Serious Implications

Did speculation in energy prices enabled by the “Enron Loophole” bring on the recession? From August 2007 to July 2008, the Commodity Fuel (energy) Price Index rose 91%

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Click on the above figure for a much better view of an interactive graph.

We’ve heard about sub-prime mortgages lent to people who couldn’t afford them, foolish buyers taking on more house than they could afford, unscrupulous bankers, mysterious investment products like “credit default swaps” and “credit derivatives.” Perhaps, one underestimated factor in the current recession and financial crisis may be the “Enron Loophole” and the commodity bubble of 2007-2008.

The above graph shows a 10-year history of fuel and energy price data. Between August 2007 and July 2008, the Index rose from approximately 129.8 to 248.4, a jump of 91%!

With food (food and other commodity prices mostly follow energy prices) and energy costs rising so quickly, did consumers face the choice between, on the one hand, buying food for their families and gas for their cars to go to work and, on the other hand, paying their mortgage? Did the commodity bubble of 2007-2008 stretch paychecks to the breaking point?

The Enron Loophole
So how did this happen? What led to skyrocketing commodity prices? NPR Marketplace host Kai Ryssdal interviewed Michael Greenberger, former member of the Commodity Futures Trading Commission (CFTC) in June 2008. An excerpt:

Ryssdal: Why is it so hard to figure out what’s going on in commodities markets — oil specifically?

Greenberger: Well, the reason it’s hard to figure out is about 30 percent of our crude oil energy futures are traded in what is called a dark market — that is a market that was deregulated in December of 2000 at the behest of Enron. Prior to that legislation being passed, all energy futures traded in the United States or affecting the United States in a significant fashion were regulated by United States regulators under a very careful regime that had been perfected over about 78 years and many observers believe that because those markets are not being policed, malpractices are being committed and traders are able to boost the price virtually at their will.

Ryssdal: You’re not really telling me that seven years on, we’re still paying the price for Enron, are you?

Greenberger: Well, this has been called the “Enron Loophole” and there are many legislators working very hard to close that loophole. There is tremendous concern about this on Capitol Hill and on a bipartisan basis, people are drafting legislation to try and get a handle on this and not eliminate speculation, but bring the speculation under the kind of time-tested controls that were used until Enron had its way and amended the law to escape traditional tested regulation on speculative activities.

Ryssdal: So what’s Congress going to do? Congress is going to get together, they’re going to pass a law and it’s going to say, “CFTC, fix this?”

Greenberger: Well, there are several proposals suggesting or proposing that light shine on these dark markets and some of the legislation goes further than others, but the bottom line is the speculators will, in the end, be policed. We will know who they are, what they’re doing, what their controls are, what effect they’re having on the market. Maybe we’ll find out that there’s nothing there.

Ryssdal: So just to be clear, you do think that we’re in a bubble, then?

Greenberger: I believe it and I’m certainly not alone in my belief. If you talk to anybody who trades in these markets on a regular basis, they will tell you that the markets are completely dysfunctional and out of control because of speculative activity.

So, before average American consumers, the “little people,” are convinced that it was themselves, through their own lack of discipline and unrealistic financial expectations, who carried the world to recession, they should understand the politicians and corporations built the road and led the way.

Don’t let them blame it all on you.

Simplified Stagflation Index for 2008

The November and December Simplified Stagflation Index (SFI) jumped due to negative inflation and wage increases. Given all the bad news about unemployment, cuts in factory orders, foreclosures, and bank insolvency, this was some good news for those of us who hung onto our jobs. The positive SFI numbers mean that workers are rebuilding some economic strength to buy, save, and invest after several years of losing it. That sunny thought, however, and hope for economic recovery, requires we continue to keep our jobs and create a lot of new ones.

The December data from the Bureau of Labor Statistics indicates that wages rose faster than inflation for non-managerial workers in the private sector, who make up about 80% of the American workforce. The key data:

Consumer Price Index (CPI) -0.7%
Average Hourly Earnings (AHE) +$0.05 or +0.27%
Average Hourly Wage $18.36/hour

Calculating the December percent increase in wages adjusted for inflation:
AHE – CPI = 0.27 -(-0.7) = 0.97
December Simplified Stagflation Index = 0.97 X 100 = 97.

The 12-Month Cumulative SFI = 317, with big increases coming since August and lower fuel prices. Real estate prices, in general, are also down over that period.

When the experts boil down all the details about the economic crisis, they will likely find three main culprits: (1) rising fuel costs (gas prices over $4 per gallon); (2) banking deregulation leading to the securitization of bad debt; and (3) the Commodities Futures Modernization Act of 2000. The problems we face as a result were preventable.

We could have avoided this mess by getting serious about energy efficiency, redesigning cars to meet higher CAFE standards, and developing renewable energy. We could have avoided the current bank bailout fiasco by keeping intact the banking regulations that separated commercial banks from investment banks. We could have kept commodities prices, including oil, from skyrocketing by requiring sane margin requirements for speculators.

For a fascinating discussion on the banking and commodities deregultion, listen to Michael Greenberger on NPR’s Fresh Air with Terry Gross