Stories about banks conspiring against the public are always in demand. So it was unsurprising to see these sentences the other day on the front page of the New York Times: “Hundreds of millions of times a day, thirsty Americans open a can of soda, beer or juice. And every time they do it, they pay a fraction of a penny more because of a shrewd maneuver by Goldman Sachs and other financial players that ultimately costs consumers billions of dollars.”
Is nothing sacred? Housing was bad enough. Now the banks are messing with our soda, beer and juice?
Actually, this scandal isn’t that new or all that scandalous -- though it raises some questions worth addressing.
The allegation is that Goldman Sachs Group Inc. and other investment banks have moved into the aluminum market in order to rig it, force prices up and thereby reap ill-gotten profits. As part of their plan, they own warehouses where they hide aluminum, thus creating a false sense of scarcity. They also crimp the market by delaying deliveries -- and earn an extra profit by charging for storage.
That’s one way of looking at it. What’s mostly going on is that the price of aluminum for future delivery has risen above its price in the spot market. This creates an arbitrage opportunity: Buy the metal and sell it forward, storing it in the meantime. If the cost of financing is very low (which it is) and the cost of storage can be held down, that trade -- stock financing, as it’s called -- makes money.
In principle, this shouldn’t unduly concern consumers. Over time, the practice can actually smooth the price of metal, slowing its fall in periods of weak demand (such as now) and braking its rise as demand recovers and the warehoused metal comes back on to the market.
Stock financing has been a feature of the metals business for several years. What prompts the most recent concern is the unusual scale of the practice, which has drawn attention to pricing anomalies and to eccentricities in the way the London Metal Exchange runs its markets. Users of aluminum are having to pay higher premiums for delivery as though there were a shortage. Yet stocks in warehouses (promised for future delivery) remain high. Businesses such as Hindalco Industries Ltd’s Novelis subsidiary are complaining about delays in getting stocks out of the warehouses; some suspect a ploy to manipulate prices and collect storage fees.
The main problem, if it is a problem, is partly self-correcting. Higher aluminum prices will at some point make stock financing unprofitable -- and as the practice unwinds, the rise in prices will be moderated. This doesn’t mean that dysfunctional market oddities shouldn’t be addressed. The U.S. Commodity Futures Trading Commission is looking at the matter. The LME has acknowledged the complaints and is looking at its practices. It recently proposed a new rule to speed withdrawal of metal from the system.
The exchange should go further. As with any market, maximum transparency is crucial. LME data is quirky, because some inventory is “dark” -- not counted as inventory because the exchange hasn’t officially certified its existence (see “eccentricities,” above). This gives sophisticated players an opportunity to mislead the market and maybe game the system. Another oddity is the provision in the exchange’s standard contract that lets warehouses charge fees long after the owner has asked for delivery, giving the warehouse owner a reason to take its sweet time. The LME should strive to stop dark inventory and limit storage charges to, say, one month after delivery is requested.
Changes such as these would be desirable regardless of who owns the warehouses. Whether banks should be in that business is a separate question. In 2003, the U.S. Federal Reserve gave banks permission to trade physical commodities, a ruling that is up for review. There are at least two good reasons for withdrawing that permission: to simplify financial institutions that are too complex and to limit the scope of the implicit subsidy that banks collect from taxpayers. To prevent Wall Street investment banks from adding to the cost of beer is not a good reason -- though the allegation does, we admit, make for a good story.
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