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Eonorable James Stone
Page Seventeen

of whether a statutory prerequisite for designation as a futures contact is ret.

Section 5(g) of the Commodity Exchange Act, 7 U.S.C. 7(g), which governs CFTC approval of futures contracts, requires a board of trade to demonstrate that "transactions for future delivery in the commodity for which designation as a contract market is sought will not be contrary to the public interest" (emphasis supplied). In addition, other provisions of the Commodity Exchange Act clearly contemplate delivery of the commodity underlying a futures contract as an essential element of a futures contract. For example, Section 4 of the Act, 7 U.S.C. 6, generally prohibits the execution of "any contract of sale of any commodity for future delivery," except on a board of trade registered as a "contract market"; the general antifraud provision of the Act, Section 4(b), applies to "any contract of sale of any commodity for future delivery," and the CFTC's jurisdictional grant under Section 2(a), 7 U.S.C. 2, extends, inter alia, to "contracts of sale of a comodity for future delivery."

Expansion of the definition of "commodity" by Congress in 1974 to include non-agricultural products and "all services, rights and interests" does not in any respect vitiate what appears to be a statutory requirerent for delivery of the commodity underlying a futures contract. Nor is the language of the Commodity Exchange Act which contemplates delivery of an underlying commodity overcome by assertions that delivery, as a matter of economics, is not essential, or occurs infrequently. Finally, nothing in the legislative history of the amendments to the Commodity Exchange Act in 1974 and 1978 contains, in our view, any indication that Congress intended to permit the trading of contracts which do not provide for the delivery of an underlying commodity.

We appreciate this opportunity to comment upon the revised KCBT stock index contract. If the Commission can be of any further assistance to the CFTC in its consideration of this contract, we stand ready to do so.

Sincerely,

Irving M. Pollack
Commissioner

The CHAIRMAN. Thank you very much. Chairman Stone.

Mr. STONE. The Commodity Futures Trading Commission has both a majority and a dissenting statement it would like to offer this morning. Mine is the dissenting statement. If you would like me to give it first, I would be happy to, but I think the majority statement would also be available now if you would prefer that first.

The CHAIRMAN. Mr. Martin, I understand you have the majority statement?

Mr. MARTIN. I do, sir. One, I would like to say first, Senator Proxmire, that on listening to your opening remarks, my first inclination was to throw the statement in over the transom and find out where I go to give up. But I thought I would stay around and try to present an alternative point of view.

I don't mean to be presumptuous, but I am going to correct Mr. Volcker. He said that the Commission had no point of view. The Commission does have a point of view, sometimes we have a little trouble getting it articulated. But I am about to go over very, very briefly. I shan't read what we have got because of the exigencies of time. So, if you will excuse me in this connection, I may, because it's difficult speaking for all of us, I may not highlight some of the same things my colleagues would. I will try to be very, very brief and ask you to let them, if they think I have not done

The CHAIRMAN. That is fine. We will have your entire statement put in, if you will, in the record.

Mr. MARTIN. Absolutely. We are concerned about what we have seen and the Commission does not believe the Federal Reserve Board can, should replace the commodity exchange as the ultimate entity controlling the setting of levels of margin for future contracts traded on those exchanges as contemplated by 2704.

The setting of margins in order to insure the integrate of futures contracts requires a level of expertise which the Federal Government neither presently possesses nor can readily acquire.

In addition, the experience of establishing a level of margin for the purpose of securities will be of little value if it should attempt to set margins in futures trading. The Commission has explained the various margins and purposes of margins required by clearing houses. Two principal purposes are offered to support providing the Federal Government with authority to set futures margins.

PRESENT LEVEL OF MARGINS SET TOO LOW

First, it is said that the present level of margins set by the commodity exchanges is too low. Government authority over margins will result in higher margins thereby alleviating the potential for excessive speculation. But what is excessive speculation? Is excessive speculation a more concise way of saying that there is a "major market disturbance" which prevents a market from accurately reflecting the forces of supply and demand or that a threat exists of a market manipulation, corner or squeeze? If this is so, then Congress has already provided the Commission with sufficient emergency authority to take any action to restore orderly trading in such a market.

Perhaps excessive speculation is intended to be a level of speculative activity which does not permit a futures market to serve either

its risk-shifting or price discovery functions. The Commission presently has authority to deal with this situation as well. In 1974, Congress added to the Commodity Exchange Act the requirement that a contract market demonstrate that trading in a particular commodity is not contrary to the public interest.

I will go on to a second justification that has also been covered by supporters of Federal margin authority. Under this view, higher levels of margin will insure that small speculators or hedgers who do not have the financial means to weather substantial adverse price movements in the futures markets will be deterred from participating in these markets. This rationale is merely an attempt to provide a built-in financial suitability requirement for futures trading. Without addressing the merits of whether a suitability rule should be adopted by the Commission or by any self-regulatory futures organization, the Commission does not believe that the policies underlying suitability are sufficient to justify disrupting the historical role of the commodity exchanges in the setting of margin. Again, there are more direct means available to accomplish these purposes, including the Commission's rules which already require disclosure of the risks of futures trading to all customers.

SILVER MARKET BUBBLE

The silver market situation which you have frequently heard referred to as a bubble, during the past year plainly evidences why neither the excessive speculation nor the suitability rationale should be accepted by Congress. If the Commission had reason to believe that during the rise or fall of silver prices excessive speculation existed causing the market in silver not to reflect accurately the forces of supply and demand, we could have taken emergency steps to change unilaterally trading rules, to impose margins, to set speculative limits to both retroactively and prospectively or even to suspend trading altogether. No member of the Commission ever recommended or even suggested that the Commission should invoke its emergency authority because there existed a "major market disturbance" or a threat of a manipulation or corner. No member ever expressed the view that the futures market was not reflecting accurately supply and demand. No member of the Commission ever asked the staff to consider what changes in exchange rules the Commission should request the exchanges to adopt in order to correct perceived market problems. Instead, the Commission unanimously agreed to let the commodity exchanges assume their responsibility as the front-line regulators of the silver markets while the Commission continued to express its concern as new developments took place in the markets.

Second, once the exchanges imposed increasingly higher levels of initial margin in connection with silver contracts-which at one. point equalled 95 percent of the value of the contract-the volume of trading decreased substantially.

Moreover, a case can be made that the silver situation demonstrates that higher margins may cause more price volatility and instability because market liquidity is decreased.

One other aspect of S. 2074 which concerns the Commission is the attempt to distinguish the regulation of futures on financial instruments from other futures contracts. In 1978, Chairman Tal

madge of the Senate Committee on Agriculture, Nutrition, and Forestry emphasized: "Regardless of . . . the underlying commodity on which a futures contract is written, a futures contract is a futures contract."

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The Commission believes that the logic underlying this view is as sound now as it was in 1978 and 1974. No one has brought to the attention of the Commission any evidence which would suggest altering the existing uniform regulatory structure for all futures trading.

Now, we are looking at what has happened, why it happened, and I am sure we will be continuing. We are not at this point ready to point any blame, but we are very much interested in the exercise evidentally going on between Treasury and Federal Reserve. I share the questions or concern that have been asked this morning, why we have not been included in this. We have, through Commissioner Dunn, been in constant contact with the other agencies regarding our role of seeking guidance and advice from them. So, I think that at this time the Commission believes it would be more appropriate for Congress to permit the Commission to fine tune the regulatory scheme for futures trading through our rulemaking powers rather than rushing to enact major statutory changes.

I trust my colleagues are content with what I have said. They may want to add a little more. I don't know.

The CHAIRMAN. Mr. Gartner, Mr. Dunn, would you want to add more or are you satisfied?

Very good. All right.

Chairman Stone, go right ahead with your statement.

Mr. STONE. Thank you, Mr. Chairman.

You have heard the majority view of the Commission. My view is somewhat different. In my opinion a law of the sort you are now considering in the form of S. 2704 would have been quite helpful in minimizing the adverse impacts of the speculative bubble on silver. As I have previously testified before both House and Senate agriculture subcommittees, my principal conclusion from the events of the last few months is that massive, unchecked and unnecessary speculation in commodities is an unacceptable threat to our Nation's tightly interwoven financial structure. Futures markets play an important economic role in commercial enterprise, but when they are perverted from that role into centers of unrestrained speculation they become a burden on commerce and a danger to the economy as a whole. When strategically placed financial institutions support, and indirectly participate in, excessive speculation, the danger is particularly clear.

INVITATION TO TROUBLE

The silver market has been a predominantly speculative market for years now, with commercial hedging activity constituting less than one fifth of the open interest at most points in time. Certain banks and brokers showed themselves all too willing to make loans which promote the speculative volume. The combination was an invitation to trouble.

That trouble arrived when the price leadership of a few disproportionately large traders provided the catalyst in 1979 to form a

speculative bubble. History has taught us that bubbles burst. And when they do, they all too often trigger economic chain reactions. The collapse of the silver bubble this March threatened damage well beyond the commodities markets.

Much attention has already been given to the impact on financial institutions. I will not dwell on that. I can only say that while we don't know, and probably will never know, how close we came to the edge of a general financial panic, it is an issue which should not have to be settled. There was no economic benefit in the craze for silver to justify even a small risk of economic collapse.

It is important to keep in mind, moreover, that risks to large financial institutions were not the only public costs of the silver bubble. These were adverse implications for employment, for inflation and for the allocation of credit.

The impact on inflation was also documented by the Bureau of Labor Statistics. It reported on February 15 that "the Producer Price Index for intermediate materials, supplies and components rose a seasonally adjusted 2.8 percent from December to January, the largest monthly increase since August, 1974."

It attributed about one quarter of this increase to the precious metal cost acceleration. The burden of this inflation, moreover, was by no means confined to luxury items. The price of medical X-ray film, an expense shared by every economic stratum, jumped 93 percent. Photosetting paper used in newspaper printing rose in cost by 75 percent.

It is an unfortunate aspect of our political life that it often requires a major catastrophe to change public policy. It would be a shame if the lessons and punishments of 1980 prove insufficient to teach us something about the dangers of excessive speculation in commodities.

A short list of corrective measures, taken together, would go far to diminish the likelihood of a recurrence of this year's bubble. One of these measures requires no further grant of legislative authority. The Commission is currently considering the use of its existing powers to impose speculative position limits in all commodities. I hope it will do so.

Congressional action, not Commission action, is necessary for the most important of preventive measures: the vesting of margin authority with some agency of the Federal Government. The full airing of the issues surrounding margin authority before both this committee and the Agriculture Committee represents an extremely useful activity at this time. Low margins are probably the single strongest inducement to widespread speculative use of futures markets.

The arguments for commodity margin control are similar in some respects to those offered with respect to the stock market during the Great Depression when President Roosevelt condemned excessive speculation in securities and commodities "as one of the most important causes of the terrible conditions" of that period. This is the case despite the fact that margins in the two areas are legally quite distinct.

Stock market margining is, in itself, a loan. In commodities, the placing of a margin deposit does not imply the taking of a loan. The distinction, however, should not be cited to obscure some im

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