Tags: JPMorgan | derivative | contract | equities

Economy Held Hostage by Energy

By    |   Friday, 19 Jul 2013 07:41 AM

The Flash Crash of May 6, 2010, occurred several hours after I wrote a column recommending a divestment from equities. Fourteen months later, the Commodity Futures Trading Commission (CFTC) released its investigative findings, which placed significant blame on high-frequency trading in oil derivative contracts.

This study suggested that nearly 95 percent of the trading volume in oil derivatives is based on short-term arbitrage opportunities — not long-term investments — which contribute heavily to high price volatility.

Due to the Commodity Futures Modernization Act signed by President Clinton, these derivative contracts were not treated as futures or securities. Therefore, dealers of these contracts were not required to maintain adequate capital to insure counterparty payments — that is, the losers did not have enough money to pay the winners.

These high-risk, excessively leveraged products turned sour, causing massive losses that continue to wreak havoc with our economy.

The market for electricity is also driven by derivative contracts. Large banks, such as Barclays and JPMorgan Chase, are each facing fines of nearly $500 million for allegedly manipulating these markets, according to the Federal Energy Regulatory Commission (FERC).

Following the collapse of Bear Stearns in 2008, I divested heavily from the equities market, averting a drop of more than 40 percent. JPMorgan purchased Bear Stearns for approximately $1 billion with a government guaranteed loan of nearly $29 billion. Included in Bear Stearns' assets were rights to sell electricity derivative contracts.

Several months after the flash crash, JPMorgan allegedly engaged in deceptive activity to profit handsomely from these contract rights. Blythe Masters of JPMorgan may have had a role in obscuring the FERC investigation, according to a report by The New York Times. She was the chief financial officer of JPMorgan and instrumental architect of the high-risk credit default swap vehicle in the mid-1990s. Since then, the deregulated derivative market grew to more than $700 trillion — or 10 times the annual world economic output.

The lesson to be learned: reduce our exposure to high-risk energy derivatives and lower our dependency on external energy sources.

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The Flash Crash of May 6, 2010, occurred several hours after I wrote a column recommending a divestment from equities. Fourteen months later, the CFTC released its investigative findings, which placed significant blame on high-frequency trading in oil derivative contracts.
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2013-41-19
Friday, 19 Jul 2013 07:41 AM
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