The Commodity Investor: Banning Banks From Owning Commodities Won’t Lower Prices

July 31, 2013

Spreading risk and removing it from banks will be the end result of new regulatory push.

 

Government intervention has finally reached the commodities markets. Ever since the 2008 financial meltdown, governments around the world have embarked on a policy of reducing risk-taking activity by banks. The U.S. government has been leading the charge with both domestic and international banks that do business in America.

Specifically, Congress has enacted the Dodd-Frank legislation, which aims to limit the amount of risk on banks’ balance sheets as well as the type of activity that banks can engage in. As a result, many banks have been forced to sell off their noncore traditional lending businesses, such as internal hedge fund and private equity units. Regulators have insisted bank-owned hedge funds have nothing to do with a banking institution’s traditional banking activities, which is to manage customer deposits and oversee lending activity. This has led banks to sell or spin off their alternative investment units.

Banks & Commodities At Risk?

Last week marked the first time that the Fed, through congressional hearings and the Federal Reserve, have taken aim at banks’ activities in the commodities space. Banks have been in the space since there were commodities to be traded. Specifically, banks are active in the industry through both the traditional banking model (lending to buyers and sellers of raw materials and acting as market makers) as well as through the alternative-asset model (by owning physical assets such as metals storage warehouses or electric transmission lines).

Now the government is telling the banks that it’s OK to lend money to airlines that want to buy or trade jet fuel, or other companies that want to hedge their commodity exposure. However, it’s drawing a line at activity that doesn’t fall within this sphere.

Beginning in the late 1990s (after the repeal of the Glass-Steagall act), banks became very active in the commodities space, purchasing everything from lithium-storage facilities to oil tankers and electric transmission lines. While a large number of banks got into the physical side of the business, three banks stand out in this area: Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS) and JPMorgan (NYSE:JPM). All in all, the three banks control physical commodity assets in excess of $20 billion.

 

Find your next ETF

Reset All