There's an interesting article in the Washington Post about oil speculation and transparency. The impact of speculation has become enormous:

Big Wall Street firms representing the interests of pension funds, endowments and wealthy individuals around the country have grown in just a few years from minor participants in the oil markets to their most dominant force.

These financial firms -- whose holdings of oil contracts are now larger than the collective demand of airlines, trucking firms and other companies that need oil to run their businesses -- have become the focus of an intense debate in Washington over whether their exponential growth is contributing to the surge in oil prices.

And, apparently, such people as Ben Bernanke are claiming that speculation has no effect on oil prices because about half the people bet that it will rise and half bet that it will fall. That sounds nice, but my bet is that is a "normal" pattern and not what we've been seeing, because then about half the people at any given time would be losing money. When the swings are as big and violent as we've seen, and fueled by margin buying, those losses will be enormous, pushing a lot of people out, which means you now have a mechanism that is leaning one way, not balanced.

Even if the bets were even, it's the mass of investment that causes the problem, because it has no balancing interest, like the organizations that actually want to use oil, and hence are interested in stability and lower prices. According to Bernanke's theory, at least have the people who are taking positions in oil - which means buyers, not sellers - want the price to go higher, a very different mindset than ever before. I'm guessing that's enough to cause the fluctuations and price surges we've seen.

The Commodity Futures Trading Commission has been tracking some of the investment activity, but is keeping the information secret, claiming that it doesn't want to reveal too much proprietary information about the traders, and that the complexity of the information alone, if made public, could have misled the commodities markets. But wouldn't you think that the people who wouldn't be misled would be the people who actually do this for a living - the traders in the commodities markets?

It sounds like the CFTC is dominated, as one might expect, by the biggest trading forces, which means the speculators. The organization does claim that it "always been and continues to be committed to market integrity and to market transparency." It just has an idiosyncratic way of showing it.

Yet Another Investment Scandal: Duping Investors

I know it must be hard to believe, but there's more evidence that when financial services companies have conflicts of interest, they tend to pay more attention to their own than to those of clients. The New York Times reported yesterday that Massachusetts has turned up evidence that USB was deliberately trying to foist risky securities that it and its employees owned onto individuals:

Auction-rate securities are preferred shares or debt instruments with rates that reset regularly, usually every week, in auctions overseen by the brokerage firms that originally sold them. They have long-term maturities or, in the case of the preferred shares, no maturity dates whatsoever. The securities are issued by municipalities, student-loan companies, closed-end funds and tax-exempt institutions like hospitals and museums.

In mid-February, the $300 billion market for these instruments collapsed, trapping investors who had been told that they were safe and easy to cash in — leaving both wealthy investors and those of modest means unable to finance their small businesses, buy homes, pay college tuition and otherwise use their money as they had planned.

Although USB is denying it, Mass. secretary of the commonwealth Bill Galvin's office apparently uncovered some blatant emails. Read the story (at the link) to see some of the panic that knowingly ran through the company as it wanted to dump inventory - and that some emails by brokers themselves suggest that they felt they were being kept in the dark about real risk as well. If it really was cash equivalent, as they allegedly claimed, then why was it so hard for them to get cash? Could they be ... lying? Maybe: were their fingers typing?

The LA Times: When Investors Should Stop Trying to Run Businesses

I wrote about the LA Times Magazine story on my blog about words and writing. However, it turned into a business rant, so I thought a link here might be worthwhile.

Adolescent Investing

You've undoubtedly seen the news stories today about the loss in stocks in the face of the quarter percent interest rate drop by the Fed. The standard rationale being offered is that Wall Street expected a half point drop. That is equivalent to saying that a screaming teenager's tantrum about not getting to do something his or her friends are doing. It's not - the problem is a lack of maturity and realism on the part of the one doing the screaming.

It's clear that Wall Street invests based on emotion, and not strictly on logic. People like Alan Greenspan have pretty much said so, and if you look at the way stocks react, you can see direct evidence and not even wait for the experts to weigh in. So, investors wanted a double cone and instead got a single scoop, and so decided that they'd go home and pout.

In other words, there's no reason to get that upset or worried about the market, because it's as useful as getting twisted up over a teenager on a rant. What the grown-up parent or investor does is take all this in stride and do what is necessary anyway.

A Sudden Realization About the Sub-Prime Crisis

I've written a fair amount about this topic, so this will be short. (Having impending deadlines, like other forms of death, concentrates the mind wonderfully.) But when I started thinking about how this debacle came to being, I wrote the following:

By combining pools of mortgages with rising housing prices, lenders were able to wash off the risk because the failure of some percentage of borrowers still left the pool safely covered.

That was the explanation I had read, but something bothered me about it. It didn't quite make sense that some juggling could improve the credit rating that much. After all, to really cover the potential default rates, you'd probably need to add a significant number of "good" mortgages that would be unlikely to default so the return on the investment had a reasonable chance of occurring. But then the default rates shouldn't have had that kind of impact. And yet, it seemed that the derivative securities were largely based on poor credit lending. How did bundling them get better ratings than the individual loans would have?

After paying attention to more reporting on the subject, I think I now understand. The rating agencies abdicated any ethical or moral responsibility to give an honest opinion on the derivatives because they are paid by the very financial institutions that were issuing them. Unfortunately, investors pay significant heed to these ratings and often pass on doing further due diligence. I could understand that from individuals who are intimidated by understanding financial matters. But these derivatives could never have taken off without significant institutional investor participation. What happened here? Don't these large organizations that hire lots of brainy people actually do their own thinking? Actually, many rely on the opinions of others far more than you might thing, certainly in proxy voting issues, as I learned in writing an article for Corporate Secretary.

So many individual investors, putting their money into money markets, pension funds, and other aggregations of cash might be taking a larger risk than they realize, because they don't always know who's really making the decisions. Where has the financial media been through all this? This story has an Enron-like cast, with lots of people writing in awe of the clever financing and no one pointing out that the Emperor ruled in the buff.