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Commodities and Other
Futures
Commodity "futures" are contracts to buy or sell certain certain goods at set prices at a
predetermined time in the future. Futures traditionally have been linked to commodities such as wheat, livestock,
copper, and gold, but in recent years growing amounts of futures also have been tied to foreign currencies or other
financial assets as well. They are traded on about a dozen commodity exchanges in the United States, the most
prominent of which include the Chicago Board of Trade, the Chicago Mercantile Exchange, and several exchanges in
New York City. Chicago is the historic center of America's agriculture-based industries. Overall, futures activity
rose to 417 million contracts in 1997, from 261 million in 1991.
Commodities traders fall into two broad categories: hedgers and speculators. Hedgers
are business firms, farmers, or individuals that enter into commodity contracts to be assured access to a
commodity, or the ability to sell it, at a guaranteed price. They use futures to protect themselves against
unanticipated fluctuations in the commodity's price. Thousands of individuals, willing to absorb that risk, trade
in commodity futures as speculators. They are lured to commodity trading by the prospect of making huge profits on
small margins (futures contracts, like many stocks, are traded on margin, typically as low as 10 to 20 percent on
the value of the contract).
Speculating in commodity futures is not for people who are averse to risk. Unforeseen
forces like weather can affect supply and demand, and send commodity prices up or down very rapidly, creating great
profits or losses. While professional traders who are well versed in the futures market are most likely to gain in
futures trading, it is estimated that as many as 90 percent of small futures traders lose money in this volatile
market.
Commodity futures are a form of
"derivative" -- complex instruments for financial speculation linked to underlying assets. Derivatives
proliferated in the 1990s to cover a wide range of assets, including mortgages and interest rates. This growing
trade caught the attention of regulators and members of Congress after some banks, securities firms, and wealthy
individuals suffered big losses on financially distressed, highly leveraged funds that bought derivatives, and
in some cases avoided regulatory scrutiny by registering outside the United States.
The
Regulators
The Securities and Exchange Commission (SEC), which was created in 1934, is the principal regulator
of securities markets in the United States. Before 1929, individual states regulated securities activities. But the
stock market crash of 1929, which triggered the Great Depression, showed that arrangement to be inadequate. The
Securities Act of 1933 and the Securities Exchange Act of 1934 consequently gave the federal government a
preeminent role in protecting small investors from fraud and making it easier for them to understand companies'
financial reports.
The commission enforces a web of rules to achieve that goal. Companies issuing
stocks, bonds, and other securities must file detailed financial registration statements, which are made available
to the public. The SEC determines whether these disclosures are full and fair so that investors can make
well-informed and realistic evaluations of various securities. The SEC also oversees trading in stocks and
administers rules designed to prevent price manipulation; to that end, brokers and dealers in the over-the-counter
market and the stock exchanges must register with the SEC. In addition, the commission requires companies to tell
the public when their own officers buy or sell shares of their stock; the commission believes that these "insiders"
possess intimate information about their companies and that their trades can indicate to other investors their
degree of confidence in their companies' future.
The agency also seeks to prevent insiders from trading in stock based on information
that has not yet become public. In the late 1980s, the SEC began to focus not just on officers and directors but on
insider trades by lower-level employees or even outsiders like lawyers who may have access to important information
about a company before it becomes public.
The SEC has five commissioners who are appointed by the president. No more than three
can be members of the same political party; the five-year term of one of the commissioners expires each year.
The Commodity Futures Trading
Commission oversees the futures markets. It is particularly zealous in cracking down on many over-the-counter
futures transactions, usually confining approved trading to the exchanges. But in general, it is considered a
more gentle regulator than the SEC. In 1996, for example, it approved a record 92 new kinds of futures and farm
commodity options contracts. From time to time, an especially aggressive SEC chairman asserts a vigorous role
for that commission in regulating futures business.
"Black Monday" and the Long Bull
Market
On Monday, October 19, 1987, the value of stocks plummeted on markets around the world. The Dow
Jones Industrial Average fell 22 percent to close at 1738.42, the largest one-day decline since 1914, eclipsing
even the famous October 1929 market crash.
The Brady Commission (a presidential commission set up to investigate the fall) the
SEC, and others blamed various factors for the 1987 debacle -- including a negative turn in investor psychology,
investors' concerns about the federal government budget deficit and foreign trade deficit, a failure of specialists
on the New York Stock Exchange to discharge their duty as buyers of last resort, and "program trading" in which
computers are programmed to launch buying or selling of large volumes of stock when certain market triggers occur.
The stock exchange subsequently initiated safeguards. It said it would restrict program trading whenever the Dow
Jones Industrial Average rose or fell 50 points in a single day, and it created a "circuit-breaker" mechanism to
halt all trading temporarily any time the DJIA dropped 250 points. Those emergency mechanisms were later
substantially adjusted to reflect the large rise in the DJIA level. In late 1998, one change required
program-trading curbs whenever the DJIA rose or fell 2 percent in one day from a certain average recent close; in
late 1999, this formula meant that program trading would be halted by a market change of about 210 points. The new
rules set also a higher threshold for halting all trading; during the fourth quarter of 1999, that would occur if
there was at least a 1,050-point DJIA drop.
Those reforms may have helped restore confidence, but a strong performance by the
economy may have been even more important. Unlike its performance in 1929, the Federal Reserve made it clear it
would ease credit conditions to ensure that investors could meet their margin calls and could continue operating.
Partly as a result, the crash of 1987 was quickly erased as the market surged to new highs. In the early 1990s, the
Dow Jones Industrial Average topped 3,000, and in 1999 it topped the 11,000 mark.
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