The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders (12 page)

Almost immediately, industry members torpedoed the proposal along much the same lines that they had argued during the
summer hearings. Nearly 15,000 comment letters poured in—an all-time record for the agency. Gensler was unmoved. Asked
during a lunch at the upscale Waldorf Astoria hotel in New York with representatives from Goldman Sachs, Credit Suisse, and other banks what the biggest hurdle to improving the derivatives world was, he pointed to his hosts and said: “The people in this room.”

Even among the CFTC’s commissioners, the position limits were controversial. Chilton was pleased, but three of his counterparts had significant doubts. Imposing specific limits on one universe of commodities contracts that didn’t exist in others would be too confusing, argued one, and stiffer oversight in the U.S. risked sending traders fleeing to more hands-off regulators in Europe and elsewhere. Another argued that although he was in favor of publishing the proposal, it was only because he wanted to see the industry’s comments, not necessarily because he agreed with what was in it.

Congress and the White House soon came to Chilton and Gensler’s aid. For several years, Representative Bart Stupak of Michigan had been pushing a bill to rein in speculation that he called the Prevent Unfair Manipulation of Prices Act, a proposal better known by its cheesy acronym: the PUMP Act. Among other things, Stupak’s bill called for the extension of position limits in energy products across all derivative markets. Backed by the Teamsters Union, an airline trade group, and numerous corporations, it would enable the CFTC to “prevent market manipulation and help eliminate the unreasonable inflation of energy prices caused by excessive speculation,” Stupak argued in congressional testimony, helping American consumers to avoid runaway costs. President Obama and Treasury Secretary Timothy Geithner also appeared to be in favor of position limits.

Those views were crystallized in a key section of the Dodd-Frank Act, a legislative behemoth passed in 2010 that was years in the making. Embracing many prior congressional attempts to curb derivatives trading, Dodd-Frank articulated new protections for consumers who used credit cards and basic banking services, set up new authorities to monitor the financial system, and forced major financial institutions to create contingency plans to protect the broader system from their own demise.

House and Senate leaders spent much of the spring and early summer of 2010 finalizing the bill, which ultimately filled 848 pages. Dodd-Frank mooted the position-limits proposal that had been published that January (which, ironically, was too narrow to meet Dodd-Frank’s requirements). But it reinvigorated the cause by curbing large trades in contracts connected to twenty-eight major commodities rather than just a handful, including gold, copper, natural gas, sugar, and crude. It also called for the central “clearing” of most swaps (a move that, as with BP’s late 2008 transactions with Glencore, insulated market participants from the credit problems of their trading counterparts) and gave the CFTC more oversight of contracts traded on foreign exchanges.

Gensler, who had been in the room throughout the all-night congressional session at which Dodd-Frank was finalized, was delighted. He was a huge proponent of Title VII, the portion of the act dedicated to contract trading and commodities, which promised to empower the CFTC substantially. Along with Dan Berkovitz, the Levin committee lawyer he had hired as the Commission’s general counsel, he collaborated with lawmakers like Arkansas Democratic senator Blanche Lincoln to fashion the final language. Being on the Hill frequently enabled Gensler to tinker with the act’s details up until the last minute—including huddling at
5
A.M.
with a New England senator to broaden an important swap-reporting requirement.

Days before President Obama signed Dodd-Frank into law on July 21, word of a new commodity-market disruption hit the press. Anthony Ward, a London hedge-fund trader
who had gotten his start at Phibro, the same company that trained Marc Rich, had amassed a huge physical position in cocoa that amounted to
nearly every bean in the London cocoa exchange network that he could physically get his hands on. The price of physical cocoa beans, tropical products that were used to make chocolate,
had shot to their highest price since 1977.

The stratospheric prices of physical cocoa sparked fury in Britain, where, as in the U.S., many people were still reeling from the financial recession. The thought of some mysterious, deep-pocketed hedge-fund manager driving up the price of everyday goods like Hob Nobs cookies and fine chocolates at a time when so many people were suffering seemed grossly unfair. The London tabloids dubbed Ward “Chocfinger,” a play on the notorious James Bond antagonist Goldfinger, and
published pictures of him looking dark-tanned and hokey in a tieless suit. On Facebook, someone created a Chocfinger graphic by superimposing
Ward’s face on a pig’s body, headed for the trough. A television camera camped for a day outside Ward’s stately London office on Curzon Street, part of the same moneyed enclave where Glencore’s traders worked.

Fellow commodity traders were almost as incensed. The
German Cocoa Trade Association reportedly dispatched an angry missive to the London International Financial Futures Exchange where cocoa is traded, charging that Ward’s company, Armajaro Holdings Ltd., had engaged in manipulation. Behind the scenes,
Armajaro fought back, arguing that they had been set up for a media drubbing by market opponents betting that cocoa prices would fall, and that their trades were entirely legitimate. Ultimately, after a brief spike, the price of
cocoa fell dramatically and Ward had to unload his physical position in a hurry. No public regulatory sanctions were ever brought.

In the months after Dodd-Frank’s passage, CFTC teams began crafting the rules that would actually execute the act’s directives in the markets. Thirty-four rules were prepared by December, a remarkable accomplishment for an agency that had been far less prolific in the past, but commodity position limits weren’t among them.

Because the commissioners were still at odds over the limits, Gensler proposed to Congress a phased implementation. To strengthen market oversight in the meantime, Chilton, who was irked about the delay, proposed implementing “position points,” threshold position levels for commodity contract traders that would trigger the CFTC’s notice and, potentially, a directive to the traders who attracted notice to downsize their positions.

On December 16, the Commission held its eighth public meeting to discuss its progress on Dodd-Frank. After listening to the back-and-forth between the staff and his colleagues about the problems with checking large commodity contract positions, Chilton, who was pressing the position-points idea, lost his temper. He cut off Berkovitz midsentence during an answer to one of his own questions, and implied that Steve Sherrod, the CFTC’s head of market oversight, was being lazy in balking at Chilton’s request to flag the Commission on large commodity contract trades.

“This isn’t just some little thing you may or may not do if you
get around to it,” Chilton told Sherrod, as reporters and staffers watched. “This is a proactive responsibility on your division . . . to come to us and make sure we know what’s happening. We’re the people that have these things on our wall.”

Gensler tried to smooth things over. “I have such respect for the staff,” he said, pointing out their long hours and willingness to solve problems. “They’re just pros.”

“Remember Reagan?” asked Chilton. “Trust but verify.”

Gensler told Chilton that as part of its weekly market surveillance, the staff would report to the Commission on parties with especially large positions—even though the parameters for doing so were still fuzzy. “I think that’s what I asked them to do forty-five minutes ago,” he said.

“Okay, good. I’m done for now,” said Chilton.

Gensler, apparently sensing the resentment around the room, called for a ten-minute break. When the meeting reconvened, Chilton was mysteriously absent.

After an excruciating pause, during which Gensler went looking for Chilton, the long-haired commissioner finally returned to the room. Gensler was arguing for an adjournment.

“This one might just need a little more time to ripen,” Gensler said with a characteristic half-smile.

J
on Ruggles was working in his Houston office one morning early in 2011 when a headhunter called with something intriguing. Delta Air Lines was searching for a vice president of fuel, the recruiter said, and the person they hired would rebuild the carrier’s commodity contract trading, or hedging, from scratch. Delta wanted to do everything differently, he explained; it was a serious opportunity, or he wouldn’t have bothered to call.

Ruggles, whose floppy hair and innocent face gave him a boy-next-door quality even at thirty-seven, was content at Bank of America’s Merrill Lynch brokerage—or, at least, as content as someone who moved jobs every few years could be. Merrill, which had been purchased by the larger bank at the nadir of the financial crisis in September 2008, lacked the pedigree of Goldman Sachs or Morgan Stanley. But as a subsidiary of a massive commercial bank with close to a trillion dollars in deposits, it did have something they didn’t: a huge stash of cash to lend to clients. Plus, Bank of America Merrill’s commodities division, which Ruggles was trying to help expand, was a fun place to work; it was run by an affable former investment banker, employed a number of
smart traders, and seemed to be gaining momentum in the years after the emergency acquisition. Despite occasionally being mocked for his designer jeans and know-it-all attitude, Ruggles felt comfortable at the place.

That hadn’t been the case everywhere. Ruggles’s résumé was filled with two- and three-year stints. Over the nearly fifteen years since leaving a post in the army, he’d worked in practically every part of the energy-trading business, from drillers to traders and consultants. He’d lived temporarily or more permanently in Houston, London, New York, Los Angeles, and Moscow. But the airline industry, which was notorious for bad trading decisions and a stodgy culture, was one area where he’d never thought to work. Airlines had a reputation for being comically bereft of any trading savvy, as exemplified by disastrous bets like the one that had led to Emirates Airline’s multibillion-dollar margin call during the crude-oil rout of 2008 and 2009. US Airways Group, also seemingly incapable of navigating the energy markets, had recently given up on hedging the price of fuel through commodity contracts altogether. Others were still tinkering with their programs after experiencing setbacks. Only one, Southwest Airlines, was known for betting correctly over the years, and even its track record had been mixed.

Still, there had to be room for improvement. Airlines were the
world’s biggest consumers of fuel after the U.S. government, and after a wave of bankruptcy filings in the mid-2000s, the need to better manage their costs was paramount. Ruggles had never heard of an airline giving to a fuel-hedging team the autonomy that the headhunter was describing, but it made Delta sound serious. So he took a meeting about the job.

Once he passed the first few rounds of interviews, Ruggles flew
to Atlanta to meet Delta’s president, Edward Bastian, and its chief executive, Richard Anderson. The executives were frank about their problems. Delta had been unsuccessful in hedging jet fuel, they explained, and had been burdened with the cost of purchasing hundreds of millions of dollars in commodity contracts that hadn’t bet accurate future market prices, making them useless as a way to curb jet-fuel costs. Delta had bought oil contracts when prices were racing higher and then sold them when prices were lower—the exact opposite of what a good investor would do. Its fuel-hedging loss for 2009 alone had been an astonishing $1.4 billion, a bill that put the company into the red for the year. Since then, Delta had slowed the hemorrhaging of money, the executives said, but there was much more still to accomplish if they were to make their hedging efforts truly worthwhile.

In the meeting, Ruggles kept his characteristic bluntness, which often got him into trouble at work, in check. In his mind, he was horrified. Some of these trades were just galactically stupid, he thought. Even as the three men spoke, Delta held a collection of crude-oil contracts, the products most often used to smooth out swings in the price of jet fuel, that were costing hundreds of millions of dollars to keep active. The contracts had been costly to purchase and wouldn’t pay profits unless crude prices rose substantially from the $100 level where West Texas oil contracts then were. Keeping all that in mind, Ruggles told the executives that their concerns were warranted.

Delta, which was spending $9 billion a year at that point on fuel, was not alone. Jet fuel was now the single biggest expense for many carriers, and they could only pass on a limited amount of the pain to cash-strapped flyers, who would abandon them altogether if prices grew too dear. Jet-fuel fees were “
out of control,”
the chief of Virgin America Airlines had recently told a reporter, calling the rising expenditure “a silent killer.” It almost made labor talks with pilot and flight attendants, once the industry’s biggest headache, seem easy by comparison.

Anderson, who was relatively new to the airline, was
considering making fare hikes. But in addition to bolstering Delta’s use of commodity contracts to “hedge,” or iron out the impact, of fuel costs, he had also contemplated a more radical move: the purchase of a physical oil asset, such as a driller or a refinery, that would win Delta greater control over the fuel that it bought.

He and Bastian broached that subject with Ruggles.

“You can’t buy an upstream operation,” Ruggles replied, using the industry’s term for a production site that actually drilled oil. He thought such an endeavor would be too cumbersome for Delta to manage, given that it had no experience in the exploration and production of oil.

A refinery purchase, however, had potential. Having helped manage refineries—crude-oil processing plants that turned the raw commodity into more usable products—and, as a consultant, advised clients on running and purchasing them, Ruggles knew a fair bit about the business. Two and a half years after the financial crisis, refiners on the East Coast had reduced capacity as a result of slowing demands for their products, meaning that there were plenty of processing plants that might be for sale. Given that, Ruggles told the Delta executives, the airline might be able to buy one more cheaply.

Anderson and Bastian seemed to like what they were hearing. Ruggles was offered a job on the spot, with a $1 million signing bonus and a salary of $300,000. If he were willing to start work immediately, the executives told him, they’d provide temporary
housing in Atlanta and a clothing allowance so he didn’t even have to fly back to Houston to get his things.

Ruggles demurred on the more immediate offer, thinking he should end things properly with Bank of America, to which he would have to give fair notice. He agreed to start in early April.

Delta had been through a rough few years. Clobbered by competition from low-fare rivals and beleaguered by jet-fuel costs in the aftermath of Hurricane Katrina, the carrier had filed for Chapter 11 bankruptcy in September 2005, the very same month in which Jennifer Fan made her $3 million gasoline trade. A year and a half later, Delta reemerged,
having cut six thousand jobs, restructured its fleet, and added more profitable international routes. But its ability to borrow money from banks was tarnished, it had lost its spot in the venerable S&P 500 index of blue-chip companies, and its shares were trading on a dodgy stock market called the “pink sheets,” whose companies didn’t meet Securities and Exchange Commission requirements, for just 13 cents apiece.

Anderson, a Delta board member, was named CEO in September 2007. Although he was in the health-care business at the time of his hiring, he had run Northwest Airlines years before, and he had been a key advisor to Delta through the final stages of its restructuring.

A Texas native and a former assistant district attorney in Houston, Anderson was understated and folksy. Tall, bespectacled, and speaking in a charming southern drawl, he was known for volunteering to build homes for the poor and dealing personally at times with consumer complaints. He often reminisced about growing up in Galveston, his hometown, and drove a pair of
Toyotas rather than using a chauffeured car. At Delta, he adopted a desk that had belonged to Delta’s founder, Collett Everman “C.E.” Woolman, who had fashioned a crop-dusting company into a passenger airline in the late 1920s; Anderson told a reporter he hoped the entrepreneur’s good vibes would “rub off” on him as the new chief executive.

By the end of 2007, after Anderson’s first few months in office, Delta had returned to profitability, establishing a $158 million employee profit-sharing pool for the first time since filing for bankruptcy protection. Passenger revenue increased, a valuable agreement with Air France that provided Delta with a greater foothold in the European markets was struck, and the airline ranked at the top of the industry for on-time arrivals. In April 2008, plans to merge with Northwest in a deal that would create the nation’s largest airline were announced.

Anderson was off to a bold start at Delta, but fuel prices remained an albatross. Unbeknownst to it at the time, the airline was headed into the most expensive period for oil in world history, and the carrier’s modest contract-hedging effort was not sophisticated enough for what was to come. Expecting additional price hikes, Delta increased its hedges to half its expected consumption for the coming months, reduced or eliminated unprofitable flying routes for the rest of 2008, and tried to preserve as much cash as possible. Still, with the expense of the Northwest merger and the climbing cost of fuel and attempts to mitigate it, Delta ended the year at a financial loss yet again.

Then came 2009 and the airline’s embarrassing $1.4 billion loss from ill-conceived commodity contract wagers. Delta had bought contracts meant to smooth out its 2009 costs as far back as 2008—in other words, during the bubble period in which prices
were expected to continue rising. But instead, those peak prices from July 2008 had reversed, dropping the U.S. oil contract price based on the future price of West Texas crude from nearly $150 to about $34 during the winter of 2008 and 2009, turning what Delta had thought would be insurance policies to help it survive inflated jet-fuel prices into expensive liabilities. The airline’s bad timing had been such that at the end of 2008, unexpectedly low crude prices had resulted in margin calls, or demands for additional cash from its banks, of $
1.2 billion, the sum required simply to keep the poorly functioning hedges intact. It was much the same scenario that Emirates Airline had faced during that period, when Morgan Stanley’s ingenious plan for curbing the Middle Eastern carrier’s exposure to runaway fuel expenses led instead to a crushing margin call of more than $4 billion, prompting John Mack’s emergency visit to Dubai.

Compared to 2009, the year 2010 was far better for Delta. But it still involved a slight loss from its attempted hedges of $89 million. Oil prices, now at about $90 in the West Texas Intermediate contract market and far closer to where their fundamental drivers of world supply and demand would have dictated, were still proving awfully hard to predict. Still, a successful hedging program would have saved Delta money rather than costing it an eight-figure sum, no matter what the market prices chose to do.

And oil in 2011 was hit with a fresh wave of political events that again drove prices higher. The problems started with agricultural commodities like wheat and corn, whose prices had shot high in the latter half of 2010 as a result of extreme weather in important grain-producing countries like Russia, China, and Australia that crimped the supply of crops. By early 2011, world food prices were hitting a
new record high each month, according to the Food and
Agriculture Organization in Rome, surging past their mid-2008 levels and making food far less affordable. Parts of the Middle East were hit particularly hard by grain costs and other economic troubles. In December 2010, a
twenty-six-year-old Tunisian fruit and vegetable vendor, devastated by poverty and political corruption, set himself on fire outside the headquarters of his provincial town two hundred miles south of Tunis, the country’s capital. Fellow workers in his town took to the streets in protest, using cell phones to film their activities. Their videos were fed onto
Facebook, Twitter, and other social media, and the demonstrations story soon went viral.

In January, the movement, which came to be known as the Arab Spring, gathered steam. Demonstrators fed up with autocracy and economic malaise gathered in town squares in Algeria, Jordan, and Egypt. Within weeks, tens of thousands of protesters filled Tahrir Square in downtown Cairo, demanding the resignation of Hosni Mubarak, the Egyptian dictator who had ruled for thirty years.
Their ranks soon swelled to hundreds of thousands, and violence broke out. Hundreds were arrested, and hundreds eventually died, as Mubarak’s security forces sought to quell the protests with brutal tactics.

In the aftermath of the Arab Spring, some have argued that
food prices were a particular stressor. In Egypt, where bread constitutes one-third of an average diet and food costs amount to more than one-third of the average household’s income, rising wheat prices had an enormous impact, argued Troy Sternberg, a research fellow at Oxford’s School of Geography, in an academic study.