How Big Banks Are Driving Up the Prices of Practically Everything

JPMorgan Chase (NYSE: JPM  ) nosed closer to a settlement with the Federal Energy Regulatory Commission over the past week as both parties work toward resolving the issue of energy market manipulation in California and other key markets.

That state's Independent System Operator had estimated that the engineered run-up in electricity prices added up to $73 million, so the big bank's reputed penalty of $410 million seems like a pretty good deal -- except for the rumored lack of sanctions against those responsible for this scandal. However, as The Wall Street Journal notes, nothing is written in stone yet, and things could possibly change.

Banks' involvement in commodities questioned
Perhaps the terms of the settlement will change, but the myriad ways in which the largest banks manipulate commodities markets very likely won't -- unless regulators force them to. Happily, the winds of change may be in the air, as a Senate subcommittee plans hearings on July 23 on the issue of banks and commodities, spurred by consumer and corporate complaints.

In addition, the Federal Reserve is taking a fresh look at the 2003 decision to allow banks to immerse themselves in commodity markets, when it opted to allow such activities as "complimentary to financial activities."

Banks have been manipulating commodities in so many ways
For years, JPMorgan, Goldman Sachs (NYSE: GS  ) , and Morgan Stanley (NYSE: MS  ) have been making a killing in the commodities markets, scooping up mass quantities of aluminum, coffee, oil, and wheat over the intervening years, according to The New York Times. They've accumulated such huge stores, in fact, that they have been purchasing warehouses to store them in, as well as pipelines and other delivery systems to transport them.

This creates problems in many ways, though not for the banks, the 10 biggest of which have made a neat $6 billion on commodities, according to Bloomberg. Where the problems tend to arise is for regulators and consumers: the former, in that they can't get a good handle on how deeply these banks are involved solely from their regulatory filings, and the latter, from the higher prices the "storing" of these commodities is causing.

It is notable that, when the Federal Reserve gave JPMorgan permission to enter the commodities game in 2005, it banned the bank from buying actual storehouses for its booty. Despite that restriction, the bank now owns a string of storage facilities, just like Goldman.

Manipulating markets
These players have known for some time that this day would come. Feeling the steely gaze of regulators, the top three have been making a show of trying to keep a cap on their activities. Morgan Stanley has considered selling its commodities trading desk, while JPMorgan and Goldman have sought buyers for their warehousing subsidiaries. JPMorgan even made changes to the board of one of its metal warehousing units in order to make it look more like a mere investment.

Meanwhile, these banks make money by creating false shortages, as well as by bending rules and regulations in order to create extra fees. With Goldman hoarding over 25% of the saleable aluminum, it's not difficult to imagine that extending the wait time from six to 16 weeks has had a moving effect on markets.

There are some nifty ways to play the commodity manipulation game, it seems. The Times article describes how Goldman uses its vast network of storehouses in the city of Detroit and its environs to make several layers of profit off of the same hunks of metal by moving them from one storage facility to another. This not only helps build in more storage time, but also increases the rental fees, generally based on the tonnage of metal on hand.

Obviously, this has been a goldmine for Goldman, since the firm has increased the number of storage facilities owned by its subsidiary, Metro International Trade Services, from 19 to 27 over the past two years. 

Goldman is an expert at the commodities game, having dipped its toes in the food commodity market back in 1991 by bundling wheat, hogs, coffee, and other popular consumables into a financial product named the Goldman Sachs Commodity Index. An article by Frederick Kaufman describes how the price of wheat eventually skyrocketed, as other bankers copied the magic formula cooked up by Goldman.

By 2008, market-induced scarcity created global food riots as millions became unable to afford food. Though the wheat market returned to some semblance of normalcy by the end of that year, the legacy of this phenomenon kept food prices higher all over the world as consumers were forced to make up for losses incurred by the food industry.

Regulators need to step in
This whole scenario smells of scam and is a perversion of the way free markets are supposed to work. Thanks to the Bank Holding Company Act, those entities had been kept from active participation in the commodity markets for decades, which explains how Goldman was able to get such a head start -- Goldman and Morgan Stanley were made into bank holding companies in 2008, during the financial crisis.

Now, their federally bestowed, five-year extension is under scrutiny, as is JPMorgan's role in the commodities markets. Though Goldman insists it observes the rules set out by the London Metal Exchange, which regulates how metals are stored and released, it appears that they have managed to get around those requirements with their on-site ferrying system. As the Times points out, the LME also takes 1% of the rents from warehouses under its purview, which likely hasn't spurred any protests on its part.

It is outrageous that these banking behemoths are allowed to squeeze profits out of the rest of the world, as they control the pricing and availability of precious metals, oil, and food. Regulators have been stepping up their oversight of banks in a big way since the financial crisis, and if there was ever an issue that needed to be addressed, it is this one. If something isn't done soon, JPMorgan and Goldman will be buying up copper next year, with the blessing of the Securities and Exchange Commission.

So, the next time you think about how high prices are, and how long it is taking the economy to bounce back from the Great Recession, don't forget to thank the big banks for their contributions. You can be sure they are thanking you, every single day.

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Read/Post Comments (3) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 23, 2013, at 11:13 AM, sturub wrote:

    I cant believe i actually pay for this service.. what a crap article where is yoru evidence and proof..just suspicions. the fool basis their nalysuis on numbers- facts..you dont have any to support this article at all. just because you make money - it doesnt make it illegal. you should know this as youy benefit from it. i am rethinkign my subscription into "THE ONE" as i type this. what crap.!

  • Report this Comment On July 23, 2013, at 3:01 PM, TMFKopp wrote:

    Sturub-

    Just as a quick clarification, this article is part of The Motley Fool's Fool.com site, which is free to all comers. The "One" service that you mention is housed in a separate part of the site (go to the top of your page and navigate to the "premium services" drop-down to find it).

    To this article though, you note:

    "just because you make money - it doesnt make it illegal."

    I don't believe the author actually said it was illegal -- though she definitely questioned the wisdom of allowing banks/investment banks to play such a role in those markets.

    Is she right? I'm not sure I completely agree, but the "Motley" in Motley Fool is a reminder that we're all about a diversity of opinions (one fast-held view is a good route to lousy investing). What I do think is that Amanda raises some thought-provoking and worthwhile questions here. And as an investor (and, in this case, an owner of GS stock), I'm always looking for challenges to what I think/believe.

    Matt

  • Report this Comment On July 23, 2013, at 6:12 PM, sturub wrote:

    Matt -

    I would find her analysis "though provoking" if she understood the commodities business, physical storage, or provided facts not some re hash of the garbage NY times article. lets allow the likes of foreign merchant energy and private equity companies to own these assets and see what happens to rents and prices. You really think Goldman ro any comapny cant take metal that doesnt belong to them and ship it around to other warehouses because they want to. if coors or coca cola needed aluminum they could just call alcoa and buy all the want. Fools should want facts not baseless dribble.

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