A two-year U.S. Senate investigation of commodity-market activities at big Wall Street banks like Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. found the firms compromised market integrity and put the broader financial system at risk.
The firms did so by influencing prices, gaining trading advantages with non-public information and entering risky businesses like uranium trading and coal production, according to the investigation.
The findings from the U.S. Senate Permanent Subcommittee on Investigations shed new light on how banks built up voluminous inventories of aluminum, copper and other commodities, often exceeding regulatory limits. It portrays banks straying far beyond their traditional business lines to dabble in lucrative but risky activities that posed legal and financial threats to the firms.
The Senate report also depicts the Federal Reserve as failing to stop the bank buildup of commodities, allowing firms like J.P. Morgan to hold assets well in excess of allowable limits. At times, the report said, the Fed was simply unaware of how much oil, aluminum and copper banks were stockpiling.
Investigators found J.P. Morgan exceeded restrictions on copper holdings by defining it as a precious metal despite its widespread use in industrial applications and exceeded aluminum limits by holding it as an asset of a subsidiary instead of the parent company. Morgan Stanley held 55 million barrels of oil storage capacity, enough supply for nearly three days' worth of U.S. consumption. The report found that Goldman engaged in "merry-go-round" transactions involving aluminum for its own financial gain.
The banks say they adequately manage the risks of the activities and don't use their commodities business to gain an unfair advantage. All three firms have moved to reduce their commodities holdings amid congressional and regulatory scrutiny.
The findings are likely to put additional pressure on the Fed as it considers whether to restrict or reduce Wall Street banks' role in physical commodity markets. Fed Gov. Daniel Tarullo is expected to testify at a Senate hearing on the report on Friday.
Democrat and Republican lawmakers said the evidence showed new reforms and restrictions are needed to rein in Wall Street's role in raw materials markets. The report recommended a series of actions that could shrink bank trading and strengthen oversight. While none of the activities highlighted in the report appear to be illegal, officials said they had not yet decided whether to refer certain matters to enforcement agencies.
"We found substantial evidence that these activities expose major banks to catastrophic risks that are poorly understood," said Sen Carl Levin, (D., Mich.), who chairs the subcommittee and will hold the two-day hearing. Executives from Goldman, J.P. Morgan, and Morgan Stanley are set to testify. "They are raising costs and uncertainty for the end users of commodities, which hurts American manufacturers and consumers."