First, there was a banking crisis. Now, after the collapse of Peregrine Financial Group, commodities markets may be on the brink of their own emergency, which could reach consumers at the gas pump or the grocery store.
The high-profile failure of two commodities brokerage firms in less than a year led to a crisis of confidence among traders of commodity futures -- agreements to buy and sell basic goods like corn, wheat and oil. If this market stops functioning properly, experts warn, consumer prices could fluctuate wildly.
“The futures industry had long been considered a very strong place to put your money,” said John Lothian, a registered futures adviser who runs an industry news and analysis service. The collapse of Peregrine, which does business as PFGBest, has “absolutely caused a crisis,” he said. “It’s going to take a while for the industry to restore its own confidence.”
The crisis took root last October with the well-publicized collapse of commodities brokerage MF Global, which lost $1.6 billion in customer funds. That was followed, earlier this month, with the failure of Peregrine, which imploded just before the firm’s founder, Russell Wasendorf, admitted to taking more than $100 million in customer cash over two decades.
The failures have caused some traders to lose faith in both of the industry’s regulatory bodies -- the Commodity Futures Trading Commission and the National Futures Association -- and the brokerage firms themselves.
“I don’t know where to put my money to trade,” George Papagiannis, a lawyer and futures trader who lost money with Peregrine and MF Global, told The Huffington Post shortly after the PFG collapse. “I love to trade, but I don’t trust any broker now. So I’m not going to until I’m sure there’s good oversight."
This sentiment could be bad news for regular consumers of basic commodities like oil and corn. Brokerages like Peregrine provide a platform for trading futures contracts, agreements to buy or sell a commodity like oil or corn at a set price in the future. Often farmers will trade futures to protect crop prices from unforeseeable fluctuations -- for example, a glut of commodities that causes prices to fall.
“A collapse of a firm means that those commercial market participants who have to intelligently hedge their purchases have less and less faith in [the firms] with whom they’re investing,” said Gene Guilford, president of the Independent Connecticut Petroleum Association, a nonprofit association of gas and fuel oil dealers. “What ends up happening with a lack of faith is retailers end up hedging less of their purchases and leaving them open to the vicissitudes of the marketplace.”
If farmers or oil dealers pull out of the markets, then there’s nothing to buffer commodity prices against unexpected fluctuations, meaning the everyday price of oil or corn could dip or spike wildly for average consumers, according to Guilford.
Futures-trading volume in the first half of 2012 was down nearly 10 percent from the same period last year, according to data from the Futures Industry Association, the industry’s main lobbying group. In June trading volume was down more than 15 percent from June 2011.
“We’re not on the cusp of a problem, we’re in a problem,” said Michael Greenberger, former director of trading and markets at the CFTC and current professor at the University of Maryland School of Law. “Nobody wants to trade.”
Since the Peregrine collapse, blame also also fallen on regulators for failing to spot that fraud, despite years of audits and the collapse of MF Global only months before. On Wednesday, CFTC chair Gary Gensler told the Senate Agriculture Committee that "the system failed to protect the customers of Peregrine," only days after the CFTC rushed approval of new rules designed to protect brokerage customers. Those rules include a requirement that brokers file daily reports on the state of segregated customer accounts.
But the reforms might not address the root of the problem. According to Greenberger, federal regulators simply don’t have the resources to keep up with the brokerage firms, leaving the door wide open to fraud.
“The system is weak because it’s not adequately supervised by the CFTC,” he said, adding that the CFTC is being “starved” for cash. In June, congressional Republicans voted to slash the CFTC budget by about 12 percent, or $25 million.
Experts warn that without proper regulatory oversight, there’s little chance that confidence will return to the commodities markets.
“It would be one thing if it were just one firm, MF Global," said Lynn Turner, former chief accountant at the Securities and Exchange Commission, now managing director at consulting firm LitiNomics. “Now we've had a couple [of brokerage failures], and I can't help but feel there are others out there. But for the grace of God, this could happen again.”