"Speculation is only a word covering the making of money out of the manipulation of prices, instead of supplying goods and services." -- Henry Ford
While I do not agree with Henry Ford, his statement is a fair approximation of the feelings of many who do not work on Wall Street. Even some on Wall Street believe that deregulation went too far.
The principal component of successful markets is "trust" -- trust in one's counterparties, trust in one's trading and settlement mechanism, and most of all, trust in market pricing. Participants need to have confidence that the playing field is level. Over the past 10 months, anyone who has read a newspaper or turned on the television has witnessed multiple stories that have eroded that trust. It is imperative to the continued success of the U.S. financial markets that trust be restored, because if investors do not trust a market, they will not invest in it. Without participation, investment wanes and growth stagnates. The first phase of the move to re-establish trust will likely be led by the CFTC, Commodity Futures Trading Commission. The rise in crude above $140 a barrel a year ago prompted Congress to examine the structure of those markets. In many respects, Congress and the CFTC are already on the same page, despite the fact that the new chairman of the CFTC was sworn in just over a month ago. The combination of CFTC Chairman Gary Gensler's announcement of summer hearings regarding new regulations and a Wall Street Journal Op-Ed by Gordon Brown and Nicolas Sarkozy has hurled speculation into the spotlight. As usual, Wall Street and its colleagues in the trading pits in Chicago have put up their guard, fearing that someone is taking aim at them. Free-market ideologues quickly ramp up the rhetoric. These individuals conveniently forget that their primary standard bearer over the past quarter of century, Alan Greenspan, recanted part of his deregulatory orthodoxy in front of Congress last year. Don't be mistaken, I am a "free marketer" who spent a noteworthy portion of my career as a proprietary trader, a.k.a. "speculator." Because of that, I believe that speculators, more than anyone else, should be battling for a level playing field, because that is where they earn their living. Despite the recent headlines and hoopla, the first phase of the CFTC's new initiative occurred a month ago in front of the Senate Agriculture Committee in a hearing titled "Regulatory Reform and the Derivatives Markets." The first panelist was CFTC Chairman Gensler. Did we mention that he is a 20-year Goldman Sachs ( GS) veteran (a former "speculator"), and was at Treasury during the Rubin-Summers era when the massive deregulatory Commodity Futures Modernization Act of 2000 was signed into law by President Clinton? It is highly unlikely that Gensler shares Henry Ford's view either. If anything, Gensler has the potential to be a modern-day equivalent to Joe Kennedy becoming the first head of the SEC. Financial historian John Steele Gordon eloquently described Kennedy's time at the SEC by noting that, "He regarded his job not only to restore the confidence of the country in Wall Street, but, equally important, to restore the confidence of Wall Street in the American economy and government." In his testimony, Gensler discussed regulating derivatives dealers (such as AIG ( AIG)), improving capital and margin requirements, regulating derivatives markets, central clearing, exchange trading, position limits and improving transparency. Most of these actions sound very similar to the structure of the U.S. equity market. Interestingly, some of the second panel group of panelists, JPMorgan executive Mark Lenczowski and Cargill executive David Dines, made the case for limiting the new regulation, whereas hedge fund manager Michael Masters and author/hedge fund executive/former Wall Street executive Dr. Richard Bookstaber, who are both "speculators," advocated new regulation.
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) 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.
In conclusion, all of these "speculators," whether it's Gensler, Bookstaber or Masters, are simply attempting to pull back the curtain on the opaque OTC derivative market to ensure that the playing field is level. The trust in pricing must be restored so commercial users, the producers and consumers, can make informed investment decisions for the future. For the "free marketers" and my Wall Street colleagues who are concerned, we knew regulation was inevitable, and we should be glad that the movement is being led by those best suited to find that balance of triangular trust among Main Street, Wall Street and the government. This article was written for TheStreet.com by Mike O'Rourke, chief market strategist at BTIG, LLC. The views and opinions expressed are his own and do not necessarily represent those of BTIG LLC. O'Rourke has no positions in the securities mentioned within. Goldman Sachs is a passive minority investor in BTIG.
