Hon. WILLIAM PROXMIRE, MINNEAPOLIS GRAIN EXCHANGE, Chairman, Banking Committee of the U.S. Senate, DEAR SENATOR PROXMIRE: The Minneapolis Grain Exchange ("Exchange") respectfully requests permission to file this statement with the Banking Committee on the above-referenced proposed legislation concerning the control of certain commodity margins. The Exchange did not request permission to testify on the hearings held on this proposed legislation on May 29 and May 0, 1980 because it was advised by the Banking Committee's staff that since agricultural controls were not included in the legislation, testimony from agricultural groups would not be heard at that time. We have been advised, however, that CFTC Chairman Stone testified during the hearings that the only thing wrong with S. 2704 was that it did not apply to all commodities traded on contract markets, including agriculture commodities. We are very alarmed with Chairman Stone's suggestion and we wanted the Banking Committee to be advised that the Exchange is unalterably opposed to any legislation that would transfer the control of commodity margins from the organize commodity exchanges to another entity. In recent years, there have been several studies conducted on commodity margins and who should control them. The Congress has considered this question several times and has always concluded that the best interest of the public are served by having margins under the control of the exchanges, where fast action can be taken by people fully familiar with all factors affecting a specific commodity. We believe that proposed legislation to transfer control from the exchanges is due in part to confusion over the reason for margins in commodity trading and the use of margins in securities trading. The term "margin" in commodities is very much different from "margin" in the securities industry. In the securities industry, margin money is lent to a buyer of securities. In commodities, on the other hand, margin is collected from both buyer and seller in equal amounts and deposited with the clearing house in an escrow account. This margin is not a down payment of any kind; it is monies deposited to ensure performance by both parties under the terms and conditions specified in the contract. The exchanges, over the years, have set margins at levels that strike a very delicate balance. Since the goal of commodity margins is guaranteeing performance, margin levels must be high enough to discourage default, but must not be excessively high, thereby discouraging and/or denying the benefits of the market to those who may need it the most. In times of unusual price movements the exchanges have been able to quickly revise margin rates up or down as necessary to meet these conditions. While in hindsight an exchange may be subject to criticism in a particular situation, this should not detract from the fine job the exchanges have done over the years by being "on the spot" in properly controlling margins, thereby facilitating the efficient marketing of commodities. We firmly believe that once the purpose of commodity margins is understood, the Banking Committee will agree that no change in the jurisdiction over margins is needed and indeed any change could be very detrimental to the utilization of the futures markets in effectively marketing commodities. We would respectfully request the opportunity to testify if S. 2704 were ever amended to cover agricultural commodities. Thank you for your kind consideration of our position. Hon. WILLIAM PROXMIRE, ALVIN W. DONAHOO, Executive Vice President and Secretary. MORTGAGE BANKERS ASSOCIATION OF AMERICA, Chairman, Committee on Banking, Housing, and Urban Affairs, DEAR MR. CHAIRMAN: The Mortgage Bankers Association of America (MBA), whose nearly 2,000 members originate and service the bulk of Veterans Administration (VA) guaranteed and Federal Housing Administration (FHA) insured home mortgages, submits the following statement for inclusion in the hearing record on S 2704, amending the Federal Reserve Act. S. 2704 proposes to cure perceived problems of excessive speculation by giving the Federal Reserve Board the authority to set initial margin requirements in certain segments of the futures market and to control the extension of credit for the purpose of financing market maintenance or initial margin in various cash and futures markets. The use of the term "similar entity" in the final line of the legislation leaves open the possibility that the Federal Reserve Board also might have authority to set initial margin in certain cash forward markets if they were found to be "similar" to a futures market in some unspecified respect. MBA opposed any change in current authority over financial futures markets. MBA also is opposed to the adoption of across-the-board restrictions on the use of credit in financial markets because we believe speculation to be essential to these markets. Excessive speculation is a symption of excessive inflation and should be treated by curbing inflation. Finally, we believe S. 2704 would interfere with efforts to strengthen the mortgage-backed securities market and prefer the more comprehensive approach of S. 2515. IMPORTANCE TO HOUSING As is well-known to members of this Committee, FHA-insured and VA-guaranteed mortgages in recent years have increasingly been marketed as Government National Mortgage Association (GNMA) mortgage backed securities (MBSs). Over $100 billion in GNMA MBSs have been issued and sold in the capital markets, enabling millions of moderate-income households to obtain mortgage financing at extremely competitive rates. Under current law, the GNMA MBS is an exempt security as is its counterpart for conventional mortgage sales, the Federal Home Loan Mortgage Corporation (FHLMC) participation certificate (PC). In addition to the over-thecounter cash market for these securities, which includes a forward market, there also exist a number of GNMA futures contracts, the most active of which is traded on the Chicago Board of Trade. This was the first financial instrument futures contract approved by the Commodity Futures Trading Commission (CFTC) and continues to be among the most successful. Its existence contributes importantly to the continued success of the GNMA security and, hence, to the FHA and VA home ownership programs. As a result, MBA believes itself to be in a unique position to address the underlying assumptions, implications, and practical consequences of S. 2704 from the perspective of a commercial user of all of the markets concerned: the futures market, the cash spot and forward markets, and the proposed exchangetraded options market. The GNMA MBS market has been subject to a series of well-publicized speculative abuses, implying the need for more systematic regulation. In some cases the integrity of financial institutions has been affected, either because of inappropriate speculation directly by them or because of their position as creditors. In the GNMA market, problems have generally arisen because firms and institutions took speculative positions that were excessive relative to their individual financial capacity. Many of these institutions should not have been speculating at all. This is quite different from the situation in the silver market where concern centers on the total volume of trading and on the impact of a few very large positions. And, while we are not competent to comment in detail on the specific developments in the silver market during the past year, we are acutely aware of and competent to assess developments in the mortgage and government bond sectors during the same period. The high level of rates and their extreme volatility have placed the entire mortgage sector under unprecedented strain and will, we expect, create pressure for a fundamental restructuring of the mortgage lending process. This consequence, which is unfortunate in that it will not be well though through or well-planned, but rather a reaction to market instability, is not the result of high speculative volume, nor is it the result of corners or squeezes or market manipulation. It results from two factors, neither of which is addressed by S. 2704. These are (1) an unprecedentedly high rate of inflation and (2) general uncertainty as to the future economic and political climate worldwide. In addition, Federal Reserve policy emphasizing control of the quantity of money rather than its price has contributed to greatly increased interest rate volatility. The flight from fixed-income investments, such as mortgages, into tangible assets, such as gold and silver, was also fundamentally the result of inflation, exacerbated by international set-backs suffered by the United States. S. 2704 does not address these problems, but instead, threatens those cash and futures instruments that permitted mortgage originators and seller/servicers to survive during the period. It appears to be the assumption of S. 2704 that because serious economic and political problems have an adverse impact on markets, the markets are somehow at fault and should be prevented from functioning during such periods. On the contrary, as uncertainty, and hence volatility and risk increase, risk transfer or hedging mechanisms become even more important to commercial users such as mortgage lenders. This in turn requires more risk-takers and an increase in speculation, not a decrease. The desirability of speculation must be judged according to its economic function and its appropriateness to the financial objectives of the people or institutions involved, not according to the misinformed negative connotations frequently ascribed to speculation by the popular press. In the case of GNMA issuers, the most pressing need is for an optional delivery vehicle that will allow mortgage lenders to cope with uncertainties as to the quantity of future production or loan origination volume. In the heightened volatility of today's markets mortgage bankers and other loan originators find it exceedingly difficult to project the proportion of mortgage commitments at a given interest rate that will actually be closed at that rate. Attempts to hedge production in process with mandatory delivery GNMA forwards or ĜNMA futures result in increased profits when rates increase, but these profits may be more than offset by losses when rates fall. Because our business as mortgage bankers is mortgage production, not speculation, we have long sought exchange-traded options on GNMA securities, which offer a much-needed capability for the mortgage industry to transfer this type of risk to others who are willing and able to assume such risks. For this reason, the speculation or financial risk-taking of well-capitalized individuals and companies serves a vital economic function and should be encouraged. Because optional instruments are especially crucial to the financing of new construction we urge the Committee not to permit exchange-traded options to become embroiled in a prolonged jurisdictional dispute. IMPACT OF S. 2704 ON SPECULATION As was explained by all of the industry and most of the government witnesses at the May 29 and 30 hearings on S. 2704, before the Senate Banking Committee, the traditional low initial margin requirements in futures markets have no relevance to the particular problems that plagued the silver market, or to "excessive speculation' as a general problem. The existing combination of initial margin, daily cash maintenance, and predetermined maximum daily price movements is virtually foolproof; it is a performance bond, not an extension of credit. An across-the-board increase in the level of initial margin would reduce market liquidity without increasing safety. On the other hand, changes in margin can be an important tool for handling abnormal situations. The current system whereby the exchanges, and ultimately the CFTC, have the authority to take emergency action is adequate and preferable to giving this authority to an agency removed from daily contact with the particular problem, and whose interests and professional expertise focus generally on issues far removed from the markets of concern to this Committee today. We do, however, agree that extensive speculation occurred in a number of sectors of the economy during the period between the fall of 1979 and mid-April of this year. The availability of credit, albeit expensive credit, undoubtedly contributed to the extensive speculation that occurred, with respect to a variety of tangible assets. It may be appropriate for the Federal Reserve Board to attempt to limit the availability of bank credit for speculative purposes. This is a difficult task, however. Although it appears easy to recognize speculation, in fact it is not. Examples of difficult judgmental situations are construction lending, inventory accumulation, and anticipatory financing of various types. We do, however, support the view that credit restrictions, if there are any at all, must apply to all speculative transactions and not simply to those involving financial instruments. While we agree that speculators can and do pyramid, adding to market volatility, the problem is not unique to financial futures or financial instruments, and therefore would have to be addressed more broadly. Given the general substitutability of collateral and the existence of unsecured lines of credit it is difficult to see how restrictions could be enforced. It may actually be easier to attack inflation and other root causes of the problems that necessitate speculation rather than merely treating the symptoms. IMPLICATIONS REGARDING JURISDICTION OVER FUTURES CONTRACTS ON FINANCIAL INSTRUMENTS MBA supports the continued exclusive jurisdiction of the Commodity Futures Trading Commission (CFTC) over all futures contracts. We recognize a futures contract to be a standardized instrument traded by open outcry on an organized exchange and one where delivery is normally the exception. We believe that there are fundamental differences in purpose, structure, and operation between futures and cash (including forward) markets that necessitates separate types of regulation. Therefore, no efficiency would be gained by combining these two different types of regulation under one governmental body. As the Federal Reserve Board itself concedes, it lacks the expertise to regulate financial futures and would have to develop it at substantial cost to the taxpayer. The CFTC, on the other hand, has accumulat ed expertise in this area and already has emergency powers similar to those that S. 2704 proposes to bestow on the Federal Reserve Board. Although a number of allegations have been made recently as to insufficient action by the CFTC and/or inappropriate activity by the affected exchanges, there is little concrete evidence offered. In particular, the close parallel between gold and silver futures prices throughout this period and the behavior of cash silver prices are strong indications that the market was responding primarily to grave economic and political uncertainty. Apparent distortions are more noticeable in the cash market and seem to relate to questions concerning adequacy of deliverable supply. Thus, if anything, there was excessive buying of and desire to buy silver (or inadequate selling). This is exactly the opposite of the way "excessive speculation" is normally used in the sense of high volume trading activity without relation to the underlying commodity. For the CFTC and the exchanges it was the case of an inadequate deliverable supply of the commodity involved. Traditional tools proved adequate to solve the problem. This is in keeping with our experience with the futures exchanges, and we feel no need for additional protection from additional, less experienced regulators. We are, of course, aware that for several years now the Securities and Exchange Commission (SEC) and the Department of the Treasury have sought jurisdiction over the burgeoning field of financial futures. The Treasury argued that trading in futures on government securities might create pressure to alter the structure and timing of Treasury issues to meet futures market delivery criteria. This problem has been solved by providing for a widening of deliverable grade securities if and when shortages arise. In essence, a traditional tool of the futures market proved adequate to solve the problem. IMPLICATIONS FOR THE GNMA FORWARD MARKET S 2704 provides for the Federal Reserve Board to regulate extensions of credit in the GNMA market and might, by virtue of the phrase "similar entity," authorize the Board to set margin requirements in the forward market. MBA recognizes the need for a more orderly market in certain U.S. government and agency securities, specifically the forward market for mortgage-backed securities, such as GNMAS and FHLMC PCs. We support the creation of a federally-sponsored and supervised selfregulatory body for this market. Accordingly, we support the thrust of S 2515, "The Government-Guaranteed Securities Act Amendments of 1980," pending before the Senate Banking Committee, and await the results of the joint study undertaken by the Federal Reserve Board, the Treasury, and the SEC as to their recommendations for the detailed form and function. We do, however, believe that authority to set levels of market maintenance and acceptable evidence of ability to perform must reside with the self-regulatory body. In the cash forward, as in the futures market, a performance bond can be an important tool for broker/dealer protection. In the cash market, however, the equally important considerations of access and participation by all producers must be carefully balanced. This requires a flexible approach which can best be effected by experts who remain close to the specifics of the market at a particular time. We are encouraged by the sophistication of the issues and considerations raised by Deputy Treasury Secretary Carswell in his testimony. We would agree that there are no easy answers. While the various markets are related, they are not the same and cannot be treated the same. Each requires a special expertise and in general will operate best when provided with its own basic regulatory framework, including existing emergency powers to cope with extraordinary circumstances, such as we have just witnessed, not only in the silver market, but throughout the economy. Accordingly, we respectfully request that further consideration of S. 2704 be delayed pending further study of its implications. We appreciate the opportunity to present our views on this matter and should be happy to furnish additional information if needed. Sincerely, ROBERT G. BOUCHER, President. THE SILVER FIASCO (By Scott D. Dial, Silver Analyst, Richardson, Tex.) My name is Scott Dial. For three generations, my family has been involved in all aspects of the silver market. Since the initiation of trading in silver futures in 1967 in New York and in 1969 in Chicago, my family and our clients have held one of the world's largest positions in the silver futures markets. We were instrumental to the growth of the Chicago Board of Trade silver market. I am a past chairman of the silver committee of the International Precious Metals Institute and past silver specialist for Clayton Brokerage Company of St. Louis, Incorporated. Unfortunately, this hearing on the futures industry is taking no oral testimony from the public. I fear therefore, that some critical issues will not be addressed, specifically, the single greatest monetary loss to the American investing public via the futures markets. This subject is hardly popular with the powers that be in the futures industry. Let me broach the subject by quoting from a full-page advertisement that I have recently run in various national publications. The first ad appeared in American Metal Market on April 15 of this year under the title, "Silver Demise." As a third generation silver bull, I have been appalled at the regulations and rule changes imposed on our nation's silver futures markets. I personally believe these actions were the real reason for the price collapse in silver; the real reason for the widely reported fiasco involving the Hunt family. One need look no further than the London silver market. That venerable market has continued to operate smoothly and efficiently. No panics. No fiascos. And none of the regulations and rule changes that we saw here! Let's keep it simple. The Hunts bought silver under the rules and the rules were changed by the losers. So who was at fault? I fully support the Hunts and all those attempting to restore the American silver futures markets to the freedom and efficiency that is the best and only way to protect the American investing public. I said that the subject was not popular. The day following the appearance of this ad I was fired by Clayton Brokerage Company. My purpose today is to urge strongly that this committee conduct or cause to be conducted by any appropriate government agency a thorough investigation into our nation's silver futures markets since September of 1979. Specifically, were new regulations imposed and rule changes made by the directors of the Chicago Board of Trade and the Commodity Exchange Incorporated and their respective clearing corporations the result of conflicts of interest? The events surrounding the awesome rise and subsequent precipitous fall in the price of silver over the past months have been publicized. I believe the actions by the two exchanges must be critically scrutinized. I am not alone in this belief. Over the past few weeks a group of investors has organized under the direction of Mr. Brian Walsh of Salem, Massachusetts. Mr. Walsh's group has advertised widely in an attempt to identify and attract those investors affected adversely by exchange actions in silver. Let me excerpt parts of a letter to me from Mr. Walsh. The letter points out the extent of public concern in this matter and outlines those areas of inquiry that might be pursued by this committee. Quoting from Mr. Walsh's letter of May 4: We are a group of investors who have been financially damaged by the recent actions of the Chicago Board of Trade and Comex, actions which virtually precipitated the collapse of the silver market . . . We have retained legal counsel and are now preparing to file a lawsuit against both of these exchanges as well as the Commodities Futures Trading Commission . . . We expect to cite Comex and CBOT directors for a conflict of interest which enabled them to place their own substantial holdings... not only ahead of, but also, in direct opposition to the vast majority of investors in the market. We further believe these actions were . . . a detriment to the free market system, and we would not be surprised to find. evidence to add complaints of conspiracy and fraud to those mentioned . . . The CFTC, we contend, was guilty of gross negligence for allowing itself to be pressured into pandering to special interests. . . These are strong words, but this group involves thousands of investors with total losses most recently calculated at one-quarter of a billion dollars. I am not here today to name names but rather to provide the background and history of this situation and to prove the need for your further inquiry. What exactly did the two exchanges do that, in my opinion, so damaged the average investor? First, beginning on September 21, 1979, the Chicago Board of Trade Clearing Corporation abruptly raised the margin requirement on silver "spreads" to my former employer, Clayton Brokerage Company, from five hundred dollars per spread to five thousand dollars per spread. This action was both shocking an unprecedented. The result? My clients and I were forced over the next few weeks to liquidate those spreads with losses in excess of forty million dollars. What particularly angered me was: (1) the same spreads in the London silver market, which was not subjected to any such regulations and rule changes, would have returned us profits in excess of twenty million dollars; (2) the increase in margin requirement by a factor of ten was only instituted the very day after all our positions were established, with no hint ever given of the impending action; and (3) |