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Banks seek change in hard-asset rule
Some criticize proposal, saying it will limit disclosure
By Thom Calandra, CBS.MarketWatch.com
Last Update: 12:11 PM ET March 12, 2003
SAN FRANCISCO (CBS.MW) - It may be much ado about nothing, but a proposed change to the way commercial banks handle commodities has some hard-asset investors riled up.
The Federal Reserve, at the request of two giant banks, is considering a rule change that would let bank-holding companies take title of nearly all commodities, like barrels of oil, briefly. The request by Citigroup (C: news, chart, profile) and UBS AG of Switzerland (UBS: news, chart, profile) essentially would let banks deal in a wider range of hard assets when they are buying, selling or designing derivatives based on those assets.
Right now, banks on American soil use derivative contracts when they are buying, selling or structuring a loan, swap or other transaction that involves commodities. As U.S. Federal Reserve rules now stand, banks can take title of only precious metals when they are in the world of hard assets.
Commercial U.S. banks are said to hold more than $50 trillion of highly leveraged derivatives on their balance sheets, and even more on behalf of clients. The growing amount of such contracts, which take the shape of forward sales, futures, options and dozens of other paper-linked transactions, led insurance executive Warren Buffett of Berkshire Hathaway (BRKA: news, chart, profile) to declare derivatives "financial weapons of mass destruction."
At the heart of the proposed rule change is the ability of banks to take title to hard goods on an "instantaneous pass-through basis." Critics contend that would limit or eliminate disclosure of derivative trades, say in the haywire energy markets. Such trades, involving billions of dollars of leveraged paper contracts, could ring alarm bells with investors if they became widely known, say some.
"It's just another rule change in a pattern of changes already well established, namely, to bend over backwards to give the banks everything they want regarding derivatives, including no disclosure," said James Turk, a former commodities financier and director of payment transaction company GoldMoney.com. "Basically my reading is that this change to the regulations is consistent with Fed policy to give banks what they want."
The new rule, if it becomes effective later this spring, appears to allow banks to increase their business in the volatile energy markets, where many transactions are actually settled physically by two parties exchanging payment for goods such as crude oil, heating oil or other petroleum-based products.
The Federal Reserve, in comments to the request for a change to so-called Regulation Y, said, "These requests arise in large part because, in certain over-the-counter forward markets (U.S. energy markets, for example), the physically settled derivative contracts traded by market participants do not specifically provide for assignment, termination or offset prior to delivery."
Traders in these markets, said the Federal Reserve in its comments, "generally settle the derivative contracts by temporarily taking and making delivery of title to the underlying commodities." Banks, on the other hand, "generally enter into back-to-back derivative contracts with third parties that effectively offset each other." See: Regulation Y rule change.
Never short JP Morgan Chase or Citibank. The fed views them as indispensible and as such, they won't go down until the U.S. Government does. 53 Tril in derivatives exposure? No prob. We can print bailout money 'till we run out of trees.....
yeah, no wonder why miners went down hard these days....
the insiders know about the dirivative rule changes....damn....
they are work'n over time to save the damn banks.....
this really sucks.....
they created the derivatives....now they are changing the rules....simply because they know they are in trouble....
I wish I was the creator !!! damn !!!
we need more people to take pysical delivery.....as for China....sure isn't make'n much of a dent....
Banks, in other words, want the same flexibility that non-bank traders have in energy and other physical-delivery markets.
Offsetting contracts that are used now by banks ensure, theoretically, that on the maturity date of a derivative contract, the producer will deliver the goods and the buyer will accept them. That reduces the banks' risk of actually holding heating oil, or soybeans, or pork bellies.
"Citigroup and UBS contend that a bank-holding company that takes title to a commodity on an instantaneous, pass-through basis takes no risk that is greater than or different in kind from the risk that it has as a holder of a commodity derivative contract that meets the current requirements of Regulation Y," the Fed said in its comments.
James Tu, director of investment research at commodities specialist Gerstein & Fisher in New York, said on the face of the rule-change request, one could interpret regulators are concerned about mounting risk for commercial banks.
According to the U.S. Office of the Comptroller of the Currency, which tracks derivative exposure, U.S. commercial banks held $53.2 trillion of derivatives at the end of the third quarter 2002, up $3.1 trillion from the second quarter. Among individual banks at the end of 2002's third quarter, J.P. Morgan Chase (JPM: news, chart, profile) had the highest derivative exposure, followed by Citibank and Bank of America (BAC: news, chart, profile).
"If their proposal is passed, that might permit banks legally to engage in shorting these commodities without limit," said Tu, who acknowledged he was speculating about the possibilities and had no direct knowledge of possible outcomes of the proposed rule change. "I guess we keep underestimating Fed's ability and willingness to stretch itself in order to save the butt of the big banks."
One author's view of battered tech sector
George Anders is the veteran Wall Street writer whose examination of technology and other companies has put him a notch or two above most financial journalists. I met him years ago, when he was a staff reporter at The Wall Street Journal and had just finished "Merchants of Debt," a revealing history of buyout specialists Kohlberg Kravis Roberts & Co. In 1997, Anders was part of a team of reporters awarded a Pulitzer Prize for national reporting.
I asked Anders, now senior editor and western U.S. bureau chief for Fast Company magazine, what his latest thoughts were about fair value in the steadily declining (but still by many measures ultra-expensive) stock market. Anders this year published "Perfect Enough: Carly Fiorina and the Reinvention of Hewlett-Packard."
"On the tech sector," Anders told me, "I'm always amazed at how much punishment a really big company can withstand at the bottom of a recession -- and still bounce back very strongly in the next upturn. I got started in business journalism writing Heard on the Street for The Wall Street Journal in the early 1980s, when Chrysler (DCX: news, chart, profile) was at $3 and everyone "knew" it was going to zero. It didn't. (The stock) roared ahead when the economy turned upward, and made it north of $30."
And speaking (above) of Citicorp, Anders says, "Same story in the early 1990s, when Citicorp fell to $10 and looked to be drowning in Third World loans. As global credit conditions got better, Citicorp leapt 10-fold as well. I'm not a stockpicker by training or temperament, but I'd be interested in seeing which non-traditional tech investors are willing to make bets that some of today's seeming casualties will rebound big at some point."
Bigger is better, the writer says. The lesson of prior cycles, says Anders, "is that the 100,000-employee companies with $40 billion a year in revenue make their way through these cycles a lot better than the 10,000-employee companies with $4 billion in revenue. Maybe they've got more marginal operations that need to be cut. Maybe they just have bigger cash cushions to get through hard times. Maybe they have a bigger loyal core of employees and customers that don't give up no matter what. But my guess is that five years from now, we'll look at this tech cycle and be struck by some company's 'back from the brink' story.