Banks should keep out of mines and warehouses; When Goldman Sachs bought the commodity trading house J Aron in 1981, it also took on Lloyd Blankfein, then a salesman of silver coins

July 24, 2013 6:49 pm

Banks should keep out of mines and warehouses

By John Gapper

When Wall Street launches into unlikely enterprises, it is time, once again, to start worrying

When Goldman Sachs bought the commodity trading house J Aron in 1981, it also took on Lloyd Blankfein, then a salesman of silver coins. Thirty-two years later, Mr Blankfein is Goldman’s chairman and chief executive and the bank owns, among other commodity assets, some aluminium warehouses near the ailing city of Detroit.

The process by which some of the biggest US banks came to own not only physical commodities but infrastructure such as oil tankers and pipelines is a fine example of mission creep since they were split up by the Glass-Steagall Act of 1933. One can see how they got there, but it is a peculiar – and not very desirable – outcome.What would happen if a Morgan Stanley oil tanker ran aground (it partly owns a company with a fleet of 120 tankers), or there were a fatal accident at a Goldman coal mine (it has a stake in Colombian mines)? Most people would be baffled by what Wall Street was doing at the scene and it could easily spark a crisis of confidence at a too-big-to-fail financial institution.

In September the Federal Reserve will have a choice of whether to allow banks to carry on as before, or roll back the boundaries of what they do. It should employ common sense and keep them out of activities that have only a tangential relationship to banking.

True, the roots of merchant banks lie in trading and finance of physical commodities. Institutions such as Baring Brothers started as commodity houses, and Salomon Brothers – now part of Citigroup – was bought by Phibro, the commodity trader, in the year that Goldman bought J Aron.

But things have changed. First, brokers used to be tiny in comparison with deposit-taking banks that had large balance sheets and the implicit backing of taxpayers. Commodity trading spilled into systemically important banks with the dismantling of Glass-Steagall and the 2008 conversion of Morgan Stanley and Goldman to bank holding companies.

Second, banks have moved on from trading commodities such as oil and metals, which has logic if they trade derivatives, to owning ships, mines and warehouses. In some cases, they have evaded the regulatory barriers by using their “merchant banking” (private equity) arms to take ownership of the latter under another guise.

Goldman’s involvement in aluminium shows how this can work. It was among banks that saw an opportunity after the 2008 crisis, when the price of aluminium fell and surplus stocks built up.

Banks and commodity groups could profit from the wide gap between futures and spot prices by financing an arbitrage trade for their clients.

This left a pile of aluminium in the hands of traders, which needed to be stored in warehouses. Banks realised that warehouses were in high demand and bought such facilities through their private equity arms in 2010. They were required by law to run trading operations and warehouses separately but they had two revenue streams.

Three years later, Goldman and JPMorgan Chase are preparing to sell the warehouses again but face a Senate inquiry into their activities. Companies including MillerCoors and North American Breweries complain that delays in being able to obtain metal from warehouses have added $3bn to their costs and raised the price of aluminium cans.

Given that the aluminium price has fallen further than the premium for getting it promptly has risen, the beer guys’ lament deserves to be played on a very small violin. They could have bought at the bottom of the market themselves, rather than letting speculators do so and then complaining loudly.

Nonetheless, there are murky aspects to aluminium trading. Banks and commodity trading groups can store some of their metal in private facilities – “dark inventory” – in order to make it appear scarce. Furthermore, the fact that banks’ investment arms decided to acquire assets that dovetailed so neatly with their trading operations feels too convenient for comfort.

This abrupt integration of metals trading and storage echoes how banks piled into subprime mortgages before the 2008 crisis, buying origination and servicing companies to securitise the loans. When Wall Street takes a detour from trading into surprising new activities, sound the alarm bell.

Commercial banks used to be barred from holding more than 5 per cent of industrial companies, partly to prevent a repetition of the way that JPMorgan took control of swaths of the steel and railway industries in the late 19th century. The rules were relaxed by the Gramm-Leach-Bliley Act of 1999, giving banks more leeway.

Even so, when the Fed permitted banks including JPMorgan Chase to trade in commodities, it specified that they should not own or operate storage and transport facilities. Somehow, Wall Street has managed to find various routes around the Fed’s original intentions.

Some banks have used merchant bank powers under the 1999 act to “temporarily” acquire industrial assets that are related to trading. Goldman and Morgan Stanley were allowed to keep existing operations when they converted to banks, while JPMorgan gained approval under another clause.

No doubt Wall Street has followed the letter of the law after employing battalions of lawyers to study it minutely, but the result is as if the intended barriers did not exist. Despite the Fed’s efforts not to allow banks to own commodity infrastructure, they plainly do so.

There is no clear need for them to own warehouses and mines, but sound reasons why they should not, from systemic risk to the difficulty of supervision. The Fed should enforce its will.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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