No sooner than I had written a post that showed the potential comparative advantage that banks had in dealing in physical commodities, did JP Morgan Chase (JPM) announce that it was throwing in the towel, and exiting the business:
Wall Street's biggest bank said an "internal review" had concluded it should pursue "strategic alternatives" for its physical commodities operations, which includes assets like its Henry Bath metals warehousing subsidiary and a vast global team trading everything from African crude to Canadian natural gas.
The firm will explore "a sale, spinoff or strategic partnership" for its physical arm, the statement said. It said the bank remained "fully committed" to its traditional financial commodity business, including trading derivatives and its activities in precious metals.
This decision was not the result of any single thing, but the cumulative result of many things:
- Greater capital requirements for banks. The maturation of commodity markets and the resulting flattening out of profits.
- The reputational risks of commodities dealing, with multiple regulators on the hunt for manipulation cases, and asking for big dollars to settle them.
- And, most recently, the political heat directed at banks' commodity trading operations. Morgan's commodity trading operation was big absolutely, but relatively not as big as Morgan Stanley's or Goldman's, and hence more readily expendable. Morgan decided to get out of the kitchen, rather than stand the heat. Especially since there is political pressure on all aspects on the banking business, and since navigating the post-Frankendodd, Volcker Rule world will be sufficiently challenging to the core businesses that commodities risks, political and reputational more than financial, just aren't worth it.
Morgan Stanley has already mooted selling off its commodity arm. It will be interesting to see what Goldman decides to do, especially in light of the Metro melodrama. The European banks (notably Deutsche (DB) and Barclays (BCS)) also have some thinking to do.
The exit or downsizing of bank commodity operations will redound to the benefit of the trading houses, and to private equity shops and perhaps hedge funds, including potentially some new entrants. I doubt it will make the commodities markets more competitive, and indeed, the opposite is more likely to be the case. This turns my mind to thoughts regarding the political economy of the pressure on the banks. The exit and downsizing also run contrary to the meme that banks have it all their way inside the Beltway.
The banks have done a terrible job of making their case. Perhaps it would be more accurate to say that they really haven't made a case at all, likely as a result of hubris. They know they are doing God's work (to steal from an old commodities guy, Lloyd Blankfein, who started his career at J Aron), but really need to work on their evangelism. There is indeed a karmic aspect to this. Almost instant karma, in fact: following my musing about that by only a few days. I don't say that with the least tinge of schadenfreude. Just stating the obvious.
I wonder what will happen to Blythe Masters, the head of Morgan's commodity operation. I know her some. Most of our interactions were positive, until we butted heads over the report I wrote on commodity trading firms: in fact, she approached me to write the report because she'd liked what I'd written on the blog, and in comments to the CFTC.
I have a distinct recollection of sitting next to her at the JPM commodities conference in October, 2011, and watching the muscles in her jaw bulge as she ground her teeth furiously. She was obviously very tightly wound. If she was that intense before a relatively low-key conference presentation, I can only imagine how her jaw is working now. My guess is that she will stay at Morgan for a decent interval, and then land somewhere else-- like perhaps a private equity commodity trading shop.
Exit for economic reasons is part of the market process. Exit driven by political or regulatory pressure is problematic. Both factors are at work now, but unfortunately political and regulatory issues are predominating. The result will be less efficient, less competitive commodity markets. Which is exactly the opposite result that the politicians and regulators baying at banks and nipping at their heels claim to want. Unintended consequences yet again.