Will Goldman Sachs 'Trade Places' with the Hunt Brothers?

Includes: GS, MS, OIL
by: Bob van der Valk

The “Eddie Murphy” rule applied to crude oil

On October 21, 2009, in his remarks at the OTC Derivatives Regulation, Futures Industry Association Expo in Chicago the Commodity Futures Trading Commission (CFTC), Chairman Gary Gensler proposed that hedge funds, financial firms or other investment funds not be exempted from clearing requirements and all standardized Over the Counter (OTC) products should be moved onto regulated exchanges or trade execution facilities.

The CFTC also recommended changes to its oversight authority, including implementation of the “Eddie Murphy” rule, taken from the 1983 comedy movie Trading Places. The CFTC will extend insider trader prohibitions to include parties who receive misappropriated information from any government agency.

In the movie, Eddie Murphy’s character outwits Randolph and Mortimer Duke into making settlement on orange juice futures at the end the trading day. The Dukes had invested their fortune in orange juice futures based on false inside information received from a person within the government agency overseeing orange juice growers. Subsequently they go bust when they are unable to pay cash to cover the margin call.

The movie was inspired by Nelson Bunker and William Herbert Hunt’s attempt to corner the market for silver in the late 1970’s. But now, Goldman Sachs (NYSE:GS) has been taking a page out of the Trading Places movie script in their attempt to the corner the market for crude oil.

Now Goldman Sachs is once again advising their investors to buy crude oil futures as a hedge against inflation thereby amassing quantities of this vital commodity way in excess of any normal capacity for supply and demand levels.

Eventually, officials at COMEX raised margin requirements on silver futures in order to check this cornering of the silver market. The highly leveraged Hunt Brothers, unable to meet their margin calls, were forced to sell. The price of silver fell dramatically; on March 27th 1980 the price fell 50% in one day, from $21.62 to $10.80. The Hunt Brothers eventually were forced into declaring bankruptcy and went back into their first love: - the oil business with Hunt Petroleum.

In the last couple of months, Goldman Sachs has been able to regain control on crude oil pricing by issuing ever laudatory press releases about the imminent shortage for this product. But this time, they have an even better grip on the price of futures for crude oil then they did before the free fall in those prices in the last part of 2008 into 2009.

They have been able to virtually eliminate their competition by wielding their ever growing political power and influence on past and current government administrations. An example of how the "good old boys" network sprung into action came during the financial crisis in September 2008.

On September 17, 2008 Henry Paulson, then Secretary of the Treasury, is quoted as saying: “It’s ridiculous that I can’t deal with Goldman at a time like this!” The quote and some information for this article were obtained from: “Too Big to Fail: How Wall Street and Washington Fought to Save the Financial System — and Themselves”, written by Andrew Ross Sorkin, which is out in print this week. Paulson is the former Chairman and CEO of Goldman Sachs and was complaining to Bob Hoyt, his general counsel, on September 17, 2008 just two days after the Lehman Brothers collapse and less the 24 hours after AIG was rescued with $85 billion of TARP money.

That very day Paulson was able to obtain a secret waiver from the ethics letter, he had signed when was appointed to his post by President George W. Bush. In the letter he agreed not to get involved in any matter related to Goldman Sachs as long as he was Secretary of the Treasury.

Paulson was scheduled to take part in a 3 P.M September 17, 2008 conference call with Ben Bernanke, Timothy Geithner, and Securities and Exchange Commission (SEC) Chairman Christopher Cox to discuss Goldman Sachs and Morgan Stanley and, but for obtaining the waiver, he would have been unable to participate.

Within an hour the waiver was granted but it was not disclosed to the public out of fear it would raise more questions about the government’s actions and perhaps lead to a bank run on Goldman. Paulson also allowed the current CEO Lloyd Blankfein to sit in on the meeting sealing the doom of Lehman Bros prior to their bankruptcy.

Timothy Geithner, the current the Secretary of the Treasury, lent his considerable weight to Goldman Sachs, his former employer, as well. Gensler, Geithner, Lawrence Summers, current advisor to President Obama on economic affairs, and Robert Rubin, are all former Goldman Sachs employees. They have kept in close contact with each other over the years as they switch back and forth between public and private positions wielding great influence over Wall Street.

Some of these meetings between those major players took place early last year in out of the way places like Moscow and Abu Dhabi in order to escape scrutiny from regulators and ever inquisitive reporters.

Raising margin requirements and end of day settlement for crude oil contracts will be a very simple way to solve the cornering of the market for crude oil by any one group of players. End-users should be made exempt from the clearing requirement. That exemption will be very narrowly defined to include only non-financial entities that utilize swaps as an incidental part of their business to hedge actual commercial risks.

Will Larry Gensler do the right thing and be able to get out of the “good old boy” network to implement the “Eddie Murphy” rule? Only time will tell, but if he does follow through gasoline and diesel fuel will become affordable again just like orange juice did after the Duke Brothers went belly up. But after all that was just a comedy movie based on fictional plot and characters – or was it?

Disclosure: The writer has no investments in any equities or commodities.