Speculators Seek to Clean Up Speculation

JPMorgan and Cargill made the case against new regulations for OTC swaps, citing the example that new capital requirements will hurt the working capital position of businesses.

Surprisingly, both firms used the example of Chesapeake Energy (CHK Quote) as a key user of these swaps. What is remarkable about that is that Chesapeake's CEO was forced to sell 94% of his shares last fall in a margin call during the financial meltdown. This is probably not the case study you want to use when arguing against additional capital requirements.

Masters advocated mandatory exchange clearing with daily margin posting, transparency, closing the swap loophole and the imposition of aggregate position limits. These are not foreign concepts to Wall Street, and following an environment of leverage-induced, liquidity-driven bubbles, it's hard to argue that they are not needed.

Masters also made the distinction between financial derivatives and derivatives on consumable commodities in reference to passive indexing.

Masters explained, "Derivatives on consumable commodities do not pay interest, dividends or rents, and they have no associated cash flows because the underlying commodities have none of these things. In fact, in many cases consumable commodities have transportation and storage costs and decay over time, which means the "yield" from holding these commodities is negative.

Speculators are permitted in the derivatives markets for consumable commodities only because they provide liquidity. If someone attempts to "buy and hold" a position in commodity futures by continuously rolling it, then that speculator is consuming liquidity."

This crisis has been accurately dubbed a "Minsky Moment" by Pimco's Paul McCulley. Investors who subscribe to this view may also be aware of Minsky's third and most dangerous form of finance, "Ponzi finance." In essence, "Ponzi finance" relies on capital gains and new borrowing to repay debt for investments. Leveraged investments that have a negative yield fit into this class.