By Christian Berthelsen And Ryan Tracy
WASHINGTON-- Goldman Sachs Group Inc. executives faced a tough
grilling Thursday before a U.S. Senate committee, as lawmakers
accused the bank of engaging in a series of aluminum transactions
to give itself an unfair advantage.
Sen. Carl Levin (D., Mich.), in a heated back and forth with
Goldman officials in charge of the firm's aluminum warehousing
business, suggested the firm moved metal between warehouses as part
of an effort to drive up prices and increase its own revenue.
"Goldman's ability to influence any portion of the price for a
key component of the industrial economy is simply unacceptable,"
Mr. Levin said. He said the investment bank's actions gave it "the
ability to affect prices and supplies of that commodity while
trading in financial instruments related to that commodity."
The hearing is part of a two-year, bipartisan probe by the U.S.
Senate Permanent Subcommittee on Investigations into how banks like
Goldman, J.P. Morgan Chase & Co. and Morgan Stanley built up
voluminous inventories of aluminum, copper and other
commodities.
A report released ahead of the hearing accused the banks of
gaining trading advantages and influencing prices and said the
banks often exceeded regulatory limits on the size of commodity
holdings. It portrays banks straying far beyond their traditional
business lines to dabble in lucrative but risky activities that
posed legal and financial threats to the firms.
At the hearing, Goldman officials denied their activities
impacted aluminum prices and insisted no confidential information
was shared with metals traders. The officials acknowledged that
after Goldman bought the warehousing business, Metro International
Trade Services LLC, in February 2010, it began engaging in deals
with other financial firms that lengthened the wait time for other
users to remove aluminum from the warehouse but denied that
influenced prices.
"There is no correlation" between length of the wait time and
aluminum prices, said Jacques Gabillon, a Goldman executive who is
chairman of the board of the aluminum warehouse business. Mr. Levin
disputed that argument. He also said Goldman traders could have
profited on the activities regardless by playing in futures markets
that are a component of the overall aluminum price.
The findings are likely to put additional pressure on the
Federal Reserve as it considers whether to restrict or reduce Wall
Street banks' role in physical commodity markets. A two-day hearing
on the report began Thursday, with Fed Gov. Daniel Tarullo expected
to testify on Friday. The Fed, which is reviewing its oversight of
banks' commodity-market activities, declined to comment.
The banks identified in the report said they adequately manage
risks of the activities and don't use their commodities business to
gain an unfair advantage. All three firms have moved to reduce
their commodities holdings amid congressional and regulatory
scrutiny.
The Senate report also depicts the Fed as failing to stop the
bank buildup of commodities, allowing firms like J.P. Morgan to
hold assets well in excess of allowable limits. The Fed restricts
commodity holdings to 5% of a financial firm's high-quality
capital, but the banks used loopholes to hold far more, the report
said. At times, the report said, the Fed was simply unaware of how
much oil, aluminum and copper banks were stockpiling.
Investigators found J.P. Morgan exceeded restrictions on copper
holdings by defining it as a precious metal despite its widespread
use in industrial applications and exceeded aluminum limits by
holding it as an asset of a subsidiary instead of the parent
company. Precious metals are exempt from a federal rule that only
5% of banks' financial trades can end with physically delivering a
commodity. Morgan Stanley held 55 million barrels of oil-storage
capacity, enough supply for nearly three days' worth of U.S.
consumption. Goldman, the report said, engaged in "merry-go-round"
transactions involving aluminum for its own financial gain.
The report also cites a previously undisclosed Fed staff review
that in 2012 recommended higher capital requirements for big banks
engaged in commodities, closer monitoring of those activities and
tougher reviews of whether the activities were actually
complementary to banks' normal lines of business. The Fed hasn't
identified how it has implemented any of the staff's
recommendations, the report said. The Fed earlier this year asked
for public comments on changes to its commodities policy.
The report didn't offer an overall estimate of profits the banks
made as a result of their physical commodities holdings.
Democrat and Republican lawmakers said the report shows
additional restrictions are needed to rein in Wall Street's role in
raw-materials markets. The report recommended a series of actions
that could shrink bank trading and strengthen oversight. While none
of the activities highlighted in the report appears to be illegal,
officials said they hadn't yet decided whether to refer certain
matters to enforcement agencies.
"We found substantial evidence that these activities expose
major banks to catastrophic risks that are poorly understood," said
Mr. Levin, who chairs the subcommittee and is holding the two-day
hearing. Executives from Goldman, J.P. Morgan and Morgan Stanley
are set to testify. "They are raising costs and uncertainty for the
end users of commodities, which hurts American manufacturers and
consumers."
Officials are concerned banks' ownership of volatile commodities
poses risks to the firms and the financial system, saying a
catastrophic event similar to the Deepwater Horizon explosion or
the Exxon-Valdez tanker spill could expose a bank to legal and
reputational risk. As liabilities mount, lenders and trading
counterparties could withdraw credit and refuse to do business with
the bank, posing a risk to the entire financial system given the
size and scope of big Wall Street banks.
The Senate report focuses heavily on events that led to a 2010
logjam in wait times to remove aluminum from Detroit metal
warehouses operated by Goldman. In September 2010, wait times at
the warehouses began to rise to unprecedented levels of as much as
two years, which the report said led to a supply shortage that
drove up aluminum prices and prompted complaints to lawmakers from
major aluminum consumers like MillerCoors LLC.
The report points to agreements between Goldman's warehousing
subsidiary and Deutsche Bank AG, London metals hedge fund Red Kite
Group and Glencore PLC, a Swiss mining and trading company. Goldman
gave the companies incentives to sign contracts to keep their metal
inside the warehouse system--increasing warehouse revenue for
Goldman and benefiting its trading position, the investigators
found. Under the merry-go-round agreements, the metal would merely
be transferred between warehouses.
In a report posted on its website Wednesday, Goldman said the
activity at its warehouse reflected the desires of its
financial-market customers and didn't affect aluminum prices or the
availability of aluminum to the broader market. Goldman is pursuing
a sale of the warehousing firm, Metro International Trade Services.
Representatives of Deutsche Bank and Glencore declined to comment.
A portfolio manager at Red Kite couldn't be reached for
comment.
The report said Deutsche Bank executed the first such deal in
September 2010, asking for delivery of 100,000 tons of aluminum in
a single transaction. The amount of metal was the largest
withdrawal in the history of the global market for physical metal
at the time, and 80 times more than the usual daily flow out of
warehouses in the area. The wait time for clients hoping to get
their metal ballooned from 20 days to four months.
Senate investigators pointed to weak oversight by the Fed, which
they said allowed companies to hold commodity assets well in excess
of regulatory limits. J.P. Morgan's physical commodities holdings
as of September 2012 were at least $17.4 billion, or about 12% of
the high-quality capital it had maintained to absorb losses and
avoid needing a taxpayer backstop, according to the report. That
was more than twice the 5% regulatory requirement.
J.P. Morgan circumvented the rule "by excluding and minimizing
the value of various assets," the report said, adding that the
regulations are "riddled with exclusions, poorly coordinated, and
currently ineffective to protect taxpayers."
The Fed's legal department hasn't objected to J.P. Morgan's
capital calculation, the report said. In a summary of its testimony
to be delivered Thursday, J.P. Morgan said it has "robust risk
management" in line with Fed rules.
Write to Christian Berthelsen at christian.berthelsen@wsj.com
and Ryan Tracy at ryan.tracy@wsj.com
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