in prices. The markets also allowed a limited role for speculators so that they could help the markets run more smoothly. These markets functioned well for many decades.

Deregulation of the commodities markets in the 1990s and especially through the Commodity Futures Modernization Act of 2000 (passed by Congress after midnight of the last day of work) removed many of the common-sense laws established in 1936. The limits on speculation were lifted, allowing massive inflows of speculative money into the relatively small commodity markets. Speculation, per se, is not bad, but when speculators dominate the market instead of businesses hedging for legitimate business purposes, the excessive speculation damages the underlying purpose of the market.

After investors lost money in the stock bubble in 2000 and real estate bubble in 2005/6, many decided to shift part of their investments into commodities. They were encouraged by an AIG-sponsored study that said commodities were a good long-term investment to help diversify an investment portfolio.

The result was an explosion in speculation on basic goods. According to hedge fund manager Michael Masters, institutional investors (pension funds, university endowments, etc.) increased their investments in commodities futures from $13 billion in 2003 to $260 billion in March 2008, and the price of 25 commodities rose by an average of 183 percent in those five years.

Testifying before Congress, Masters said, “In 1998, the average commodity derivatives market was about 25% speculative… By 2008, speculators comprised about 65% of [commodity markets]. Bona fide physical hedgers [farmers and businesses who actually work with physical commodities] once outnumbered speculators [people in the commodity markets just to make money off money with no interest in actually receiving the physical goods] by 3 to 1; now speculators outnumber hedgers 2 to 1. The positions of bona fide physical hedgers doubled during this ten-year period, while the positions of speculators rose by 1200%.”

Instead of serving the producers and consumers of physical commodities for whom they were created, the futures markets have become a casino for big-time investors. The result in 2008 was catastrophic, as excessive speculation drove up world food and oil prices to record highs. Remember $4 gallons of gasoline? The same thing happened with several other key commodities during this period.

When food commodity prices rise, it affects poor communities most heavily. Low-income families spend a much higher percentage of their money on food. Also, while wheat and corn are only a small percentage of the price of a hamburger eaten by the middle class, poor families in the global South often buy pure commodities like sacks of wheat and corn.

So, for example, when the export price of U.S. corn tripled, from $94 a metric ton at the start of 2005 to $281 per ton in May 2008[1], the poorest in the world—often dependent on U.S. food imports–felt the full impact.

The UN estimated that an additional 130 million people were driven to hunger by the price spikes. The situation grew so desperate that in dozens of countries where chronic hunger is a reality, food riots broke out. In Bangladesh, where an estimated 30 million of the country’s 150 million were thrown into hunger, at least ten thousand protestors clashed with police resulting in dozens of injuries.

It was especially heartbreaking to know that the severe crisis was caused in part by investors who raked in millions in profits from their bets that food prices would rise. The sheer weight of their bets that the price would go up became a self-fulfilling prophecy and drove market prices up.

While there were clearly some supply and demand factors behind the food price increases–such as droughts in Australia and a growing middle class in Asia–the dramatic influx of speculative money betting that the prices would rise drove prices up much further than would have occurred through simple supply-and-demand forces. And when those same investors pulled money out of commodities in late 2008 to cover loses in other areas, prices plummeted even faster than they had risen.

Organizing Against Food Speculation

The tragedy of basic food out of reach of the hungry due to speculation brought together one of the most diverse coalitions in recent times. During the negotiations over the bill, an incredibly powerful alliance formed called the Derivatives Reform Alliance (DRA). Participating members included the Americans for Financial Reform coalition of over 200 national, state and local unions; consumer groups and social justice organizations; large business associations that use commodity markets to hedge their prices such as the Air Transport Association (major airlines), Petroleum Marketers Association of America (gas stations), and the Agricultural Retailers Association; and a plethora of religious, development and small farmer organizations. A partial list of the members of the DRA is here.

Pitted against hundreds of millions of dollars of Wall Street lobbying, these groups used  strategic advocacy work, and succeeded in pressuring Congressional members to pass a bill that is much stronger, in terms of derivatives reform, than most would have ever imagined a year ago.

The Alliance’s three priorities were:

- Do away with the opaque over-the-counter (OTC) market by making all trades go through exchanges and clearinghouses to provide more transparency and require collateral for trades so as to avoid another meltdown like in 2008. The bill will cover 80-90% of derivatives trading in this manner. The remaining 10-20% that will not have to go through exchanges is reserved for legitimate commercial end-users of commodity markets.

- Establish limits as to how much a trader can hold in a certain commodity, and

- Aggregate these limits across all the different markets.

We won all of these objectives and more (see below).

Hopefully the U.S. will be able to use the strong financial reform bill to lead other countries to take similar measures through the G8, G20 and bilaterally. To help, a newly formed group of international organizations recently met to strategize on how to best influence the G20 and other multilateral institutions to create a global consensus around measures to regulate commodity markets.

In the United States, the campaign will continue to work in three areas:

1) Implement financial reform: Many details of the Wall Street Reform and Consumer Protection Act still need to be defined by regulators. We will work to make sure that the law is not watered down in its implementation. The Commodity Futures Trading Commission, CFTC (the agency responsible for regulating commodity markets) has defined 35 rulemaking topics and Wall Street already has three teams of lobbyists per topic. It will be important to keep vigilant.

2) Fix tax inequalities in commodity markets: Senator Wyden (D-OR) will soon introduce the Stop Tax-breaks for Oil Profiteering and Commodity Speculation Act or the STOP Speculating on Commodities Act. This bill would make all who participate in food and energy commodity markets pay the same tax rates. Currently (and ironically), legitimate commercial users of commodity markets pay a higher tax rate than financial institutions, and pension funds and endowments pay no taxes on money made in the commodity markets due to their tax-exempt status. Wyden’s bill would have all participants pay the same, which would basically end the problem of commodity indexes and exchange-traded funds (ETFs) (see below). Please call your Senators and ask them to cosponsor the STOP Commodity Speculation Act. Click here to learn more about the problems with commodity indexes and ETFs.

3) Divestment campaign: One thing the reforms did not address was the problem of commodity indexes and exchange-traded funds (ETFs), which are like mutual funds of commodities. These are the tools that pension funds and endowments mostly use to invest in commodities.

We will work to convince investors to pull their investments out of commodities (modeling on the anti-Apartheid campaign in the 1980s). This coming school year we hope to get campaigns going in different universities for students and teachers to pressure their endowments to divest from commodities, and we will be approaching different pension funds about the same issue, asking them to stop gambling on hunger.

If you work for a company or organization that has a pension plan, talk with the managers of those funds and ask if your money is invested in commodities. If it is, demand that they withdraw those investments. To follow these campaigns and see how you can participate, check the website for regular updates.

What the financial reform bill will do:

  • Fully close the “Enron Loophole” by empowering the Commodity Futures Trading Commission (CFTC) with authority over off-exchange (over-the-counter) derivatives markets, and by requiring across-the-board transparency for all derivatives.
  • Require that derivatives be exchange-traded or cleared with real-time reporting, reducing systemic risk and market instability and uncertainty.  The final bill, unlike previous iterations, would also give the CFTC additional tools to enforce this requirement.
  • Provide a narrowly-defined hedge exemption for legitimate commercial end-users to clearing and capital requirements for derivatives.
  • Close the “Foreign Markets Loophole” by requiring that foreign boards of trade register with the CFTC if they plan on doing business in our markets.
  • Provide the CFTC with additional authority to prosecute fraud and manipulation when it occurs. Since its inception, the CFTC has been handicapped by a less-than-adequate legal standard to prove manipulation, especially when compared to the authority provided other agencies and commissions such as the SEC. As a result, the CFTC has only successfully prosecuted one case over the last 35 years. The new measure will remedy this.
  • Protects commodity trading “whistleblowers” who cry foul when they see fraud, manipulation or other violations of the law occurring.
  • Require banks to “spin-off” their energy swaps trading operations into a separately capitalized entity that cannot access federally insured deposits. Other swaps in commodities (except gold and silver), equities and risky credit default swaps are included as well. This is expected to dampen the willingness of Wall Street speculators to take excessively leveraged positions in commodities, including energy.
  • Empower the CFTC to set speculation limits in all markets, and requires them to set aggregate speculation limits across all markets.
  • Prohibit “insider trading” in commodity futures, options and swaps on government information that is not yet public or otherwise made available to the trading community.
  • Make permanent the CFTC Energy Markets Advisory Committee, which was established in early 2008 at the urging of NEFI and its coalition allies to provide an environment for energy end-users and industry groups to express concerns to regulators.  It further states that hedgers and consumers must be represented on the advisory committee.  Sean Cota (Cota & Cota, Bellows Falls, VT) currently represents our industry on the existing committee.
  • Require a study into existing and prospective carbon trading markets.  There has been concern that if government sets a price on carbon through a cap-and-trade scheme or some other method, that such a market could become subject to excessive speculation and volatility, and could become more of an investment opportunity for Wall Street than a tool for reigning in greenhouse gas emissions.  This concern created skepticism among even the most liberal Senators and helped kill an economy-wide cap-and-trade program, at least for now.
  • Give regulators one year to enact new rules and regulations, and require them to cooperate and coordinate here there is overlap between multiple agencies.

Glossary of Terms

Commodity – basic resources such as crude oil, natural gas, wheat, soybeans, corn, cows, pigs, aluminum, copper, gold, etc.

Commodity futures markets – markets created to allow buyers and sellers of physical commodities to hedge their prices and to determine the market price of the commodities

Hedge – a bet in the opposite direction from your primary risk. As a farmer wants the price of grain to be high, a hedge is any bet (contract) in the opposite direction, i.e. buying a future that rises in value if grain prices drop. That effectively locks in a price for a future sale, which allows farmers and businesses to plan ahead more easily without having to worry about drastic price swings.

Commodity Index – like to a mutual fund of commodities, in that an investor’s money is spread among a number of commodities. For example, in an investor buys $1000 of the S&P/Goldman Sachs commodity index, $700 would be invested in energy futures like crude oil and natural gas, $140 in agricultural commodities like wheat, corn and soybeans, $80 in industrial metals like aluminum and copper, and the rest in livestock and precious metals.

Commodity exchange-traded funds (ETF) – similar to a commodity index except that it can be traded more easily on exchanges, and it doesn’t need to include a number of commodities, but is sometimes only one commodity as in the case of the United States Natural Gas Fund (UNG) and U.S. Oil Fund (UNO) that only speculates in crude oil.

David Kane is an associate for Latin America in the Maryknoll Office for Global Concerns, where he also works on international trade and economic issues. He served for nine and a half years as a Maryknoll lay missioner in Joao Pessoa, Brazil and worked with the Jubilee Brazil campaign, a coalition of social organizations that mobilizes Brazilian society around the issues of debt, free trade and militarization. He is a frequent contributor to the CIP Americas Program.


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