[Senate Hearing 111-155]
[From the U.S. Government Publishing Office]




                                                        S. Hrg. 111-155
 
               EXCESSIVE SPECULATION IN THE WHEAT MARKET

=======================================================================

                                HEARING

                               before the

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                 of the

                              COMMITTEE ON
                         HOMELAND SECURITY AND
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               ----------                              

                             JULY 21, 2009

                               ----------                              

       Available via http://www.gpoaccess.gov/congress/index.html

       Printed for the use of the Committee on Homeland Security
                        and Governmental Affairs

               EXCESSIVE SPECULATION IN THE WHEAT MARKET

                                                        S. Hrg. 111-155

               EXCESSIVE SPECULATION IN THE WHEAT MARKET

=======================================================================

                                HEARING

                               before the

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                 of the

                              COMMITTEE ON
                         HOMELAND SECURITY AND
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                             JULY 21, 2009

                               __________

       Available via http://www.gpoaccess.gov/congress/index.html

       Printed for the use of the Committee on Homeland Security
                        and Governmental Affairs

                  U.S. GOVERNMENT PRINTING OFFICE
53-114                    WASHINGTON : 2009
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        COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii              TOM COBURN, Oklahoma
THOMAS R. CARPER, Delaware           JOHN McCAIN, Arizona
MARK L. PRYOR, Arkansas              GEORGE V. VOINOVICH, Ohio
MARY L. LANDRIEU, Louisiana          JOHN ENSIGN, Nevada
CLAIRE McCASKILL, Missouri           LINDSEY GRAHAM, South Carolina
JON TESTER, Montana
ROLAND W. BURRIS, Illinois
MICHAEL F. BENNET, Colorado

                  Michael L. Alexander, Staff Director
     Brandon L. Milhorn, Minority Staff Director and Chief Counsel
                  Trina Driessnack Tyrer, Chief Clerk


                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                     CARL LEVIN, Michigan, Chairman
THOMAS R. CARPER, Delaware           TOM COBURN, Oklahoma
MARK L. PRYOR, Arkansas              SUSAN M. COLLINS, Maine
JON TESTER, Montana                  JOHN McCAIN, Arizona
MICHAEL F. BENNET, Colorado          JOHN ENSIGN, Nevada
            Elise J. Bean, Staff Director and Chief Counsel
                      Rachael Siegel, GAO Detailee
              Christopher Barkley, Minority Staff Director
                   Timothy R. Terry, Minority Counsel
                     Mary D. Robertson, Chief Clerk


                            C O N T E N T S


                                 ------                                
Opening statements:
                                                                   Page
    Senator Levin................................................     1
    Senator Coburn...............................................    10
    Senator Collins..............................................    13
    Senator Tester...............................................    15
    Senator Bennet...............................................    15
Prepared statement:
    Senator McCaskill............................................    63

                               WITNESSES
                         Tuesday, July 21, 2009

Hon. Gary Gensler, Chairman, Commodity Futures Trading Commission    16
Thomas Coyle, Vice President and General Manager, Chicago and 
  Illinois River Marketing LLC, Nidera, Inc., and Chairman, 
  National Grain and Feed Association............................    33
Hayden Wands, Director of Procurement, Sara Lee Corporation, and 
  Chairman, Commodity and Agricultural Policy, American Bakers 
  Association....................................................    36
Mark Cooper, Director of Research, Consumer Federation of America    38
Steven H. Strongin, Head of the Global Investment Research 
  Division, The Goldman Sachs Group, Inc.........................    39
Charles P. Carey, Vice Chairman, CME Group.......................    52

                     Alphabetical List of Witnesses

Carey, Charles P.:
    Testimony....................................................    52
    Prepared statement...........................................   143
Cooper, Mark:
    Testimony....................................................    38
    Prepared statement...........................................    87
Coyle, Thomas:
    Testimony....................................................    33
    Prepared statement...........................................    71
Gensler, Hon. Gary:
    Testimony....................................................    16
    Prepared statement...........................................    64
Strongin, Steven H.:
    Testimony....................................................    39
    Prepared statement...........................................   129
Wands, Hayden:
    Testimony....................................................    36
    Prepared statement...........................................    76

                                APPENDIX

``Excessive Speculation in the Wheat Market,'' Majority and 
  Minority Staff Report, Permanent Subcommittee on 
  Investigations, June 24, 2009..................................   159

                                Exhibits

 1. GOutstanding Chicago Wheat Futures Contracts Purchased by 
  Commodity Index Traders, 2004-2009, chart prepared by the U.S. 
  Senate Permanent Subcommittee on Investigations................   425
 2 GChicago Wheat Prices, Daily Difference Between Futures and 
  Cash Price (Daily Basis), chart prepared by the U.S. Senate 
  Permanent Subcommittee on Investigations.......................   426
 3. GChicago Wheat Prices, Difference Between Futures Price and 
  Cash Price (Basis) in Chicago at Contract Expiration, chart 
  prepared by the U.S. Senate Permanent Subcommittee on 
  Investigations.................................................   427
 4. GExample of a Hedge With Convergence, chart prepared by the 
  U.S. Senate Permanent Subcommittee on Investigations...........   428
 5. GExample of a Hedge Without Convergence, chart prepared by 
  the U.S. Senate Permanent Subcommittee on Investigations.......   429
 6. GCash Price of Wheat (Soft Red Winter Wheat), chart prepared 
  by the U.S. Senate Permanent Subcommittee on Investigations....   430
 7. GDocument entitled The Case for Commodities as an Asset 
  Class, prepared by Goldman Sachs and Co., June 2004............   431
 8. GResponses to supplemental questions for the record submitted 
  to Charles P. Carey, Vice Chairman, CME Group..................   498
 9. GResponses to supplemental questions for the record submitted 
  to Steven H. Strongin, Head of the Global Investment Research 
  Division, The Goldman Sachs Group, Inc.........................   503
10. GResponses to supplemental questions for the record submitted 
  to Mark Cooper, Director of Research, Consumer Federation of 
  America........................................................   507
11. GResponses to supplemental questions for the record submitted 
  to The Honorable Gary Gensler, Chairman, Commodities Futures 
  Trading Commission.............................................   510


              EXCESSIVE SPECULATION IN THE WHEAT MARKET

                              ----------                              


                         TUESDAY, JULY 21, 2009

                                   U.S. Senate,    
              Permanent Subcommittee on Investigations,    
                           Committee on Homeland Security  
                                  and Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:34 p.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Carl Levin, 
Chairman of the Subcommittee, presiding.
    Present: Senators Levin, Tester, Bennet, Coburn, and 
Collins.
    Staff Present: Elise J. Bean, Staff Director and Chief 
Counsel; Mary D. Robertson, Chief Clerk; Rachel Siegel, 
Detailee (GAO); David Katz, Counsel; Allison Murphy, Counsel; 
Christopher Barkley, Staff Director to the Minority; Timothy R. 
Terry, Counsel to the Minority; Marcelle John, Detailee (IRS); 
Kevin Wack, Congressional Fellow; Sam Katsin, Intern; Peter 
Kenny, Law Clerk; Malachi Zussman-Dobbins, Intern; Melissa Mann 
(Senator McCaskill); Nichole Distefano (Senator McCaskil); 
Jason Rosenberg (Senator Tester); Rachel Clark (Senator 
Tester); Catharine Ferguson (Senator Bennet); Brandon Milhorn 
(HSGAC/Senator Collins); Asha Mathew (HSGAC/Senator Collins); 
and Mary Beth Carozza (HSGAC/Senator Collins).

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Good afternoon, everybody. The Subcommittee 
will come to order.
    For more than 5 years now, this Subcommittee has been 
taking a hard look at how our commodity markets function. In 
particular, we have examined how excessive speculation in those 
markets has distorted prices, overwhelmed normal supply and 
demand factors, and can push up prices at the expense of 
consumers and American business.
    In 2006, for example, the Subcommittee released a report 
which found that billions of dollars in commodity index trading 
on the crude oil market had pushed up futures prices in 2006, 
causing a corresponding increase in cash prices, and were 
responsible for an estimated $20 out of the then $70 cost for a 
barrel of oil. A 2007 report showed how a single hedge fund 
named Amaranth made huge trades on the natural gas market, 
pushed up futures prices, and increased natural gas prices for 
consumers and American business.
    At today's hearing, our focus is on wheat. Using the wheat 
market as a case history, we show how commodity index trading, 
in the aggregate, can cause excessive speculation and price 
distortions. As in our prior investigations, this examination 
has taken us into the upside down world of financial 
engineering that we find ourselves in today, where instead of 
talking about supply and demand affecting wheat prices, we have 
to talk about the impact of complex financial instruments like 
commodity indexes, swaps, and exchange traded funds, and what 
happens when speculators buying these derivative instruments 
begin to dominate a futures market instead of the commercial 
businesses buying futures to hedge against price changes.
    These are complicated issues. It took the Subcommittee an 
entire year to compile and analyze millions of trading records 
from the three U.S. futures markets where wheat is traded, 
including the largest exchange of the three in Chicago. We also 
interviewed numerous experts, researched the issues, and 
released a 247-page report explaining our findings.
    Our report, which was issued by myself and Senator Coburn 
last month, concludes that the huge number of wheat futures 
contracts being purchased by derivative dealers selling 
commodity index instruments have, in the aggregate, constituted 
excessive speculation in the Chicago wheat market, resulting in 
unwarranted price changes and an undue burden on commerce.
    Our report presents a variety of data in support of its 
findings, but, necessarily, I can highlight only a few key 
points here. The first point is the huge growth in commodity 
index investments over the past 5 years. According to estimates 
by the Commodity Futures Trading Commission (CFTC), about $15 
billion was invested in commodity indexes in 2003. By mid-2008, 
that figure had grown to $200 billion, a 13-fold increase.
    Commodity indexes are mathematical constructs whose value 
is calculated from the value of a specified basket of futures 
contracts for agricultural, energy, and metals commodities. 
When the prices of the selected futures go up, the value of the 
index goes up. When the futures prices go down, the index value 
goes down.
    Speculators don't invest directly in a commodity index, 
since the index itself is nothing more than a number that 
constantly changes. Instead, they buy financial instruments--
derivatives--whose value is linked to the value of a specified 
commodity index. In essence, speculators place bets on whether 
the index value will go up or down. They place those bets with 
derivative dealers, usually by buying a financial instrument 
called a ``swap'' whose value is linked to the commodity index. 
The derivative dealer charges a fee for entering the swap, and 
then effectively holds the other side of the bet. When the 
index value goes up, the speculator makes money from the swap. 
When the index value goes down, the derivative dealer makes 
money from the swap.
    Most derivative dealers, however, don't like to gamble on 
these swaps; instead they typically hedge their bets by buying 
the futures contracts on which the index and related swaps are 
based. Then if their side of the swap loses value, they offset 
the loss with the increased value of the underlying futures. By 
holding both the swap and the futures contracts upon which the 
swap is based, derivative dealers are protected from financial 
risk whether futures prices go up or down. By taking that 
position, derivative dealers also avoid becoming pure 
speculators in commodities; instead, they facilitate the 
speculative bets being placed by their clients, while making 
money off the fees paid for the commodity index swaps.
    Since 2004, derivative dealers buying futures to offset the 
speculative bets made by their clients have begun to dominate 
U.S. commodity markets, buying a wide range of futures for 
crude oil, natural gas, gold, corn, wheat, and other 
commodities. This chart, Exhibit 1,\1\ shows the impact on the 
Chicago wheat futures market alone. It shows that derivative 
dealers making commodity index trades have bought increasing 
numbers of wheat futures, with their aggregate holdings going 
from 30,000 wheat contracts in 2004 to 220,000 in 2008, a 
seven-fold increase in 4 years. Derivative dealers making 
commodity index trades now hold nearly half of the outstanding 
wheat futures--long open interest--on the Chicago Exchange.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 1, which appears in the Appendix on page 425.
---------------------------------------------------------------------------
    Derivative dealers seeking to offset the speculative bets 
of their clients have created a new demand for futures 
contracts. Their objective is simple: to buy a sufficient 
number of futures to offset their financial risk from selling 
commodity index swaps to their clients. Their steady purchases 
of futures to buy wheat have had a one-way impact on futures 
prices--pushing the prices up. In addition, their purchases 
have created a steady demand for wheat futures, without 
creating a corresponding demand in the cash market. The result 
in recent years has been Chicago wheat futures prices which are 
routinely much higher than wheat cash prices, with a persistent 
and sizable gap between the two prices.
    Now, the next two charts show how this gap has grown over 
time. The first chart, Exhibit 2,\2\ looks at the day-to-day 
difference between wheat futures and cash prices in the Chicago 
wheat market over the last 9 years. It shows that, from 2000 to 
2005, the average daily difference between the average cash and 
futures price for wheat in the Chicago market, also called the 
``basis,'' ranged between 0 and 50 cents. In 2006, that price 
gap or basis began to increase, in sync with the increasing 
amount of commodity index trading going on in the Chicago wheat 
market. By mid-2008, when commodity index traders held nearly 
half of the outstanding wheat futures--long open interest--on 
the Chicago Exchange, the price gap had grown to between $1.50 
and $2 per bushel, a huge and unprecedented gap.
---------------------------------------------------------------------------
    \2\ See Exhibit No. 2, which appears in the Appendix on page 426.
---------------------------------------------------------------------------
    Now, the next chart, which is Exhibit 3 \3\ in the books, 
shows the same pattern when the Chicago wheat futures contracts 
expired. Wheat futures contracts are available in only 5 months 
of the year--March, May, July, September, and December. This 
chart looks at the expiration date for each of those five 
contracts from 2005 to 2008 and shows the gap between the final 
futures price and the cash price on that date. The data shows 
that this gap, or the basis, grew from 13 cents per bushel in 
2005, to 34 cents in 2006, to 60 cents in 2007, to $1.53 in 
2008, a more than ten-fold increase in 4 years, providing clear 
evidence of a dysfunctional market. And, again, this increasing 
price gap took place at the same time commodity index traders 
were increasing their holdings to nearly half of the wheat 
futures contracts on the Chicago Exchange.
---------------------------------------------------------------------------
    \3\ See Exhibit No. 3, which appears in the Appendix on page 427.
---------------------------------------------------------------------------
    To understand the significance of this price gap, we need 
to take a step back and focus on the purpose of commodity 
markets. Commodity markets have traditionally had two primary 
purposes: first, to help farmers and other businesses establish 
a price for the delivery of a commodity at a specified date in 
the future; and, second, to help them hedge against the risk of 
price changes over time.
    Futures prices are the result of numerous traders making 
individual bids to buy or sell a standard amount of the 
commodity at a specified date in the future. That date can be 1 
month, 6 months, or even years in the future. At the same time 
this bargaining is going on to establish prices for the future 
delivery of a commodity, businesses are also bargaining over 
prices for the immediate delivery of that commodity. A price 
for the immediate delivery of a commodity is referred to as the 
cash price. Traditionally, futures prices and cash prices have 
worked together. That is because, as the delivery date in a 
futures contract gets closer, the futures price logically 
should begin to converge with the cash price so that, on the 
date the futures contract expires and delivery is due, the two 
prices are very close.
    Now that is what is supposed to happen. But in some 
commodity markets like the wheat market, price convergence has 
broken down. When price convergence breaks down, hedges stop 
working and no longer protect farmers, grain elevators, grain 
merchants, food producers, and others against price changes. 
And we will hear today how these businesses are losing the 
ability to hedge in the Chicago wheat market and are incurring 
unanticipated costs from failed hedges and higher margin costs. 
We will also hear how, in many cases, those businesses have to 
eat those costs because the fierce competition over food prices 
won't allow them to increase their prices to cover the extra 
expense. In other cases, when they do pass on those higher 
costs, consumers, of course, lose.
    Virtually everyone this Subcommittee has contacted agrees 
that price convergence is critical to successful hedging. When 
the futures and cash prices don't converge at the time a 
futures contract expires, hedges don't work. There is no 
dispute over that. In the prepared statement, which I will put 
in the record, I provide a detailed explanation of why price 
convergence is essential to effective hedging. In the interest 
of time and because there is pretty much a consensus in support 
of that point, I am not going to repeat that explanation here.
    The key issue is what is causing the prices not to 
converge. While there are many possible contributing factors, 
including artificially low storage prices or delivery problems, 
our investigation found substantial and persuasive evidence 
that the primary reason why prices have not been converging in 
the Chicago wheat market is the large number of wheat contracts 
being purchased by derivative dealers making commodity index 
trades.
    Those derivative dealers have been selling billions of 
dollars in commodity index swaps to customers speculating on 
commodity prices. By purchasing futures contracts to offset 
their financial risk, derivative dealers created an additional 
demand for wheat futures that is unconnected to the cash 
market, and that has contributed to the gap between the two 
prices. We know of no other significant change in the wheat 
market over the past 5 years which explains the failure to 
converge other than the huge surge of wheat futures bought by 
derivative dealers offsetting the sale of commodity index swaps 
to their clients. I emphasize the word ``significant.'' We know 
of no other significant change in the wheat market over the 
past 5 years.
    The massive commodity index trading affecting the wheat 
futures market in recent years was made possible in part by 
regulators. Existing law requires the CFTC to set limits on the 
number of futures contracts that any one trader can hold at any 
one time to prevent excessive speculation and other trading 
abuses. Those position limits are supposed to apply to all 
traders, unless granted an exemption or a waiver by the CFTC.
    With respect to wheat, the CFTC has established a limit 
that prohibits any trader from holding more than 6,500 futures 
contracts at any one time. But over the years, the CFTC has 
also allowed some derivative dealers to exceed that limit. The 
CFTC granted exemptions to four derivative dealers that sell 
commodity index swaps, allowing them to hold up to 10,000, 
17,500, 26,000, and even 53,000 wheat futures at a time. The 
CFTC also issued two ``no-action'' letters allowing the manager 
of one commodity index exchange-traded fund to hold up to 
11,000 wheat futures and another fund manager to hold up to 
13,000 wheat futures. Together, those exemptions and waivers by 
the CFTC permit six derivative dealers to hold a total of up to 
130,000 wheat futures contracts at any one time, instead of 
39,000, or two-thirds less, if the standard limit had applied.
    Part of the reason that the CFTC granted these exemptions 
and waivers was because it got mixed signals from Congress. In 
the Commodities Exchange Act, Congress told the CFTC to set 
position limits to prevent excessive speculation, and it 
authorized the CFTC to grant exemptions only for commercial 
users needing to hedge transactions involving physical 
commodities in the cash market. But in 1987, two key 
congressional committees also told the CFTC to consider 
granting exemptions to financial firms seeking to offset purely 
financial risks. It was in response to this direction that the 
CFTC eventually allowed the derivative dealers selling 
commodity index instruments to exceed the standard limits.
    These exemptions and waivers have enabled derivative 
dealers to place many more speculative bets for their customers 
than they could have otherwise, resulting in an increased 
demand for wheat futures contracts to offset the financial 
risk, higher wheat futures prices unconnected to cash prices, 
failed hedges, and higher margin costs.
    That is why our report recommends that the CFTC reinstate 
the standard 6,500 limit on wheat contracts for derivative 
dealers. Imposing this limit again would reduce commodity index 
trading in the wheat market and take some of the pressure off 
wheat futures prices. If wheat futures prices remain higher 
than cash prices after the existing exemptions and waivers are 
phased out, our report recommends tightening the limit further, 
perhaps to 5,000 wheat contracts per derivative dealer, which 
is the limit that existed up until 2006.
    Our report also recommends that the CFTC examine other 
commodity markets to see if commodity index trading has 
resulted in excessive speculation and undue price changes. This 
Subcommittee has said before that excessive speculation is 
playing a damaging role in other commodity markets, especially 
the crude oil market where oil prices go up despite low demand 
and ample supplies. And I might add here that our full 
Committee has done some significant investigations and hearings 
on the same subject under the leadership of Chairman Lieberman 
and Ranking Member Collins.
    The CFTC has promised a top-to-bottom review of the 
exemptions and waivers it has granted to derivative dealers and 
has signaled its willingness to use position limits to clamp 
down on excessive speculation in all commodity markets, to 
ensure that commodity prices reflect supply and demand rather 
than speculators gambling on market prices to turn a quick 
profit. That review is badly needed, and we appreciate the 
agency's responsiveness to the turmoil in the markets.
    [The prepared statement of Senator Levin follows:]

              PREPARED OPENING STATEMENT OF SENATOR LEVIN

    For more than five years now, this Subcommittee has been taking a 
hard look at how our commodity markets function. In particular, we have 
examined how excessive speculation in those markets has distorted 
prices, overwhelmed normal supply and demand factors, and can push up 
prices at the expense of consumers and American business.
    In 2006, for example, the Subcommittee released a report which 
found that billions of dollars in commodity index trading on the crude 
oil market had pushed up futures prices in 2006, caused a corresponding 
increase in cash prices, and were responsible for an estimated $20 out 
of the then $70 cost for a barrel of oil. A 2007 report showed how a 
single hedge fund named Amaranth made huge trades on the natural gas 
market, pushed up futures prices, and increased natural gas prices for 
consumers and American business.
    At today's hearing, our focus is on wheat. Using the wheat market 
as a case history, we show how commodity index trading, in the 
aggregate, can cause excessive speculation and price distortions. As in 
our prior investigations, this examination has taken us into the upside 
down world of financial engineering that we find ourselves in today, 
where instead of talking about supply and demand affecting wheat 
prices, we have to talk about the impact of complex financial 
instruments like commodity indexes, swaps, and exchange traded funds, 
and what happens when speculators buying these derivative instruments 
begin to dominate a futures market instead of the commercial businesses 
buying futures to hedge against price changes.
    These are complicated issues. It took the Subcommittee an entire 
year to compile and analyze millions of trading records from the three 
U.S. futures markets where wheat is traded, including the largest 
exchange of the three in Chicago. We also interviewed numerous experts, 
researched the issues, and released a 247-page report explaining our 
findings. Our report, which was issued by myself and Senator Coburn 
last month, concludes that the huge number of wheat futures contracts 
being purchased by derivative dealers selling commodity index 
instruments have, in the aggregate, constituted excessive speculation 
in the Chicago wheat market, resulting in unwarranted price changes and 
an undue burden on commerce.
     Our report presents a variety of data in support of its findings, 
but, necessarily, I can highlight only a few key points here. The first 
point is the huge growth in commodity index investments over the past 
five years. According to estimates by the Commodity Futures Trading 
Commission (CFTC), about $15 billion was invested in commodity indexes 
in 2003. By mid-2008, that figure had grown to $200 billion, a 
thirteenfold increase.
    Commodity indexes are mathematical constructs whose value is 
calculated from the value of a specified basket of futures contracts 
for agricultural, energy, and metals commodities. When the prices of 
the selected futures go up, the value of the index goes up. When the 
futures prices go down, the index value goes down.
    Speculators don't invest directly in a commodity index, since the 
index itself is nothing more than a number that constantly changes. 
Instead, they buy financial instruments--derivatives--whose value is 
linked to the value of a specified commodity index. In essence, 
speculators place bets on whether the index value will go up or down. 
They place those bets with derivative dealers, usually by buying a 
financial instrument called a ``swap'' whose value is linked to the 
commodity index. The derivative dealer charges a fee for entering the 
swap, and then effectively holds the other side of the bet. When the 
index value goes up, the speculator makes money from the swap. When the 
index value goes down, the derivative dealer makes money from the swap.
    Most derivative dealers, however, don't like to gamble on these 
swaps; instead they typically hedge their bets by buying the futures 
contracts on which the index and related swaps are based. Then if their 
side of the swap loses value, they offset the loss with the increased 
value of the underlying futures. By holding both the swap and the 
futures contracts upon which the swap is based, derivative dealers are 
protected from financial risk whether futures prices go up or down. By 
taking that position, derivative dealers also avoid becoming pure 
speculators in commodities, instead facilitating the speculative bets 
being placed by their clients, while making money off the fees paid for 
the commodity index swaps.
    Since 2004, derivative dealers buying futures to offset the 
speculative bets made by their clients have begun to dominate U.S. 
commodity markets, buying a wide range of futures for crude oil, 
natural gas, gold, corn, wheat and other commodities. This chart, 
Exhibit 1, shows the impact on the Chicago wheat futures market alone. 
It shows that derivative dealers making commodity index trades have 
bought increasing numbers of wheat futures, with their aggregate 
holdings going from 30,000 wheat contracts in 2004, to 220,000 in 2008, 
a sevenfold increase in four years. Derivative dealers making commodity 
index trades now hold nearly half of the outstanding wheat futures 
(long open interest) on the Chicago Exchange.
    Derivative dealers seeking to offset the speculative bets of their 
clients have created a new demand for futures contracts. Their 
objective is simple: to buy a sufficient number of futures to offset 
their financial risk from selling commodity index swaps to clients. 
Their steady purchases of futures to buy wheat have had a one-way 
impact on futures prices--pushing the prices up. In addition, their 
purchases have created a steady demand for wheat futures, without 
creating a corresponding demand in the cash market. The result in 
recent years has been Chicago wheat futures prices which are routinely 
much higher than wheat cash prices, with a persistent and sizeable gap 
between the two prices.
    The next two charts show how this gap has grown over time. The 
first chart, Exhibit 2, looks at the day-to-day difference between 
wheat futures and cash prices in the Chicago wheat market over the last 
nine years. It shows that, from 2000 to 2005, the average daily 
difference between the average cash and futures price for wheat in the 
Chicago market, also called the basis, ranged between 0 and 50 cents. 
In 2006, that price gap or basis began to increase, in sync with the 
increasing amount of commodity index trading going on in the Chicago 
wheat market. By mid 2008, when commodity index traders held nearly 
half of the outstanding wheat futures (long open interest) on the 
Chicago Exchange, the price gap had grown to between $1.50 and $2 per 
bushel, a huge and unprecedented gap.
    The next chart, Exhibit 3, shows the same pattern when the Chicago 
wheat futures contracts expired. Wheat futures contracts are available 
in only five months of the year, March, May, July, September, and 
December. This chart looks at the expiration date for each of those 
five contracts from 2005 to 2008, and shows the gap between the final 
futures price and the cash price on that date. The data shows that this 
gap, or basis, grew from 13 cents per bushel in 2005, to 34 cents in 
2006, to 60 cents in 2007, to $1.53 in 2008, a more than ten-fold 
increase in four years, providing clear evidence of a dysfunctional 
market. And again, this increasing price gap took place at the same 
time commodity index traders were increasing their holdings to nearly 
half of the wheat futures contracts on the Chicago Exchange.
    To understand the significance of this price gap, we need to take a 
step back and focus on the purpose of commodity markets. Commodity 
markets have traditionally had two primary purposes: first, to help 
farmers and other businesses establish a price for the delivery of a 
commodity at a specified date in the future, and, second, to help them 
hedge against the risk of price changes over time.
    Futures prices are the result of numerous traders making individual 
bids to buy or sell a standard amount of the commodity at a specified 
date in the future. That date can be one month, six months, or even 
years in the future. At the same time this bargaining is going on to 
establish prices for the future delivery of a commodity, businesses are 
also bargaining over prices for the immediate delivery of that 
commodity. A price for the immediate delivery of a commodity is 
referred to as the cash price. Traditionally, futures prices and cash 
prices have worked together. That's because, as the delivery date in a 
futures contract gets closer, the futures price logically should begin 
to converge with the cash price so that, on the date the futures 
contract expires and delivery is due, the two prices are very close.
    That's what supposed to happen. But in some commodity markets like 
the wheat market, price convergence has broken down. When price 
convergence breaks down, hedges stop working and no longer protect 
farmers, grain elevators, grain merchants, food producers, and others 
against price changes. We will hear today how these businesses are 
losing the ability to hedge in the Chicago wheat market, and are 
incurring unanticipated costs from failed hedges and higher margin 
costs. We will also hear how, in many cases, those businesses have to 
eat those costs because the fierce competition over food prices won't 
allow them to increase their prices to cover the extra expense. In 
other cases, when they do pass on those higher costs, consumers lose.
    Virtually everyone this Subcommittee has contacted agrees that 
price convergence is critical to hedging. When the futures and cash 
prices don't converge at the time a futures contract expires, hedges 
don't work. Let me explain in more detail why price convergence is 
critical to the ability of farmers, elevators, and others to use the 
futures markets to manage their price risks. Let's use the example of a 
county grain elevator that buys wheat from a local farmer, stores it, 
and sells the grain to a major bakery later in the year.
    When the grain elevator buys the wheat and stores it, the value of 
that grain will fluctuate as grain prices change over time. If grain 
prices go up, the wheat is worth more. If prices go down, the wheat is 
worth less and could even drop below what the elevator paid for it. To 
protect itself, the elevator typically turns to the futures market to 
hedge its price risk.
    This chart, Exhibit 4, shows how the elevator uses the futures 
market to protect itself from a drop in wheat prices. The example 
assumes the grain elevator bought wheat on July 15 for $4 per bushel 
and wants to sell it to a bakery in December. In July, when the 
elevator buys the wheat, it checks the futures prices and finds that 
the price for delivering wheat in December is $6 per bushel. Since that 
price is $2 more than what it paid for the wheat, the elevator wants to 
lock in that gain. So in July, the elevator obtains a futures contract 
to deliver a standard amount of wheat to a specified storage warehouse 
in December at $6 per bushel.
    The grain elevator is now said to be ``hedged,'' because it has 
grain in storage--which is called being ``long'' in the cash market--
and a futures contract to deliver wheat at a specified price in the 
future--which is called being ``short'' in the futures market. In a 
properly functioning futures market, any loss in the cash value of the 
stored wheat from July to December should be offset by a gain in the 
value of its futures contract over the same period.
    Here's how it works. When December arrives, the elevator acts to 
``unwind'' its hedge so that it doesn't have to actually incur the 
expense of delivering its wheat as the futures contract specifies--to a 
faraway warehouse--and can instead deliver it to its customer, the 
bakery. To offset its obligation to deliver wheat in December, the 
elevator goes onto the futures market in December and buys a futures 
contract obligating it to take delivery of the same amount of wheat 
during that same month of December. The contract to buy wheat in 
December can then be used to offset the $6 per bushel contract to sell 
wheat in December, and the two futures cancel out. The elevator is then 
free to sell its stored wheat to the bakery at the prevailing cash 
price.
    The key to a successful hedge here is whether the December cash and 
the December futures prices have converged. The example on the chart 
assumes that both the cash and futures prices have converged in 
December to $3 per bushel. That means the elevator, in December, can 
buy a December futures contract to take delivery of wheat at $3 per 
bushel, offset it against its contract promising to sell wheat in 
December for $6 per bushel, and realize a net gain of $3 in the futures 
market. In the cash market, the elevator can sell its grain to the 
bakery at the prevailing cash price of $3 per bushel, which is a $1 per 
bushel loss compared to the $4 it paid to buy the wheat. But that $1 
loss in the cash market, when subtracted from the $3 gain in the 
futures market, results in an overall gain of $2 per bushel--exactly 
what the elevator sought when it initiated the hedge in July.
    The December price convergence was critical to the success of the 
elevator's hedging strategy. It is only because the December wheat 
futures price and the December wheat cash price were the same that the 
grain elevator was able to offset its December futures and December 
cash transactions, and realize the $2 gain promised by its hedge in 
July.
    The next chart, Exhibit 5, shows what happens when the cash and 
futures prices don't converge. This chart uses the same assumptions--
that, in July, the grain elevator purchased wheat from a farmer for $4 
per bushel and obtained a futures contract promising to sell the wheat 
for $6 per bushel in December. In this example, however, the futures 
price stays higher than the cash price throughout the life of the 
hedge. When the futures contract expires in December, the December 
futures price is $5 per bushel, while the December cash price is $3. 
That means when the elevator buys a futures contract in December to 
offset its earlier hedge, it will have to buy a futures contract at $5 
per bushel, which when offset against its futures contract to sell the 
wheat for $6 per bushel, results in a net gain in the futures market of 
only $1 per bushel. In the cash market, the elevator still sells the 
wheat that it bought at $4 per bushel to the bakery for $3, resulting 
in a loss of $1 per bushel. Subtracting the $1 loss in the cash market 
from the $1 gain in the futures market leaves the elevator without any 
net gain to pay its expenses.
    If the elevator hadn't bought a futures contract in December to 
unwind its hedge that way, it could have lost out even more, by having 
to pay the costs of transporting its wheat to an approved warehouse in 
December. The point of the hedge made in July was not to deliver wheat 
to a warehouse in December, but to lock in a gain and protect it from 
price changes. The effectiveness of that hedge requires price 
convergence, however, and that's exactly what has been lacking on too 
many occasions in the Chicago wheat market in recent years.
    The key issue is what is causing the prices not to converge. While 
there are many possible contributing factors, including artificially 
low storage costs or delivery problems, our investigation found 
substantial and persuasive evidence that the primary reason why prices 
have not been converging in the Chicago wheat market is the large 
number of wheat contracts being purchased by derivative dealers making 
commodity index trades. Those derivative dealers have been selling 
billions of dollars in commodity index swaps to customers speculating 
on commodity prices. By purchasing futures contracts to offset their 
financial risk, derivative dealers created an additional demand for 
wheat futures that is unconnected to the cash market, and that has 
contributed to the gap between the two prices. We know of no other 
significant change in the wheat market over the past five years which 
explains the failure to converge other than the huge surge of wheat 
futures bought by derivative dealers offsetting the sale of commodity 
index swaps to their clients.
    The massive commodity index trading affecting the wheat futures 
market in recent years was made possible in part by regulators. 
Existing law requires the CFTC to set limits on the number of futures 
contracts that any one trader can hold at any one time to prevent 
excessive speculation and other trading abuses. Those position limits 
are supposed to apply to all traders, unless granted an exemption or 
waiver by the CFTC.
    With respect to wheat, the CFTC has established a limit that 
prohibits any trader from holding more than 6,500 futures contracts at 
any one time. But over the years, the CFTC has also allowed some 
derivative dealers to exceed that limit. The CFTC granted exemptions to 
four derivative dealers that sell commodity index swaps, allowing them 
to hold up to 10,000, 17,500, 26,000, and even 53,000 wheat futures at 
a time. The CFTC also issued two ``no-action'' letters allowing the 
manager of one commodity index exchange traded fund to hold up to 
11,000 wheat futures and another fund manager to hold up to 13,000 
wheat futures. Together, these exemptions and waivers permit six 
derivative dealers to hold a total of up to 130,000 wheat futures 
contracts at any one time, instead of 39,000, or two-thirds less, if 
the standard limit had applied.
    Part of the reason that the CFTC granted these exemptions and 
waivers was because it got mixed signals from Congress. In the 
Commodities Exchange Act, Congress told the CFTC to set position limits 
to prevent excessive speculation, and authorized the CFTC to grant 
exemptions only for commercial users needing to hedge transactions 
involving physical commodities in the cash market. But in 1987, two key 
Congressional Committees also told the CFTC to consider granting 
exemptions to financial firms seeking to offset purely financial risks. 
It was in response to this direction that the CFTC eventually allowed 
the derivative dealers selling commodity index instruments to exceed 
the standard limits.
    These exemptions and waivers have enabled derivative dealers to 
place many more speculative bets for their customers than they could 
have otherwise, resulting in an increased demand for wheat futures 
contracts to offset the financial risk, higher wheat futures prices 
unconnected to cash prices, failed hedges, and higher margin costs.
    That's why our report recommends that the CFTC reinstate the 
standard 6,500 limit on wheat contracts for derivative dealers. 
Imposing this limit would reduce commodity index trading in the wheat 
market and take some of the pressure off wheat futures prices. If wheat 
futures prices remain higher than cash prices after the existing 
exemptions and waivers are phased out, our report recommends tightening 
the limit further, perhaps to 5,000 wheat contracts per derivative 
dealer, which is the limit that existed up until 2006.
    Our report also recommends that the CFTC examine other commodity 
markets to see if commodity index trading has resulted in excessive 
speculation and undue price changes. This Subcommittee has said before 
that excessive speculation is playing a damaging role in other 
commodity markets, especially the crude oil market where oil prices go 
up despite low demand and ample supplies.
    The CFTC has promised a top-to-bottom review of the exemptions and 
waivers it has granted to derivative dealers, and signaled its 
willingness to use position limits to clamp down on excessive 
speculation in all commodity markets, to ensure commodity prices 
reflect supply and demand rather than speculators gambling on market 
prices to turn a quick profit. That review is sorely needed, and we 
appreciate the agency's responsiveness to the turmoil in the markets.
    I am grateful to my Ranking Member, Senator Coburn, and his staff 
for their participation in and support of this bipartisan 
investigation, and I would like to turn to him now for his opening 
statement.

    Senator Levin. I am very grateful to my Ranking Member, 
Senator Coburn, and his staff for their participation in and 
their support of this bipartisan investigation, and I turn to 
him now for his opening statement. Dr. Coburn.

              OPENING STATEMENT OF SENATOR COBURN

    Senator Coburn. Senator Levin, thank you very much and let 
me, first of all, tell you what a pleasure it is to get to work 
with you and to tell you how highly I think of your staff on 
this Subcommittee. They have been very helpful, and I have 
learned a great deal. This is the second hearing that I have 
been with Senator Levin on.
    Let me thank you for having the hearing. The people of 
Oklahoma, I think, are uniquely invested in the commodities 
market, not just the wheat but the oil and natural gas, and the 
subject is appropriate for them.
    As most people know, Oklahoma is the delivery point of West 
Texas Intermediate crude, the global benchmark. It is delivered 
not far from my home, and we also produce a tremendous amount 
of hard red winter wheat. So coming from a farming State, I 
have had a particular interest in this, and I am pleased with 
today's hearing. And I have also heard from hundreds of our 
constituents, especially in the last year, that got caught in a 
bind in what happened.
    I understand that commodity markets exist to help buyers 
and sellers price their goods efficiently and to manage risks 
associated with producing and carrying inventory, with 
acquiring financing, with unanticipated price changes over 
time. Seasonally-produced crops such as wheat can be 
particularly vulnerable to some of these risks.
    At the outset, however, I want to be clear. I do not 
believe we are alleging any wrongdoing on the part of index 
investors or anyone else. These investments represent 
individuals making economic choices in a free market, regular 
Americans seeking slightly better returns for their university 
endowments, their stock portfolios, or their retirement funds. 
Index investors are really nothing more than many of us who 
have gotten somewhat more sophisticated in how we spread our 
risk and how we invest.
    Nor are we alleging that index investors caused high cash 
commodity prices or that they are somehow responsible for more 
expensive consumer goods, like cereal, crackers, and bread. Our 
investigation did not show that. Our investigation did, 
however, reveal that an abundance of long open interest helped 
to inflate futures prices and thereby disconnect future prices 
from cash prices, impairing farmers' and elevator operators' 
ability to hedge price risk. Because, in the absence of 
convergence, elevator operators are often forced to liquidate 
their stock at a cash price well below the futures price at 
which they had established their hedges. This results in 
expensive and unnecessary losses and drives market participants 
not to use the futures market at all, and that is hardly a 
desirable result for us.
    Very few industry participants disagree that index fund 
participation contributed to the problems in the Chicago wheat 
market. For most, however, the focus of their criticism was not 
the index investors but the CME contract, which they believe 
created persistent structural problems in a market that the 
large index influx merely exacerbated.
    So what is the best solution? Frankly, I agree with Mr. 
Coyle, with the National Grain and Feed Association, that a 
free-market solution is most desirable, and I too prefer to see 
the wheat contract come back into balance with minimal 
intervention by the Federal Government. Is that possible?
    On the one hand, it has not yet done so, but, on the other 
hand, we have seen some recent changes to the CME contract that 
I hope will be sufficient. I applaud the CME for their 
recently-implemented contract changes; noting that just this 
month it amended its wheat contract, chiefly to provide for 
additional delivery locations and to increase the storage rate 
for wheat.
    Last, a word of caution. Like a lot of ``solutions'' to 
complex problems that Congress oftentimes gets involved in, 
including those offered here today--like compelled load-out, 
additional delivery points, higher storage fees, and even our 
own report's recommendation--carry the risk of unintended 
consequences. While there is little doubt that scaling back 
index participation will work to improve convergence, investor 
capital does not stand idle for long, and interest will flow 
into other products and other markets, perhaps overseas.
    The world is flat when it comes to world economic and 
financial considerations, and global competition for capital 
has become more fierce than ever before. The United States is 
losing this competition to countries like Singapore, 
Luxembourg, Hong Kong, and especially the U.K. Nations such as 
these are making smarter tax and regulatory policies, and these 
decisions are paying great dividends in the form of increased 
jobs and investments for their citizens. These countries 
understand that financial activity, especially those relating 
to derivatives and money management, crosses international 
borders with the greatest of ease, and they have rolled out the 
welcome mat for them.
    So our challenge is to, as unintrusively as possible, help 
to restore the balance to the Chicago market and help to ensure 
a well-functioning marketplace, one with a helpful balance of 
liquidity, volatility, and risk, and one that does not 
necessarily harm economic activity.
    I thank the witnesses who are here today for their 
testimony and the time that they spent preparing that, and I 
would note, Mr. Chairman, at 4 to 4:30 p.m., I will have to be 
gone, but I will return.

              PREPARED OPENING STATEMENT OF SENATOR COBURN

    Mr. Chairman, I want to thank you for calling this important 
hearing. The people of Oklahoma are, I think, uniquely invested in the 
commodities markets and are interested in the subject at hand. Oklahoma 
is the delivery point of West Texas Intermediate crude oil, the global 
benchmark. It's delivered in Cushing, Oklahoma, not far from my home 
town of Muskogee. My state also produces a tremendous amount of ``hard 
red winter wheat.'' So, coming from a farming state, I have had a 
particular interest in this investigation and am pleased with today's 
hearing.
    Commodity markets exist to help buyers and sellers price their 
goods efficiently and to manage risks--risks associated with producing 
and carrying inventory, with acquiring financing, with unanticipated 
price changes over time. Seasonally produced crops--such as wheat--can 
be particularly vulnerable to some of these risks. I know--I have a lot 
of friends back home who are farmers, merchants, and elevator 
operators, and I can tell you they're hurting. As if soaring energy and 
fertilizer costs last year weren't enough, folks also had to deal with 
volatile wheat prices at home, an evaporation of credit (if not 
outright insolvency) at their bank, and a stronger dollar that made 
their product less competitive abroad--where much of the Oklahoma wheat 
crop ends up. All of this on top of a persistent, years-long 
nonconvergence problem in the Chicago wheat market.
    At the outset, however, I want to be clear: we are not alleging any 
wrongdoing on the part of index investors or anyone else; these 
investments represent individuals making economic choices in a free 
market, regular Americans seeking slightly better returns for their 
university endowments, stock portfolios, and retirement funds. Index 
investors are really nothing more than teachers, firefighters, 
policemen and average hardworking people. Nor are we alleging that 
index investors caused high cash commodity prices or that they are 
somehow responsible for more expensive consumer goods like cereal, 
crackers, and bread. Our investigation did not support such 
conclusions.
    Our investigation did, however, reveal that an abundance of long 
open interest helped to inflate futures prices and thereby disconnect 
futures from cash prices, impairing farmers' and elevator operators' 
ability to hedge price risk. Because, in the absence of convergence, 
elevator operators are often forced to liquidate their stocks at a cash 
price well below the futures price at which they had establish their 
hedges. This results in expensive and unnecessary losses and drives 
market participants not to use the futures market at all, hardly a 
desirable result.
    Very few industry participants disagreed that index fund 
participation contributed to the problems in the Chicago wheat market. 
For most, the focus of their criticism was not the index investors, but 
the CME contract, which they believe created persistent structural 
problems in a market that the large index influx merely exacerbated.
    So what is the best solution? Frankly, I agree with Mr. Coyle, with 
the National Grain and Feed Association, that a free market solution is 
most desirable, and I, too, ``prefer to see the wheat contract come 
back into balance with minimal intervention'' from the federal 
government. The question is: is this possible? On the one hand it has 
not yet done so, but on the other we have seen some recent changes to 
the CME contract that I hope will do the trick. I applaud the CME for 
their recently-implemented contract changes. Just this month, it 
amended its wheat contract, chiefly to provide for additional delivery 
locations and to increase the storage rate for wheat.
    Lastly, a word of caution: like a lot of ``solutions'' to complex 
problems, those offered here today--compelled load-out, additional 
delivery points, higher storage fees and even our own report's 
recommendation--carry the risk of unintended consequences. While there 
is little doubt that scaling back index participation will work to 
improve convergence, investor capital does not stand idle for long, and 
interest will flow into other products and other markets, perhaps 
overseas. The world is ``flat,'' and global competition for capital has 
become more fierce than ever before. The United States is losing this 
competition to countries like Singapore, Luxembourg, Hong Kong, and 
especially the U.K. Nations such as these are making smarter tax and 
regulatory policies, and these decisions are paying great dividends in 
the form of increased jobs and investment. These countries understand 
that financial activity--especially those relating to derivatives and 
money management--crosses international borders with the greatest of 
ease, and they have rolled out the welcome mat.
    So our challenge is to, as unintrusively as possible, help to 
restore balance to the Chicago market and help to ensure a well-
functioning marketplace, one with a helpful balance of liquidity, 
volatility, and risk, and one that does not unnecessarily harm economic 
activity.
    I thank the witnesses for their presence here today and look 
forward to hearing their testimony.

    Senator Levin. Thank you so much, Dr. Coburn.
    Let me now call our first witness for this afternoon's 
hearing: Gary Gensler, the new Chairman of the Commodity 
Futures Trading Commission, your first appearance before the 
Subcommittee. We welcome you.
    Pursuant to Rule VI, all witnesses who testify before this 
Subcommittee are required to be sworn, so I would ask you to 
please stand and raise your right hand. Do you swear that the 
testimony you are about to give this Subcommittee will be the 
truth, the whole truth, and nothing but the truth, so help you, 
God?
    Mr. Gensler. I do.
    Senator Levin. Oh, I am sorry. Senator Collins, apparently 
had an opening statement, and in that case, I will interrupt 
Dr. Gensler's testimony and call on you, Senator Collins.

              OPENING STATEMENT OF SENATOR COLLINS

    Senator Collins. Thank you, Mr. Chairman. I will not delay 
the testimony long, but I do appreciate the opportunity to make 
just a few comments.
    First of all, Mr. Chairman, let me thank you and recognize 
you for your many years of leadership in exposing excessive 
speculation, market abuses, and manipulation. As you kindly 
mentioned, last year Chairman Lieberman and I held a series of 
hearings investigating the skyrocketing price of energy and 
agricultural commodities. Our hearings gathered compelling 
evidence that excessive speculation in futures markets was a 
significant factor in pushing up oil and agricultural commodity 
prices.
    Chairman Levin and the Ranking Member, Senator Coburn, have 
undertaken an in-depth and exhaustive investigation of 
speculation by delving into the inner workings of the wheat 
market. I believe that the data and analysis that they have 
presented make another compelling case that excessive 
speculation has caused our commodity markets to become unmoored 
from those who actually make a living using the underlying 
commodities, as well as by the consumers who pay the ultimate 
price.
    I want to just share with the Subcommittee, quickly, an 
example that we talked about last spring. It involved a bakery 
owner from Maine, Andrew Siegel, who testified before us. He 
experienced a truly astonishing increase in the price of the 
50,000 pounds of flour that he uses each week. In September 
2007, he was paying $7,600 per week for 50,000 pounds of flour. 
By February 2008, he was paying $28,000 a week for the same 
amount of flour. That obviously jeopardized his ability to 
continue in business, and he identified Federal ethanol 
policies as well as excessive speculation as the major culprit.
    So my point is that the working of these markets have real-
life consequences. They affect not only the pension funds and 
university endowments and other institutional investors who are 
simply trying to get a better return and seek diversification 
of their assets, but they also affect the small baker; they 
affect the elderly widow who is heating her home with heating 
oil; they affect the farmers; they affect the purchasers of 
agricultural and oil commodities.
    So to try to combat the effect that speculation has had in 
our commodity markets, I have introduced the Commodity 
Speculation Reform Act. This bill would limit the percentage of 
total contract holdings that non-commercial investors could 
maintain in any one commodity market, and the bill would also 
close the swaps loophole that currently allows financial 
institutions to evade position limits intended to prevent an 
investor from cornering a market.
    I do want to say that we have made progress in one area 
that our Subcommittee has focused on, and that is the lack of 
staff and other resources for the Commodity Futures Trading 
Commission. Along with Senator Durbin, I serve on the 
Subcommittee on Appropriations that has jurisdiction, and I am 
pleased to report to the Members of this Subcommittee that we 
have provided a 21-percent increase in the budget for the 
Commodity Futures Trading Commission. And I think this is going 
to help the CFTC to more effectively monitor markets, analyze 
the vast amount of complex trading data, and more quickly 
respond to problems in the operations of the futures markets.
    I personally believe that while I commend the Commission 
for looking at regulatory reforms, we also need to legislate in 
this area, and I know the Chairman has been a real leader as 
well in pursuing legislative reforms over the last few years.
    So I am very pleased to be here with you today, and thank 
you so much for allowing me to make some comments.

             PREPARED OPENING STATEMENT OF SENATOR COLLINS

    Mr. Chairman, thank you for your many years of leadership in 
exposing excessive speculation, market abuses and manipulation. Last 
year, Chairman Lieberman and I held a series of hearings investigating 
the skyrocketing price of energy and agricultural commodities. Our 
hearings gathered compelling evidence that excessive speculation in 
futures markets was a significant factor pushing up oil and 
agricultural commodity prices.
    Chairman Levin and Ranking Member Coburn have undertaken an in-
depth and exhaustive investigation of speculation by delving into the 
inner workings of the wheat market. The data and analysis they have 
presented make another compelling case that excessive speculation has 
caused our commodity markets to become unmoored from those who actually 
make their livelihoods using the underlying commodities, as well as 
consumers who pay the ultimate price.
    Last spring, Andrew Siegel, the owner of a bakery in Maine, 
testified before the full Committee that the dramatic increase in the 
price of the 50,000 lbs. of flour that he used per week from September 
2007 to February 2008 made it nearly impossible to operate his small 
business. He identified federal ethanol policies and excessive 
speculation as the major culprits.
    Our hearings demonstrated that massive new holdings of commodity 
futures by pension funds, university endowments, and other 
institutional investors appeared to be driving up prices. These 
investors' intentions may be simply to provide good returns and 
investment diversification, but many experts believe the size of their 
holdings are distorting commodity markets and pushing prices upward.
    To combat the effect that speculation has in our oil and 
agricultural commodity markets, I have introduced the Commodity 
Speculation Reform Act. This bill would limit the percentage of total 
contract holdings that non-commercial investors could maintain in any 
one commodity market and close the ``swaps loophole'' that currently 
allows financial institutions to evade position limits intended to 
prevent an investor from cornering a market.
    Although commodity market reforms must still be made, Congress has 
made important progress addressing another problem our hearings 
identified: inadequate funding for the Commodity Futures Trading 
Commission (CFTC). The CFTC is responsible for ensuring that the 
commodities markets provide an effective mechanism for price discovery 
and a means of offsetting price risks. But CFTC's workload has grown 
rapidly over the past decade as trading volume increased more than ten-
fold, reaching well over 3.4 billion trades in 2008. Actively traded 
contracts have grown by a factor of five--up from 286 in 1998 to 1,521 
in 2008.
    As the Ranking Member of the Appropriations Subcommittee for 
Financial Services, I joined with Chairman Durbin to increase funding 
for the CFTC to $177 million--an increase of 10 percent over the 
President's fiscal year 2010 request. This funding would provide CFTC 
with 21 percent more resources than last fiscal year. This additional 
investment will enable the CFTC to more effectively monitor the futures 
markets, analyze a vast amount of complex trading data, and more 
quickly respond to problems in the operations of the futures markets.
    I thank the Chairman and Ranking Member for their work in this 
area. It will help make the case for needed reforms.

    Senator Levin. Thank you so much, Senator Collins. Senator 
Tester.

              OPENING STATEMENT OF SENATOR TESTER

    Senator Tester. Chairman Levin and Ranking Member Coburn, 
thank you very much for having this hearing. This hearing is 
liable to be a lot of fun for me. I should explain. I am a 
farmer, an actively engaged farmer. Last Sunday I got the 
combine ready to go so this weekend we can start harvesting 
wheat, hard red wheat.
    For years, the neighborhood has been talking about the fact 
that the Chicago Board of Trade has been playing poker with our 
livelihood. So it is an issue that is very important because, 
as Mr. Wands says in his statement, grain is not an asset 
class, but--and I paraphrase--food. So it impacts consumers, it 
impacts family farmers and farmers of all type; it impacts the 
middlemen, too.
    I guess I would just say--and if you can answer this in 
your opening statement, I will not have to ask: Does supply and 
demand exist in a cash market? Or has the futures market 
distorted that supply and demand?
    What is the overall impact on the cash market of futures 
trading, if any?
    So, with that, I will save my questions until the end. 
Thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator Tester. Senator Bennet.

              OPENING STATEMENT OF SENATOR BENNET

    Senator Bennet. Thank you, Mr. Chairman. I would like to 
thank you and the Ranking Member for your leadership on this, 
and thank the staff as well for excellent work. The written 
materials for this hearing were among the most fascinating I 
have read in a long time.
    This issue is very important to my State. Farming is risky 
business. It is a notoriously thin margin the people in the 
food industry have, and it is not a business in which people 
enrich themselves or pay themselves large bonuses.
    I expect to hear a lot today about the value index traders 
have added to commodity markets by increasing liquidity and 
shifting risk off of farmers, processors, and end users. And 
while this is often true, in practice the written testimony 
that we read from traditional market users strongly suggests to 
me that it is harder to hedge risk today than it was 10 years 
ago. And that is what has my attention about the kinds of 
distortions that Chairman Levin talked about.
    So, Mr. Chairman, thank you for allowing me to make an 
opening statement, and thank you for holding this hearing.
    Senator Levin. Thank you so much, Senator Bennet. We 
appreciate both of those opening statements, and I am sorry I 
did not call on my colleagues for them. I sometimes get 
confused as to whether I am in the Armed Services Committee 
where our general practice is not to or our Subcommittee here 
where our general practice is to. So forgive me for that 
oversight.
    Now, Mr. Gensler, please.

TESTIMONY OF HON. GARY GENSLER,\1\ CHAIRMAN, COMMODITY FUTURES 
                       TRADING COMMISSION

    Mr. Gensler. Thank you, Chairman Levin, Ranking Member 
Coburn, Members of the Subcommittee. Thank you for letting me 
testify here today. I hope my written testimony can go into the 
record, and I will try to summarize as best I can and answer 
some of the questions.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Gensler appears in the Appendix 
on page 64.
---------------------------------------------------------------------------
    Senator Levin. All of the written testimony will be made 
part of the record. We will operate under a 10-minute rule here 
today, so try to summarize the best you can. When 10 minutes 
comes, I think you will be given a light, if that light system 
is working. Thank you.
    Mr. Gensler. All right. Thank you.
    The Subcommittee's report on excessive speculation in the 
wheat market is a very important contribution to the whole 
market's and the CFTC's understanding of the convergence 
problems in the wheat market. The wheat convergence problem is 
at the core of the CFTC's mission, that all commodities 
contracts, but particularly those tied to physical commodities, 
need to be able to be relied upon by producers, farmers, grain 
elevator operators, end users, and the bakery owner that the 
Senator referred to. Also, for hedging and price discovery, we 
seek fair and orderly markets that have a price discovery 
function coming together free of manipulation and fraud, but 
also free of the burdens of excess speculation.
    I would like to start this afternoon with a quick review of 
the lack of convergence, which was so well summarized in your 
report, but also talk about at least three of the factors that 
we think are part of this phenomenon; and then, second, talk a 
little bit about what the CFTC has embarked upon most recently, 
and some of the hearings that we have coming up on some of 
these very related topics; and then, last, talk a little bit 
about some of the recommendations in your report.
    In terms of the wheat markets themselves and the wheat 
convergence, you are absolutely right and your charts were very 
helpful. There has been a lack of convergence in the market, 
meaning that the futures price and the cash price are not 
coming together. And this is at the absolute core of the 
markets and has been so for well over a century, since corn and 
wheat started on the Chicago Board in the 19th Century. And it 
has failed to converge. There is progress based on the 
difference with the Toledo price. Your chart was Chicago, but I 
apologize I am using a different reference. The convergence 
problem got out to over $1 last year. It is now based upon some 
of the changes in the contract down to 80 cents in one spot, 
and some say it is a little bit better than that. But it is not 
satisfactory for the CFTC. We do not think this is enough 
progress, and we are going to be monitoring it very closely 
into the September contract, which is the next contract to come 
up.
    Three factors--I mean, many factors have been talked about 
in the marketplace, but there are three factors I would like to 
focus on today that we believe have contribute to this lack of 
convergence: one, the design of the contract itself; two, the 
influx, as you put it, of financial investors and index 
investors in the market; and, three, what I will call ``large 
carry,'' but I will talk about when this marketplace is at 
``fully carry.'' That means basically that the prices of the 
out or deferred futures contracts are higher than the earlier 
months.
    In terms of the design of the wheat contract itself, much 
has been addressed by your report and by the CME to try to free 
up more delivery capacity. If a contract in the futures market 
is structured in such a way that the cash market and the 
futures market can come together, then it is more likely to 
converge. Senator Coburn talked about West Texas intermediate. 
That contract has converged, and it has a different contract 
design than this contract.
    The recent changes by the CBOT in this regard to try to 
address the contract effectively is trying to say there is more 
places that the wheat can be delivered. They have more than 
doubled that to try to say that there are more places wheat can 
be delivered into the contract to bring convergence. But as we 
have noted, it has not happened yet.
    A second factor in the marketplace is what I will call full 
carry or large carry, and it seems that there are more problems 
in convergence when we get to full carry. What does this mean? 
It means that the earlier contracts--there are five contracts 
in a year, as the Chairman mentioned. But the earlier contracts 
are priced lower than the later-dated contracts. And if it is 
attractive to a financial investor to hold that later-dated 
contract because they can get more than their cost of money at 
the bank, their cost to carry, and more than the storage cost, 
then they are more inclined to keep that contract out. At least 
the statistics that we look at indicate that the convergence 
problem is higher during these full carry periods than 
otherwise.
    If you look over the last 20 or 30 years, the wheat market 
usually is not at full carry, meaning it usually is not 
attractive to pay the bank, pay the storage, pay the insurance, 
and keep it. We have been in a period of full carry. Is this a 
symptom or a cause? Is it a symptom, something that is 
occurring because of other factors, possibly the index 
investors? Or is it a cause? But it is certainly related to 
this.
    And then, third, I wanted to mention the relative size of 
this market. The Chicago contract is really a very small 
market, about $1.5 billion a year annual production, real 
farmers producing wheat. It is about $1.5 billion. It is only 2 
percent of the global production in wheat. However, this is a 
global contract that many investors are looking at and are 
looking to try to get exposure, to use a financial word, 
``exposure'' to this asset class. But it is real wheat. It is 
real farmers. It is only $1.5 billion of production.
    So the influx of index investors over this period of time 
has effectively taken about half of the long position. About 
half of the contracts are owned by effectively index investors. 
That is equivalent to about 3 years of annual production. So, 
on the shoulders of a very hearty Midwestern crop is placed the 
whole global financial markets trying to get exposure to wheat. 
And in all of the other markets that we follow--corn, soybean, 
crude oil, natural gas--this is the highest ratio with regard 
to the market. A little over half of the market is long index 
investing, and the ratio to the underlying annual production 
being over 3:1 gives you a sense of the magnitude that this 
small crop is sort of shouldering. I think all these factors 
relate to this lack of convergence.
    Now, with regard to the recent changes, as I said, these 
recent changes look directionally in the contract to be 
positive. We have an agriculture committee that advises us. We 
are looking at it very closely. We are going to keep a close 
eye on what happens in the September contract. But as I said, 
we at the CFTC are not satisfied with where this is.
    There are a number of other recommendations in the 
marketplace. Some were mentioned. Forced closeout, meaning that 
the grain that is in a delivery elevator or on a delivery point 
has to be actually delivered out to a future contract, is one 
alternative. Another alternative of moving the delivery points 
down the Mississippi closer to where the export market is. A 
third, which is used in Minneapolis, is called ``cash 
settlement.'' All three of these and others we think need to be 
considered and further looked at.
    We also believe broadly, more broadly to this circumstance, 
that we at the Commission should take a close look at all 
position limits for commodities of finite supply and look at 
the hedge exemptions that have been issued, really starting 
back in 1991. We publicly announced we are having hearings. We 
are having our first hearing next Tuesday, and then Wednesday, 
and then we have a third hearing the following week--where we 
have asked for a broad array of experts, probably from both 
sides of this debate, to come in and really talk to us about if 
we set position limits in the agricultural commodities, ought 
we not also set them for energy commodities? If we set them, 
shouldn't we really mean them? And how should we look at this 
bona fide hedging exemption, which initially, as Congress laid 
out and the Chairman noted, was for commercial hedgers, but 
after 1991 was widened out for other hedgers?
    We are looking forward to hearing from a broad array of 
witnesses, but we think that our statute clearly says that we 
shall set position limits to protect against the burdens that 
may come to markets from excess speculation. I look forward in 
our question-and-answer period to get further into that.
    We also think we need to work with Congress and work 
aggressively with Congress to bring the whole over-the-counter 
derivatives marketplace under regulation; that if we only do 
this in the futures market, money can travel to other markets. 
So not only do we need to bring over-the-counter derivatives 
under regulation to better protect the American public and 
enhance transparency, but we also need to bring aggregate 
position limits to the whole market structure.
    Mr. Chairman and this Subcommittee, in terms of the 
recommendations in your report, we are looking very closely at 
all the recommendations. As it relates to the hedge exemptions 
in the agricultural space, whether they be for the swap dealers 
or the no-action letters that you referred to, we are looking 
at those very closely. As I mentioned, the hearings next week 
are going to be very important to us as a Commission. But the 
individual exemptions and, particularly the no-action letter 
exemptions, say on their face that they were not consistent 
with the original intent of what a bona fide hedger is. I mean, 
they are financial investors, not directly commercial hedgers. 
We certainly would look forward to working with this 
Subcommittee about all of the recommendations, but the key 
recommendations on the hedge exemptions and no-action letters 
we are looking at very closely and will be taking up next week 
in our hearing.
    I think with that I am out of time and out of testimony.
    Senator Levin. Thank you so much, Mr. Gensler.
    We will have maybe 10 minutes for each of our questions on 
the first round.
    In your written testimony, you said the following: ``The 
continued lack of convergence in important segments of the 
wheat . . .''--this is page 1, third paragraph. ``The continued 
lack of convergence in important segments of the wheat market 
has significantly diminished the usefulness of the wheat 
futures market for commercial hedgers. The reduced ability of 
these firms to hedge their price risks increases the cost of 
doing business. Ultimately, it is the American consumer who 
will bear the burden of these increased costs.''
    Am I reading your testimony accurately?
    Mr. Gensler. Yes, I believe that convergence is at the core 
of our mission for a good reason. It is because we have to have 
convergence so that producers and grain elevator operators, 
millers, purchasers, and bakeries can hedge their risk, and 
then the American public benefits by that.
    Senator Levin. All right. And that the inability to hedge 
price risks increases the cost of doing business, and 
ultimately it is the American consumer who bears that burden?
    Mr. Gensler. Yes.
    Senator Levin. You have also in your written testimony said 
that, ``Hedging in the futures markets only works to the extent 
that the price of the commodity in the cash market and the 
price of the commodity in the futures market converge as a 
futures contract expires.''
    I just want to make that a clear statement, and I want to 
just make sure you stand by that statement.
    Mr. Gensler. I stand by it. It is my written testimony.
    Senator Levin. All right. I want to put some focus on that 
written testimony.
    Now, will the CFTC, as part of its review, look at the 
question of whether or not commodity index trading constitutes 
excessive speculation in the aggregate so that position limits 
should be restored for derivative dealers?
    Mr. Gensler. The Commodity Futures Trading Commission is 
going to look at position limits across all classes of 
speculators. Our statute is set up in such a way that under the 
provisions, we are supposed to look at this and only exempt 
bona fide hedgers. So we will be looking at it not only for 
index investors and exchange-traded funds and exchange-traded 
notes, but also for swap dealers and across the broader class 
of speculators in financial markets.
    Senator Levin. Now, our Exhibit 3 \1\ and your reference to 
Toledo both show that the gap between futures and cash prices--
in other words, the basis--has grown dramatically in the last 5 
years--on our chart from 13 cents to $1.53. In your testimony, 
referring to the Toledo situation, the gap has gone during the 
same period from 5 cents to $1.07. Is that correct?
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    \1\ See Exhibit No. 3, which appears in the Appendix on page 427.
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    Mr. Gensler. That is correct, sir.
    Senator Levin. In our case, it is a 13-fold increase in 4 
years; with your material from Toledo, it is a 21-fold increase 
in 4 years. So even though the dollar amount may be somewhat 
less, $1.02, compared to the Chicago futures prices and cash 
prices in our report, which is $1.53, the percentage increase 
is actually greater in Toledo than it is in Chicago.
    Mr. Gensler. Both point to the same problem.
    Senator Levin. All right. And that is the problem that we 
want to focus on and are glad that you are focusing on. Our 
report concludes that the increase in the number of futures 
contracts from 30,000 contracts in 2004 to 220,000 contracts in 
2008 has created this additional demand for futures contracts 
unconnected to and without parallel in the cash market. Would 
you agree with that? In other words, there is no increase in 
the cash market that equals that increase in the futures 
market?
    Mr. Gensler. That is correct, sir. The annual production 
and the number of millers and bakers and buyers are generally 
about the same. That is correct.
    Senator Levin. Now, are the demands of the derivative 
dealers for futures a significant cause of the increased number 
of futures contracts which are out there? We estimate it is 
about 45, 50 percent now in the futures market that is demand 
by the index investors. Do you have a percentage? Or do you 
disagree with our percentage that about half the market is now 
those index investors?
    Mr. Gensler. We are looking at the same data. About half of 
the current market--I mean, it fluctuates, but about half of 
the current futures outstanding right now is in this long index 
investors or swap dealers who are intermediating for the index 
investors.
    Senator Levin. As to the issue of price convergence, a 
competing theory which has been offered for why there is a lack 
of price convergence is that the Chicago wheat contract is 
flawed. It makes delivery too difficult, allows holders of 
wheat to hang onto wheat too easily, and charges too little for 
storage.
    Isn't it true that for most of the last 5 years, at least, 
the same wheat contract has been in place?
    Mr. Gensler. It is true. I do think that some of those 
design problems in the wheat contract make this market far more 
susceptible to these problems. These problems occur more when 
we get into a period of what I earlier called ``full carry'' as 
well. So if there was a perfectly blue sky out, everything was 
shiny, maybe you would not see as much of a convergence 
problem. But there is a problem in the design of the contract 
and we get into these periods of full carry, we see this far 
more aggravated.
    Senator Levin. Do you believe that the dramatic increase in 
commodity indexed trading and the futures which are purchased 
to hedge against a risk, has played a significant role in the 
failure of convergence?
    Mr. Gensler. I think, Mr. Chairman, that it is part of the 
role.
    Senator Levin. Would you say it is a significant part?
    Mr. Gensler. I would like to stay with, I think, it is a 
contributing factor to this.
    Senator Levin. And how much it contributes, are you going 
to let us know after some study is completed or what?
    Mr. Gensler. Mr. Chairman, I think that we have to work to 
get the design of the contract better. We are watching that 
very closely. I also believe that we are going to take and use 
every authority we have currently, looking at position limits 
and hedge exemptions. So we are not actually separately 
studying whether it is a 5-percent contributor or a 75-percent 
contributor. We do think that in these market environments of 
full carry and with this contract design, it has been a 
contributing factor.
    Separate from that, we think that our authorities are such, 
the Congress said in the 1930s that we shall set position 
limits, and we should go about that job to help protect against 
the burdens that can come from excess speculation.
    Senator Levin. And when are you going to be deciding 
whether to carry out that mandate--in other words, remove the 
exemptions, remove the waivers? When are you going to be making 
a decision on whether you will be doing that?
    Mr. Gensler. We are going to do it through this process of 
the hearings. We have three hearings set for the next 2 weeks, 
and then based upon those hearings, we have a Commission 
process. There are four of us now on the Commission, and we 
will work through that in as expeditious a manner as we can.
    Senator Levin. Do you expect that decision will be made by 
the fall?
    Mr. Gensler. I would hope so, but also I recognize I have 
four commissioners and I have to count votes and work through a 
very complicated matter. And as you rightly noted, it has been 
since 1991 that these exemptions have been in place in many 
instances.
    Senator Levin. The position limit that you have in effect 
prohibits traders from holding more than 6,500 contracts at a 
time, and that is designed to prevent excessive speculation. 
But the exemptions and the waivers have created some real big 
loopholes in that.
    In response to our questions, CFTC told us that it had 
granted exemptions to four derivative dealers selling swaps, 
and it provided no-action letters to two fund managers, which 
together would allow these six entities to hold up to 130,000 
wheat contract instead of the 39,000 which would be allowed if 
that standard limit of 6,500 contracts at any one time had 
applied.
    Now, in its prepared settlement, the CME tells us that the 
number of exemptions is really much larger. They have granted 
exemptions to 17 entities selling commodity index swaps and 
allowed them to hold up to 413,000 wheat contracts at a time. 
They have also said in their prepared statement that, prior to 
being approved by the CME, all index traders were required to 
receive prior CFTC approval. The CME did not grant any 
exemptions to index traders that the CFTC had not already 
granted.
    So there seems to be a difference there. Your testimony is 
that six entities allowed to hold up to 130,000 wheat 
contracts, but the CME says 17 entities allowed to hold up to 
413,000 wheat contracts, and I am wondering why those numbers 
are so different.
    Mr. Gensler. Mr. Chairman, I believe that the exemptions 
you referred to that are in the CME testimony refers to 15 
parties that have various hedge exemptions dating back 
sometimes 18 years, and these two no-action letters, 
approximating 400,000 contracts in aggregate. I believe that is 
an accurate figure.
    In the Subcommittee's report, I believe that it is a 
slightly narrower question, which was just those granted 
explicitly for index investing. So I believe the 130,000 in 
your report, which is just a subset of the total 400,000, but I 
believe approximately 400,000 is an accurate figure for all 
hedge exemptions in this category.
    Senator Levin. All right. Again, I would say that in their 
prepared statement, prior to being approved by CME, they say 
all index traders were required to receive prior CFTC approval.
    Mr. Gensler. Well, all hedge exemptions, whether they were 
explicitly for index trading or for other reasons, for 
agricultural do get CFTC exemptions, as opposed to crude oil 
which is done by the exchanges.
    Senator Levin. Thank you very much. Dr. Coburn.
    Senator Coburn. Isn't the real reason that there is no 
problem with price convergence in Cushing, Oklahoma, is because 
if you have your name on that barrel of oil, you better be 
there in Cushing because delivery is going to happen?
    Mr. Gensler. Senator, you are correct that is one of the 
design features. It is in essence a forced load-out, so to 
speak.
    Senator Coburn. So delivery does have a lot to do with some 
of this lack of convergence?
    Mr. Gensler. Yes.
    Senator Coburn. Explain to me the history of why we went 
from 5,000 to 6,500 contracts.
    Mr. Gensler. Though I was not at the Commission at the 
time, the earlier look at this was--setting position limits for 
agricultural commodities was a concept to ensure that we have 
at least a minimum number of participants in a market and a 
diversity of speculators and diversity of points of view. And 
so the Commission set them so that no one trade could have more 
than 10 percent of the first part of the market, the first 
25,000 contracts, and 2.5 percent of the rest.
    I believe that back then it was raised from 5,000 to 6,500 
just because the overall market had grown. So it was trying to 
use percentage limits but adapt it for a larger market.
    Senator Coburn. And you testified earlier that this market 
really had not grown in terms of the actual wheat coming into 
it over the last 10 years, essentially, in terms of raw product 
available for the contracts?
    Mr. Gensler. Yes, I believe the question was the last few 
years. I do not know about the last 10 years.
    Senator Coburn. OK, so the last 5 years. So it would seem 
to me that if you have the same amount of wheat coming in and 
now 50 percent of the contract purchases are by people who are 
not commercial--they are not end users, they are not what we 
would consider the traditional use of a commodity exchange to 
hedge or plan, it would seem to me that there is no question 
that there is a direct relationship of index funds and the 
long-held positions that would account for some of this non-
convergence. Would you agree with that?
    Mr. Gensler. Well, I think they are a contributing factor 
to it, and as I said, the CFTC I believe earlier was just 
looking that the overall market for the futures--not the cash 
but the futures had grown and was trying to keep up with that 
in moving that from 5,000 to 6,500.
    Senator Coburn. So let us talk about corn then. Has the 
overall number of contracts on corn grown?
    Mr. Gensler. I would probably have to get back to you on 
the exact dates and times on the corn.
    Senator Coburn. But there is no question we are planting a 
heck of a lot more corn in this country because we, in my 
opinion, have foolishly said we are going to use it for 
petroleum. But we do have more corn that is out there and more 
contracts, right?
    Mr. Gensler. I do not have the exact figures in my head as 
to the number of contracts----
    Senator Coburn. You came prepared for wheat today. I 
understand.
    Mr. Gensler. I apologize. I can get back to you just on the 
number----
    Senator Coburn. What I am trying to say is there is corn, 
there is soybeans, and there is wheat. You talked about this 
$1.5 billion worth of dollars in wheat. I know there is a whole 
lot more than that in corn, and we have had a tremendous 
stimulation to the production of corn. And so why aren't we 
seeing similar problems with corn? Because I know there is 
index funds on corn as well.
    Mr. Gensler. Right. Senator, I do believe the corn market 
and the corn futures market, both cash and futures, are much 
larger than wheat. And in wheat, we actually have on the 
Chicago market just 20 percent of U.S. production because we 
also have Kansas City, which is more related to Oklahoma. We 
have Minneapolis, which I think is probably more related to 
your home State; whereas, in corn, it has a very different 
contract design, much larger market. So index investors are a 
much smaller percentage of the open futures interest in corn 
just because the corn cash and futures market are much larger.
    Senator Coburn. And there is much less of a problem with 
convergence in those markets.
    Mr. Gensler. There has been some convergence issues, much 
smaller in corn or in soybean.
    Senator Coburn. Right, OK. How aggressive should Congress 
be--and this is opinion, and I am not going to hold you to it, 
but I would like to have your opinion because you are sitting 
there as the head of the CFTC. How aggressive should we be in 
going after this versus letting you under your authority try to 
fix this problem?
    Mr. Gensler. I think this is a partnership with Congress. I 
think that there are many things we can do under our current 
authority, but there are many areas where we need help, as 
Senator Collins said earlier. We need help with resources, and 
we thank you very much for that recent vote in the 
Subcommittee. But we also need a great deal of help in terms of 
setting aggregate position limits and bringing reform to the 
over-the-counter derivatives marketplace.
    I think within our current authority we can address 
position limits for futures, both in the agricultural and 
energy space, and there will be a great deal of debate, and 
that is why we are having these hearings. I do think our 
authority is very clear that we can do this in the futures 
market, but we do need your help to make sure that then money 
does not flow elsewhere and that we just push it into a opaque 
or offshore market.
    Senator Coburn. Right. That is a concern that I have 
because I think if we become too restrictive here, the invested 
capital goes somewhere else.
    Senator Levin mentioned the price of oil and speculation on 
that. Is there any doubt in your mind on the effect of index 
funds on oil price. And this is for education. I am not trying 
to score a point. I am just trying to get educated. Do you 
think that they--when we had $140 a barrel----
    Mr. Gensler. I think, Senator, that we had a worldwide 
asset bubble in a lot of classes of assets. We saw it in the 
housing market, and the American people was hurt by that. But 
we also had an asset bubble that peaked in June 2008 in many 
commodity classes, not just wheat and corn but also oil and 
natural gas. That asset bubble had a lot of reasons, but part 
of it was financial investors thinking, all right, this is an 
asset class, just like I invest in stocks or invest in bonds or 
maybe emerging market stocks; we should move X percent into 
energy markets.
    And so I think it was a contributing factor, but there are 
many factors in the overall energy market.
    Senator Coburn. Do you think the double-down and double-up 
index funds that are double-hedged have any extra contribution 
to some of the phenomenon we have seen?
    Mr. Gensler. I am not sure I am familiar with the double--
--
    Senator Coburn. Well, like DXO, for example. That is one on 
oil, which is a double-up. For every point you get up, you get 
twice as much. In other words, it is doubly hedged.
    Mr. Gensler. Oh, I see, yes.
    Senator Coburn. Do you think those have any impact at all 
on price swings? Do you think the average investor who is being 
told to invest in an index fund has any idea about what the 
risks associated with that are?
    Mr. Gensler. I think the category that you named is just 
part of the broader phenomenon of asset investment that 
particularly when there are swings, when there is a swing in 
mood.
    Senator Coburn. Volatility.
    Mr. Gensler [continuing]. That it could bring in. In terms 
of the average investor--and certainly this is something, I am 
sure, that the SEC and Chair Schapiro and I will look at, too--
I think exchange-traded funds can be a very good product when 
well understood by an investor in the stock market or even in 
the bond market. As for exchange-traded funds in the commodity 
markets, it is still open to me whether investors fully 
understand the high fees and the transaction costs because 
every one of these funds has to constantly roll their positions 
trying to chase to stay even with the underlying assets.
    Senator Coburn. A couple of the things that you have 
described in your testimony, solutions that might be possible--
compelled load-out, changing delivery location to the Gulf, 
adding a new contract which is cash-settled. What are the 
potential unintended consequences if you were to do that? Have 
you thought through that? And could you discuss those with me? 
For example, shifting to the Gulf, what are the unintended 
consequences in the market if that were to happen?
    Mr. Gensler. Senator, on each one of them, there are pros 
and cons and would have to actually be decided by the exchange 
themselves rather than the CFTC. We have included them in my 
testimony, to highlight there are alternatives. And we have an 
agriculture committee that advises us on these as well.
    Frankly, there are always winners and losers when you move 
a delivery point because the basis starts to shift between the 
cash and the futures market. So in that example, you can move 
down the Gulf, where most of the export market is and so forth. 
Originally the export market was off the Great Lakes if we go 
back decades. That is why the delivery points were close to 
Chicago. But as more of the export market has moved down the 
Mississippi, that is why some people have recommended that. But 
there would be some winners and losers.
    Senator Coburn. Farmers in Oklahoma during this phenomenon 
in 2008 wanted to sell their crops and could not because the 
grain elevators could not because everybody was blocked out. 
Everybody in agriculture lost. The question is: Who won?
    Mr. Gensler. Not the American consumer.
    Senator Coburn. The American consumer did not win, but the 
American farmer sure as heck did not win either.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you, Dr. Coburn. Senator Tester.
    Senator Tester. Yes, I would like Exhibit 5 put up,\1\ and 
I would assume, Mr. Chairman, is this a real example or is it 
just a projected example?
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    \1\ See Exhibit No. 5, which appears in the Appendix on page 429.
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    Senator Levin. Projected.
    Senator Tester. It is a projected example.
    Senator Levin. Yes.
    Senator Tester. OK. Kind of following on what Senator 
Coburn had to say, because the previous chart had a triangle 
where they converged. They both went down to $3. The futures 
fell quicker than the cash price did. Who loses when there is 
no convergence?
    Mr. Gensler. I think a lot of people lose when there is not 
convergence.
    Senator Tester. Is it the farmer that loses? Is it the 
investor that loses? Who loses?
    Mr. Gensler. The farmer and anyone in the physical 
commodity chain has less confidence in an ability to hedge 
their risk and less confidence in the underlying price 
discovery.
    Senator Tester. OK. That is assuming the farmer hedges.
    Mr. Gensler. It does, but if the farmer does not have 
hedging available to them, they are then bearing the risk.
    Senator Tester. OK. So I guess what I am asking is, Is it 
the investor that loses there, or is it the farmer because this 
artificially depresses cash prices?
    Mr. Gensler. What it goes to, to at least me, Senator, is 
the reliability of the price discovery in the market itself in 
that it becomes less reliable. To some farmers, they would say, 
rightly, the future is $2 more. Shouldn't I get $2 more for my 
blood, sweat, and tears and all my inputs?
    Senator Tester. Right.
    Mr. Gensler. And that is a very valid question, and some 
farmers would not even use the contract because they would say 
it does not work.
    Senator Tester. OK. And you do not need to bring the 
previous one up because you can imagine it. The previous one, 
the cash price still went to $3, which I think is an accurate 
example at some point in time. So the cash price, which is the 
market I sell on, there is no change. The change here is that 
the futures contract did not fall down to the price of the cash 
price. And so as a farmer who does not hedge, it is still $3 a 
bushel. Who loses on that? Somebody has got to lose because if 
there is not a loss with convergence, what is the negative?
    Mr. Gensler. You are saying when it does converge?
    Senator Tester. When it does not converge.
    Mr. Gensler. Does not?
    Senator Tester. I get it when it converges. When it does 
not converge--convergence is where you want to be. If you do 
not converge, what is the real problem here? Is there a problem 
or is it just a fact we do not converge?
    Mr. Gensler. I believe it is a problem because the design 
of these contracts are that you can actually deliver, maybe 
not--maybe you would be the farmer that did not deliver, but 
that some farmer can put it in a vehicle or put it on a barge 
and actually physically deliver it.
    Senator Tester. So these future contracts are based on real 
grain. You are not going to have more future contracts than you 
have grain available.
    Mr. Gensler. There is supposed to be an ability to deliver 
into a futures contract, and even if there were more futures 
than there was grain, then anybody who has grain who meets the 
certain quality standards can deliver that grain into the 
future. You should be able to collect that $2 if you were 
willing to transport the grain to the delivery point.
    Senator Tester. OK. Let us talk about the design that 
controls better, which is one of the solutions you talked 
about, and Dr. Coburn said the world is flat, and he is 
probably right. If you design your contracts better, what would 
stop them from going to Europe or China--I do not know where 
these contracts are sold, but I assume they are sold other 
places--or Canada, other places than just here where they do 
not have as strict of controls? Or are the controls in place in 
all those other countries and they do not have this kind of----
    Mr. Gensler. We actually have the world's majority share of 
trading of futures on wheat contracts. There is Kansas City, 
Minneapolis, and Chicago, the three big ones. It is well over 
half. I cannot recall the exact statistic.
    Senator Tester. Does the convergence problem exist in the 
other parts of----
    Mr. Gensler. No. The convergence problem is big in Chicago. 
One of the things that is unique in Chicago is that market--
which is only about 20 percent of the U.S. production--is the 
bellwether. That is the benchmark for a lot of historical 
reasons that had to do with Chicago's dominance over Kansas or 
Minneapolis in terms of----
    Senator Tester. I understand that.
    Mr. Gensler [continuing]. Risk capital.
    Senator Tester. Can you speak to foreign markets where they 
sell futures contracts? Is there a convergence problem there?
    Mr. Gensler. No, I am not aware of one, but maybe other 
experts could tell you later. I am not aware of a convergence 
problem there. It is really in the Chicago Board of Trade 
contract.
    Senator Tester. OK. What impact, if any, do price supports 
from the Federal Government have on futures?
    Mr. Gensler. I think that all economic factors--including 
price supports from the Federal Government and others--affect 
both cash and futures markets.
    Senator Tester. I will get to that in a second.
    Mr. Gensler. But I will try to address it now. I think that 
cash and futures are very linked. They should converge at the 
time of expiration. In grain markets as well as oil markets, 
the two relate. So any economic factor, whether it is Federal 
Government driven or elsewise, will affect both futures and 
cash markets, and particularly the outward dated ones.
    Senator Tester. Does supply and demand exist in the wheat 
markets?
    Mr. Gensler. I believe that supply-and-demand factors are 
very important in the wheat markets.
    Senator Tester. OK. That is good enough. So--and it was 
about 16 months ago--the price of wheat--and Senator Coburn was 
correct, the elevators would not buy it. But on their board 
they had somewhere around $18 to $20 a bushel, depending on 
what kind of quality you had. Now that same wheat is probably 
worth a third to 40 percent of what it was then.
    That difference in the marketplace--and it is a difference 
that Senator Collins talked about her baker. I mean, that is 
why it went up. It went up at the farm gate, which, quite 
frankly, I love, but I do not like to see it go up and down 
crazy. We like some consistency. And if the futures market 
forced it to go up and was part of the impacts that forced it 
to go up--which I believe it was; I think it was much more than 
supply and demand in that particular case.
    Do you think that the three things that you talked about to 
change will solve that problem? And ultimately, in the end, 
what impact do you think that those three things will have on 
the cash price of wheat to the farm gate?
    Mr. Gensler. I think if the exchanges decided to do it by 
moving delivery points or forced load-out or this cash-settled 
contract, we would have convergence between the cash and 
futures market for sure. I think that those three things would 
lead to convergence.
    The cash prices ultimately are tied, as you said, to 
supply-and-demand factors, but related to futures, they would 
be somewhere in between. I cannot predict, out of the 80 cents 
of lack of convergence now, whether it would be closer to the 
current cash price or closer to the current futures price, but 
obviously somewhere between that 80-cent spread.
    Senator Tester. To be clear, I am not sure the price does 
reflect supply and demand, to be clear, because quite honestly 
there are a lot of things that--I mean, if you get rain in 
Kansas, the price of wheat can drop, and nobody knows that that 
is going to increase production an ounce at that point in time.
    Mr. Gensler. Right.
    Senator Tester. Just for my information--6,500 futures 
contracts, how many dollars are in a futures contract? What 
kind of money are we talking about?
    Mr. Gensler. Well, it is not much because a futures 
contract is 5,000 bushels.
    Senator Tester. You are talking 325,000 bushels.
    Mr. Gensler. Right, times $3 to $4, so it is about $1 
million.
    Senator Tester. OK. And how many of these folks are out 
there trading this? How many traders are out there, do you 
know? How many of these 6,500-bushel contracts are out there? 
How many people are eligible to trade up to 6,500 futures 
contracts?
    Mr. Gensler. All the participants in the market are 
eligible to trade up to the 6,500 contracts.
    Senator Tester. So I could do it if I wanted to.
    Mr. Gensler. Yes. There are these exemptions that were 
previously referred to. Fifteen parties have hedge exemptions, 
and then there are these two no-action letters. I believe only 
eight or nine of them are currently over their limits right 
now.
    Senator Tester. OK. I appreciate your being here, and I 
appreciate your answering the questions. I, quite frankly, am 
like probably most people; I do not understand this. In fact, I 
do not understand it so bad that 22 years ago I got out of the 
conventional grain market because I did not want to have to put 
puts and calls and all that garbage. I just wanted to raise 
wheat and sell it for a reasonable price.
    And so I made some conversions in my operation, but what I 
will tell you is this: If you can do things in the marketplace 
to stop artificially inflating or artificially deflating the 
price of wheat--and I am much more concerned about the latter 
than the former--you have been successful. Thank you.
    Mr. Gensler. Thank you, Senator.
    Senator Levin. Thank you, Senator Tester. Senator Collins.
    Senator Collins. Thank you, Mr. Chairman.
    Senator Tester, are you telling us that it is easier to be 
a U.S. Senator than to be a wheat farmer?
    Senator Tester. I go back every weekend because it is much 
easier to be a farmer. [Laughter.]
    Senator Collins. Mr. Gensler, let me ask you a basic 
question. Why does the CFTC set position limits for 
agricultural products but allow the exchanges to decide whether 
or not there should be position limits for energy products, 
like oil?
    Mr. Gensler. Senator, I am trying to figure that out 
myself. It is a lot of history before us. We were originally 
set up in the Great Depression, our predecessor was, and we set 
agricultural limits. When the oil products started trading in 
the late 1970s, there was a deference to the exchanges to do 
it. There are some agricultural products, like livestock, where 
there is also deference to the exchanges.
    What is clear to us in terms of our legislative history, is 
that the exchange's only responsibility is to protect against 
what is called manipulation and congestion, and they only set 
position limits for the last 3 days of the spot month for oil 
products.
    We have a responsibility under our statute to set position 
limits to protect against the burdens that may come from 
excessive speculation, this concept of making sure there is a 
minimum number of players in a marketplace. So we are going to 
look very actively through the hearings and hopefully post the 
hearings at possibly setting position limits for energy futures 
as well.
    Senator Collins. I certainly hope that you will. I do not 
think it makes sense--even though I have great respect for the 
exchanges--to delegate that authority. It does not make sense 
to me that for most agricultural products the Commission is 
setting the position limits, but when it comes to energy 
products, it is left up to the exchanges.
    Do you need legislative authority to set position limits 
when it comes to oil products, or do you already have 
authority?
    Mr. Gensler. I believe that we have ample authority to do 
it with regard to futures. As it relates to swaps and over-the-
counter derivatives, we would have to work with Congress to get 
that authority.
    Senator Collins. Well, I certainly want to give you that 
authority.
    I want to go back to some testimony you gave. I believe you 
said that the index traders, the non-commercial traders, 
because of waivers and no-action letters may have held up to 60 
percent of the outstanding wheat contracts. Is that accurate? 
Did I understand that?
    Mr. Gensler. Currently the index investors through swap 
dealers have about half of the market. It has ranged from as 
low as 35 percent to about 55 percent in the last number of 
contracts, but yes.
    Senator Collins. So that is a huge influence on the market. 
And did that come about because of the exemptions that the 
Commission started granting in 1991 to the 6,500 wheat futures 
contract limit?
    Mr. Gensler. I think it was certainly facilitated by that, 
but I think the index investment came about in large part 
because there was a change of focus, maybe even philosophy, 
about 4 or 5 years ago that commodities were an asset class. 
Though some parties used to invest, it dramatically took off 
around 2004 and 2005. Your earlier reports have shown this in 
the oil markets as well and so forth.
    Senator Collins. It is my understanding that the exemptions 
permitted four of the swap dealers to exceed that limit, so 
instead of being held to 6,500, one was 10,000, one was 17,500, 
one was 26,000, one was 53,000, and then there were two no-
action letters that allowed an index-related exchange fund to 
hold up to 11,000 contracts, and another fund manager to hold 
up to 13,000 wheat futures contracts.
    I do not know what the right number is for a position 
limit. I do not know whether the recommendation of PSI that it 
return to 5,000 is correct or whether 6,500 is correct. And I 
would look to the Commission to set the right level.
    But I am concerned if index funds are not held to the same 
level that everyone else plays by and if there is a difference 
in the levels for commercial traders versus non-commercial 
traders.
    Is there a reason that there should be a different limit?
    Mr. Gensler. Again, Senator, I am finding myself in vast 
agreement with you and the Chairman on these matters. The 
reasoning in the past was that the index investors or the swap 
dealers were hedging a financial risk, not necessarily a strict 
commercial risk tied to the ownership of grain. They were 
hedging a risk of inflation, that if they invested in 
commodities, they were somehow hedging their financial risk 
rather than a strict product or merchant risk.
    Senator Collins. The problem is if it has an impact on the 
market as a whole. I understand that the index funds are just 
trying to do their fiduciary duty and get as good a return as 
possible. But I am concerned about what the impact is of this 
massive influx of funds and the number of contracts that are 
held by non-commercial traders.
    Mr. Gensler. Yes, and, Senator, I think that there is a 
very strong logic that whatever position limits we have be 
consistently applied across the markets; and whether they are 
at 6,500, as you said, or some other number. If we move forward 
in the oil space, we should find a consistent approach that 
makes these markets work to the benefit of the American public 
and ensure that they are fair and orderly and that we do 
protect against some burdens of the excess outsized positions.
    Senator Collins. Exactly. And that is what I think we 
should do, vest in the Commission, if you need additional 
authority, to directly set those position limits in both 
agricultural futures markets and the energy futures markets, 
and then it seems to me they should be the same for all 
players. And that is what I would like to encourage you to take 
a look at.
    I want to switch to another issue. Last year, we had a lot 
of discussion about closing what is known as the ``London 
loophole,'' and it is my understanding that this is the 
loophole that allowed traders to trade U.S. oil futures 
contracts on a foreign exchange without facing the same sort of 
position limits that they would on an American exchange. And, 
typically, I believe this activity took place on ICE in London, 
and there were various bills that we introduced to ``close the 
London loophole.''
    What the Commission did at about that same time is to enter 
into an information-sharing agreement with the U.K. regulator, 
the Financial Services Authority. But I am told that earlier 
this month--it was supposed to allow for better information 
sharing, and transparency--but I am told that earlier this 
month there was an incident that has caused many people to 
question the adequacy of that information-sharing agreement.
    Specifically, it is my understanding that earlier this 
month PVM Oil Futures Limited, a London-based oil brokerage 
firm, admitted that one of its traders had been able to 
artificially cause the price of crude oil to spike by 2 percent 
in just 1 minute, and that this information was not conveyed 
promptly by the FSA, the British regulator, to the Commission.
    What is your reaction to that incident?
    Mr. Gensler. The incident that you are referring to, I will 
call it a ``rogue trader'' at this broker in London on the 
Brent crude contract, not on the WTI but the Brent crude 
contract. We actually were informed by the FSA within a number 
of hours. I do not know if it was a half a day because there 
are some time differences and so forth, but I did see that 
report in the Financial Times on London. I do not know what it 
was referring to because it was not maybe in an hour, but it 
was certainly within half a day or so that we knew about it.
    I think on the more substantive point, what we were able to 
do last year as a Commission is to make sure there is 
information sharing. We announced just 2 weeks ago that we are 
going to include in our Commitments of Traders report, in our 
weekly trading report of all the large trader positions on the 
West Texas Intermediate and other linked contracts of ICE. They 
are also subject to position limits as of last year. We are now 
looking at what other gaps might be remaining between our 
current regime with ICE and if there is anything further, 
again, to best protect the American public. The information 
sharing is going to be pushed out into the Commitments of 
Traders report, and they are actually committed and subject on 
the linked contracts to be within our position limit regime.
    Now, I say ``our position limit regime.'' We have not set 
position limits yet. But if we were to set position limits, we 
would set it both on NYMEX and the ICE contracts.
    Senator Collins. Thank you. Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator Collins. And we 
would be asking you to let us know what your position is on 
that legislation to close the London loophole for the record, 
if you would.
    Mr. Gensler. I would look forward to doing that.
    Senator Levin. I have a few additional questions for you, 
and then Senator Collins may have some. Then we will move on to 
the next panel.
    We recommend in our report that the CFTC phase out all of 
the exemptions and waivers that have been granted to commodity 
index traders and to reinstate the 6,500 limit for them. Do you 
believe that you currently have the authority to take that step 
should you decide to do so?
    Mr. Gensler. I think that we have the clear authority to do 
it as it relates to the two no-action letters. Right on the 
face of it, they do not qualify for the bona fide hedge 
exemption. As it relates to all of the hedge exemptions, the 
other 15, I think that we have the authority, but those were 
issued under rules of the Commission, and so it takes a 
different process and approach, and----
    Senator Levin. It would take a rulemaking?
    Mr. Gensler. Probably.
    Senator Levin. All right. But you have the authority, 
should you decide to issue that rule?
    Mr. Gensler. Well, I am going to have to ask my general 
counsel--which I should be thanking you for, by the way, that 
Dan [Berkovitz] joined us at the Commission.
    Senator Levin. He looks very happy where he is at. Can you 
find out whether or not he believes that authority exists?
    Mr. Gensler. He said he will do it for us, and we will get 
back to you. I believe we do have it, but if there are any gaps 
in that, we will be asking for your help on that.
    Senator Levin. All right. Exchanges typically charge a 
transaction fee and a clearing fee for each commodity trade 
that takes place on the exchange or is cleared. So, naturally, 
the exchanges do not want limits that are going to reduce their 
fee income.
    Now, is that an economic consideration that you will be 
taking into account in your review?
    Mr. Gensler. No.
    Senator Levin. Finally, let me give you this series of 
questions that are linked together. You said that the major 
influx of derivative dealers or index traders have contributed 
to the failure of convergence. You have told us that this 
afternoon.
    You have told us, I believe, that the lack of convergence 
hurts people who want to hedge, such as elevators. Are you with 
me so far?
    Mr. Gensler. Yes. That is a ``yes'' to both of those.
    Senator Levin. All right. Now, if elevators are hurt, 
because they cannot effectively hedge, is it fair to say that 
farmers who deal with those elevators would also be hurt?
    Mr. Gensler. Yes. I believe that farmers, merchants, anyone 
down the production line who cannot hedge is left with the risk 
that then they do not have as good an opportunity. This is at 
the core of these markets to make sure that farmers, merchants, 
elevator operators, and even ultimate purchasers can hedge 
their risk and make their own economic choices whether to hedge 
or not to hedge.
    Senator Levin. All right. Now, some have said that if you 
imposed standard position limits on commodity index traders, it 
will not be effective because they are going to get around the 
limit by setting up new subsidiaries to engage in commodity 
index trades. Should you decide to impose the standard position 
limits, what is your response to that argument--that you could 
not do it if you wanted to, they will just get around it?
    Mr. Gensler. I think that they need to be set at the 
control or legal entity position. I would also say that we need 
to work together on the over-the-counter derivatives 
marketplace. If we set them in the futures marketplace, we have 
to be cognizant that some trades will just move over there to 
the over-the-counter derivatives marketplace.
    Senator Levin. Thank you very much.
    Mr. Gensler. Thank you, Mr. Chairman. Thank you, Senator 
Collins.
    Senator Levin. We appreciate very much your testimony. 
Thanks.
    I would now like to welcome our next panel to this 
afternoon's hearing. First, Thomas Coyle, who is the Vice 
President and General Manager of Nidera Inc., and the Chairman 
of the National Grain and Feed Association.
    Hayden Wands, who is the Director of Procurement at Sara 
Lee Corporation and Chairman of Commodity and Agriculture 
Policy at the American Bakers Association.
    Mark Cooper, who is the Director of Research for the 
Consumer Federation of America.
    And Steven Strongin, Head of the Global Investment Research 
Division of Goldman Sachs Group.
    We very much welcome you. We appreciate your cooperation. 
As you heard before, pursuant to Rule VI, all witnesses who 
testify before this Subcommittee are required to be sworn, so 
at this time I would ask all of you to please stand and to 
raise your right hand. Do you swear that the testimony you will 
provide this Subcommittee will be the truth, the whole truth, 
and nothing but the truth, so help you, God?
    Mr. Coyle. I do.
    Mr. Wands. I do.
    Mr. Cooper. I do.
    Mr. Strongin. I do.
    Senator Levin. The timing system is, again, a 10-minute 
timing system. I guess we are going to ask for 7 minutes on 
this one because we have four witnesses on this panel, so let 
me try a 7-minute round for your oral testimony. Your entire 
statement will be made part of the record, and we will first 
call on Mr. Coyle.

   TESTIMONY OF THOMAS COYLE,\1\ VICE PRESIDENT AND GENERAL 
  MANAGER, CHICAGO AND ILLINOIS RIVER MARKETING LLC, NIDERA, 
    INC., AND CHAIRMAN, NATIONAL GRAIN AND FEED ASSOCIATION

    Mr. Coyle. Thank you, and good afternoon, Chairman Levin. I 
appreciate the opportunity to testify today, and I congratulate 
you on the recent publication of a very interesting and 
insightful report about the U.S. wheat markets. We believe this 
extensive report looks at futures markets from a new 
perspective. We agree strongly with the key conclusions and 
believe it is critical that steps are taken to correct the 
imbalances documented in the report.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Coyle appears in the Appendix on 
page 71.
---------------------------------------------------------------------------
    That said, we believe there are actions that can be taken 
to achieve this goal before implementing a restriction on 
trading, which is a key recommendation of the report.
    As capital invested in agricultural futures has increased 
dramatically in recent years, we have become convinced that it 
has reduced the effectiveness of futures as a hedging tool for 
grain hedgers. The impact has been very dramatic on the Chicago 
Board of Trade wheat contract where commodity index traders 
hold 56 percent of open interest when spread trades are 
excluded. Their share of open interest has remained at a 
consistently high level regardless of price and today 
represents ownership of more than 160,000 contracts, which is 
almost two times the size of the U.S. soft red wheat crop.
    These positions held by commodity index traders are 
primarily long only, held for extended periods, and are not 
responsive to changes in price. We believe this situation, in 
which a large portion of the open interest is not for sale at 
any price for extended periods, has drained liquidity out of 
the contract and contributed to extreme volatility.
    We believe strongly that invested capital has been the 
significant factor contributing to a disconnect between cash 
wheat values and wheat futures prices--a view confirmed in your 
report.
    Efficient performance of futures markets is critically 
important to grain hedgers and producers. Futures markets help 
grain hedgers manage price and inventory risk, assist producers 
and elevators in valuing their product, and facilitate risk 
transfer and marketing opportunities. Performing these key 
tasks requires a dependable relationship, convergence between 
cash and futures.
    Last year's extreme volatility in wheat markets emphasized 
this disconnect between cash and futures for soft red wheat. 
While cash markets work to seek fair value of the crop, 
traditional basis relationships between cash and futures no 
longer seemed to apply. The result was an unprecedented 
increase in basis risk for grain elevator operators and a 
serious concern for the banks that provide their financing. The 
imbalance was so acute that basis levels in the interior 
increased to more than $2 per bushel to offset the high price 
of futures and seek the market value for physical bushels.
    As cash and futures diverged, grain hedgers were also 
subject to larger and larger margining requirements to maintain 
their hedges. The Ag banking system performed well in 2008, but 
our industry narrowly escaped a real tragedy in which many 
firms could have been forced out of their hedge positions and 
out of business. Today, there is a real concern about whether 
lenders have the capacity to respond to a repeat situation.
    To put this serious situation in perspective, I will share 
a case of a very well-run and conservative grain elevator 
operation in Michigan. The company projected a $10 million 
financing shortfall, but in a 3-week period in early 2008, the 
amount grew to $70 million. For a country elevator operation, 
this is unheard of. Fortunately, we were able to acquire their 
inventories and take assignment of their forward contracts. I 
can give you an example of a similar situation in Wisconsin, 
where the result was not so fortunate.
    The risk of running out of capital was so severe in 2008 
that many elevators were forced by financial constraints to 
reduce or even eliminate cash forward contract offerings to 
producers. Producers were frustrated in their attempts to lock 
in favorable pricing opportunities at a time when fuel costs 
and other input costs were escalating dramatically. Our 
industry's traditional function as a conduit for efficient 
pricing for the producer was impaired as the relationship 
between cash and futures deteriorated in wheat.
    The NGFA has worked actively with the CME for solutions to 
these performance problems, and we appreciate the CME Group's 
openness and responsiveness to our industry's concerns. We 
hoped that markets would correct themselves over time, as 
efficient markets tend to do over time. However, the 
extraordinary situation in the wheat contract has prevented the 
market from correcting in a timely manner.
    The CME has just implemented a number of changes to the 
wheat contract, and these follow a range of changes that were 
made a year ago as well. Included in the recent changes are 
seasonal storage rates and the addition of many new delivery 
locations. These are significant changes that should have a 
positive impact.
    We are hopeful that these contract changes will move the 
wheat contract back towards convergence, but they may not be 
enough. If the current changes do not re-establish convergence, 
the CME Group must be prepared to move quickly on additional 
measures to complete the task. We believe the CME Group is 
committed to restoring contract performance and already has a 
concept of variable storage rates under consideration that we 
believe holds promise. It will be critically important that the 
CFTC move contract improvements through its approval processes 
expeditiously.
    One important component in the discussion is enhanced 
transparency in futures markets. The Commitments of Traders 
report changes implemented by the CFTC in early 2007 were very 
useful. To further enhance transparency, we recommend that the 
Commission add the same level of detail to the lead month--the 
contract month with the largest open interest. While this would 
not necessarily improve convergence, the information would 
assist hedgers in their decisionmaking and would also assist 
the Commission and policymakers in evaluating participation of 
various types of traders.
    Finally, the one area of the report that we are not ready 
to embrace is the recommendation to restrict participation by 
these new financial participants. Despite the difficult 
environment and the imbalance they have created, we would 
prefer to see the wheat contract come back into balance with 
minimal intervention. However, if contract changes at the CME 
are unable to achieve convergence quickly, we recognize that 
restrictions may become necessary.
    That ends my testimony, and I will be happy to answer any 
questions.
    Senator Levin. Thank you very much, Mr. Coyle. Mr. Wands.

TESTIMONY OF HAYDEN WANDS,\1\ DIRECTOR OF PROCUREMENT, SARA LEE 
 CORPORATION, AND CHAIRMAN, COMMODITY AND AGRICULTURAL POLICY, 
                  AMERICAN BAKERS ASSOCIATION

    Mr. Wands. I would like to thank the Senate Permanent 
Subcommittee on Investigations, and especially Chairman Carl 
Levin and Ranking Member Tom Coburn, for holding this 
critically important hearing on excessive speculation in the 
wheat markets. Again, my name is Hayden Wands. I am Director of 
Procurement at Sara Lee. I am here today speaking on behalf of 
the American Bakers Association as the Chairman of the American 
Bakers Association (ABA) Commodity and Agricultural Policy 
Committee.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Wands appears in the Appendix on 
page 76.
---------------------------------------------------------------------------
    Since the inception of the grain exchange over 150 years 
ago, bakers have utilized the exchanges for purchases of 
necessary ingredients. These markets enabled farmers to know 
what price they can receive for their grains in the coming 
months and years and allowed manufacturers to plan for their 
businesses' futures by using these same price points as a 
component for the food products they produce. This was, and 
still should be, the intent of these critical markets.
    Unfortunately, the use of these markets has dramatically 
changed since 2005. With the influx of index funds, volatility 
increased and commodity prices rose to record levels in 2008. 
While other supply-and-demand issues also impacted prices in 
2008, the record investment of index funds cannot be 
overlooked. They are buying agricultural commodities and using 
the investments as a new marketable asset class. Grain is not 
an asset class, but an ingredient in many basic foodstuffs--
staples of the American diet.
    The resulting volatility caused by the influx of index 
funds in the wheat market has been dramatic. Historically 
speaking, a 10-cent price change in wheat futures contracts was 
considered extreme. But today market fluctuations of 30 to 40 
cents a day are all too common. Currently, index funds own 196 
percent of this year's wheat crop. To put that in perspective, 
index funds own 22 percent of the soybean crop and only 13 
percent of the corn crop.
    The increase in volatility can be seen in the increase of 
the monthly trading ranges of wheat. In 2005, the monthly 
trading range's average was 39 cents a bushel. In 2008, trading 
ranges increased by 461 percent to $1.81 a bushel and are 
currently at 269 percent above 2005 levels at $1.05 a bushel. 
As long as index funds continue to hold such a large share of 
wheat contracts and do not have to operate within limits, 
volatility in the markets will continue to harm farmers, food 
producers, and American consumers.
    The significance of the index funds' positions is increased 
due to the finite nature of the supply of the physical wheat. 
With accumulation of long-only positions by index funds, the 
availability of futures contracts diminishes as they 
effectively take contracts out of the available pool. As a 
result, the few remaining contracts are price rationed to 
reduce the demand for additional purchases of contracts, which 
greatly increases volatility.
    Bakers cannot escape the impact of index fund activities. 
For example, as wheat prices skyrocketed to record highs in 
2008, bakers were forced to increase prices for their baked 
goods or consider other equally undesirable measures, such as 
decreasing staff or shutting down operations entirely.
    Members of the ABA testified before Congress regarding this 
impact. Frank Formica, owner of Formica Brothers Bakery at 
Atlantic City, New Jersey, testified before the House Committee 
on Small Business, noting he typically paid $7,000 a week for 
flour, but in April 2008, he paid $20,000 a week for the same 
amount of flour--a three-fold increase in cost. Many other 
bakers shared similar stories about flour cost increases during 
this same time period.
    The impact of market volatility has driven away smaller but 
extremely important market participants. Small businesses, 
including bakers, grain elevators, and millers, who cannot 
qualify for large credit lines may find it extremely difficult 
to participate in the current market. These businesses may look 
for alternative hedging mechanisms since hedging in the futures 
market may become an activity reserved for companies that carry 
extremely large amounts of liquidity and credit.
    In addition, the lack of convergence continues to be a 
major issue in the futures market. ABA strongly believes that 
the lack of convergence exhibited in the market, and 
particularly in the Chicago wheat market, is a symptom of the 
problem caused by the accumulation of long-only positions by 
index funds rather than the root of the problem itself. If 
contract limits were placed on index funds, lack of convergence 
would be addressed.
    Index funds have erroneously been categorized differently 
from that of a traditional speculator. They operate under the 
auspices of a bona fide commercial hedger. Bona fide commercial 
hedgers receive an exemption allowing them to operate without 
contract limits and are only limited to the actual amount of 
grain they produce, store, or use for feed or food production. 
Due to this discrepancy, the index funds currently operate in 
the market without encountering any natural or regulatory 
limits to the amount of contracts that can be purchased.
    ABA strongly believes that index funds must operate within 
the confines of a contract limit similar to the limits that 
traditional speculators have efficiently operated for many 
years. Placing limits on hedge fund activity will be critical 
in restoring the integrity of the Chicago wheat contract, as 
well as all wheat contracts, and will allow the market to 
return to manageable volatility. As such, the ABA fully 
supports the Subcommittee's recommendation to phase out 
existing wheat waivers for index traders by creating a standard 
limit of 6,500 wheat contracts per trader.
    Volatility in the markets is a major concern to the baking 
industry. Today's volatility represents millions of dollars 
daily in undue financial risk. Commodity markets will be able 
to once again respond to natural and fundamental supply-and-
demand influences through implementation of contract limits.
    I would again like to thank Chairman Levin and Ranking 
Member Coburn as well as Members of the Subcommittee for the 
opportunity to provide the views of the American Bakers 
Association on this important subject. Thank you.
    Senator Levin. Thank you so much, Mr. Wands. Mr. Cooper.

  TESTIMONY OF MARK COOPER,\1\ DIRECTOR OF RESEARCH, CONSUMER 
                     FEDERATION OF AMERICA

    Mr. Cooper. Thank you, Mr. Chairman. In my testimony, I 
outline a broad empirical and theoretical explanation of how 
excessive speculation has made a major contribution to the 
recent gyrations and failures in commodity markets and why they 
harm the public. I have made my case with respect to oil and 
natural gas, which is what I know best, but based on my reading 
of the Subcommittee's analysis of the wheat market, I am 
convinced that everything I have said applies to wheat as well.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Cooper appears in the Appendix on 
page 87.
---------------------------------------------------------------------------
    The debate over excessive speculation is over. The reports 
of the Subcommittee on oil, natural gas, and most recently 
wheat, as well as my own analyses of oil and natural gas, which 
antedated those of the Subcommittee, leave no doubt about the 
fact that excessive speculation was an important cause of 
problems in commodity markets. The only question on the table 
is: What should we do to prevent excessive speculation from 
afflicting these markets in the future?''
    Good analysis must be the launch point for good policy. A 
valid scientific claim that A causes B requires three critical 
elements that are in your report:
    One, temporal sequence. A must proceed B.
    Two, correlation. A and B should move together in the 
expected direction.
    And, three, explanatory linkage. There needs to be a 
mechanism that shows how and why A would move B.
    The policy relevance of scientifically valid causal claims 
is that policymakers can adopt policies to change A and expect 
that the effect will be to change B. In the case of commodity 
prices, if it is concluded that excessive speculation is 
harmful and it is concluded that the influx of financial 
investors--as Mr. Gensler calls them, perhaps to preserve the 
good name of speculators--then policies to dampen the influx of 
those funds will reduce speculation and improve the outcome for 
consumers.
    It is absolutely clear that these markets are vital to the 
functioning of our economy. The purpose of commodity markets is 
to smooth the flow of production in the real economy to allow 
farmers and bakers to plan, hedge, and organize their 
production. It is absolutely clear that excessive speculation 
disrupts this flow. It raises price, creates volatility, drives 
these people out of the market, makes it difficult to hedge, 
and difficult to plan their production. You have ample evidence 
of that.
    This Subcommittee's research demonstrates the three 
elements of causal explanation. There is no doubt about the 
temporal sequence between the influx of funds and the dramatic 
increase in price volatility and other aberrations in these 
markets. And when you buy a futures contract, as you have 
heard, you influence the price. You set the price by holding 
that open position at the price you have agreed to. Explanatory 
linkages here as well. These financial investors behave 
according to a financial logic which treats commodity futures 
as assets, not resources. They pay less attention to the 
fundamentals of the real economy and more attention to 
financial formulas. Index traders just kept pouring money in 
and adjusting their portfolios according to the logic of their 
index managers. When regulators finally threatened oversight 
and when general liquidity in the economy dried up, the 
financial investors vacated the market. And lo and behold the 
aberrations declined, as you have seen.
    Near-perfect correlation like this, with perfect 
correlation on the way up and perfect correlation on the way 
down, is very rare and very persuasive. The reason the 
opponents or critics of your bill--your report cannot offer you 
an alternative explanation is that finding that perfect 
correlation is very difficult. They just say, well, it must 
have been something else because we do not think it was what 
you think it was.
    But even more importantly, you have heard today the 
underlying mechanisms that link the influx of traders to the 
problems. Traders profit from rising and volatile prices in a 
variety of ways, and they contribute to those outcomes. As 
account values rise, excess margins and special allowances 
allow traders to take money out of their market or leverage 
more trading to keep the upward spiral going. Traders and 
exchanges benefit from transaction fees that grow with value 
and volume. As long as there is more money coming into these 
markets that is willing to bid up the price, the old money 
already in the market benefits by staying long.
    Of course, it is easy to ensure the inflow of funds when 
the managers of those funds also are the advisers to these 
financial investors who tell them what to do. It is easier to 
sustain the upward spiral of prices when speculators are also 
the analysts who release reports hyping the market with reports 
of how high prices are and how they will go. When oil was $145 
a barrel last year, Wall Street was telling us they had to go 
to $200, it would go to $200. I will remind you it is $60 today 
after the speculative bubble has burst.
    So setting position limits is one step that is absolutely 
critical. Defining entities properly is another step. Mis-
defining index traders as commercials was disastrous. They are 
not. They do not take delivery. They do not look at the real 
market. They only look at their financial performance.
    Eliminating conflicts of interest would be extremely 
important as well. We have the individual firms on too many 
sides of this transaction, and ultimately we really have to 
think about the incentives we have given for the 
financialization of everything in America as an asset class and 
fail to pay enough attention to the real economy. We have to 
change the incentives so activity goes back into the real 
economy as opposed to these purely financial activities.
    Thank you.
    Senator Levin. Thank you very much, Mr. Cooper. Mr. 
Strongin.

    TESTIMONY OF STEVEN H. STRONGIN,\1\ HEAD OF THE GLOBAL 
  INVESTMENT RESEARCH DIVISION, THE GOLDMAN SACHS GROUP, INC.

    Mr. Strongin. Thank you very much, Chairman Levin. We 
commend you for your leadership in addressing the factors 
affecting the functioning of the commodity markets, which we 
view as a critical endeavor. We appreciate the opportunity to 
present our thoughts on your report entitled ``Excessive 
Speculation in the Wheat Market.'' This is a substantial piece, 
which provides a rich and detailed history of the wheat market 
and raises critical issues, such as the importance of price 
convergence between the cash and futures markets.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Strongin appears in the Appendix 
on page 129.
---------------------------------------------------------------------------
    I have been involved with the commodity markets for the 
last 15 years, having helped construct and manage commodity 
index products for much of that time. I served as a member of 
the Policy Committee for the Goldman Sach's Group, Inc. (GSCI), 
from 1996 to 2007, at which time the index was sold to the S&P, 
and I have continued to serve on the Policy Committee 
maintained by the S&P.
    When we conceived of the GSCI in the early 1990s, we did so 
with an eye toward improving liquidity by helping fill the gap 
between the large numbers of producers who needed to hedge 
their risk and the more limited number of consumers who are 
willing to provide those hedges. Since then, passive 
investments have become a crucial source of this liquidity. 
Capital provided by passive investments is needed to balance 
these markets, helping them to fulfill their mission of 
allowing producers and consumers to operate more efficiently 
and manage their price risk. Yet investors who have provided 
this liquidity have been, in our opinion, inappropriately 
characterized as speculators with no real economic interest in 
these markets.
    Most of these investors are, in fact, large-scale asset 
allocators who seek to invest in markets in which capital is in 
short supply. In doing so, they aim to earn a reasonable long-
run return by improving the underlying economics of the 
industry. They, therefore, require real economic justifications 
for their investments.
    As such, their primary concerns mirror those of the 
Subcommittee--namely, what is the realistic capital needed by 
these markets? Will investment distort prices and, therefore, 
reduce long-run returns? And are these markets liquid enough 
not to be distorted by passive capital?
    Reflecting these concerns, we have sought to structure the 
GSCI so that it provides the greatest possible liquidity with 
the least possible market impact from passive investments. We 
have regularly assessed whether capital allocated to individual 
contracts exceeds the ability of these markets to absorb that 
capital.
    Turning our attention to the specific issues raised and 
recommendations made by the Subcommittee's report. As we 
mentioned earlier, this is a substantial piece, but our ongoing 
work assessing the liquidity of the GSCI leads us to some 
important and differing conclusions from some of those reached 
in the report. We outline these key differences here and refer 
you to our written testimony for greater detail. We hope our 
thoughts prove useful.
    First, the Subcommittee report concludes that passive index 
investments have been responsible for price volatility in the 
CME wheat market. We monitor distortions in the markets by 
comparing market performance across contracts. For example, 
comparing price performance of Chicago wheat to the performance 
of other agricultural markets without passive index 
investments. In these markets, we observe similar price moves. 
For example, wheat contracts not included in passive indices, 
such as Minneapolis wheat, have experienced even greater price 
volatility than Chicago wheat. For example, Minneapolis wheat 
increased by over 270 percent from January 1, 2007, to the 
peak, while wheat prices in the Chicago market rose by 170 
percent.
    We also monitor this issue by looking at the performance of 
commodities that are subject to similar economics as Chicago 
wheat, such as rice and oats. Here we also find similar price 
patterns. For example, Chicago wheat, and oat prices have 
declined by 58 percent and 54 percent, respectively, from the 
peak to July 15, 2009. This analysis strongly implies that 
passive investments were not the cause of the price distortions 
in the Chicago wheat market. Therefore, restrictions in passive 
investments would not likely have lessened price volatility.
    We would also note that our work on the impact of 
speculation shows that non-index speculation has had far more 
impact than passive index investments, both per dollar invested 
and in total. The reason for this is simple. Index investments 
are made slowly and predictably, and contracts are exited well 
before settlement. Non-index investments, however, tend to be 
strongly correlated with underlying fundamentals, and they tend 
to be focused on price levels. Thus, their size is adjusted to 
passive index investments, offsetting the effects of those 
investments.
    Second, the Subcommittee report also concludes that passive 
index investments impede price convergence in the Chicago wheat 
market, which we believe is a very important issue. However, 
our view is that this lack of convergence is driven by flaws in 
the design of the futures contracts. Put simply, the high 
degree of flexibility of delivery options built into the 
Chicago futures contracts and the difficulty of delivery into 
those contracts for producers makes the futures more valuable 
than the underlying wheat. This is particularly true when the 
volatility of cash wheat prices is high. If we compare the 
value of these options with the basis volatility raised as a 
concern by the Subcommittee, it is clear that contract design 
caused much of the basis risk.
    The importance of the delivery restrictions in the Chicago 
wheat market, pushing up the value of the futures relative to 
the cash market is something the Chairman and the Members of 
the Subcommittee have already highlighted with respect to the 
WTI market. We think the solution parallels suggestions made by 
the Subcommittee about oil--namely, expand the number of 
delivery sites and generally ease the terms for delivery.
    The Subcommittee also suggests that position limits or the 
elimination of index investing would reduce volatility in wheat 
prices. Given our view that index investing did not cause price 
volatility or convergence issues, we do not think there will be 
much to gain by implementing such restrictions. However, there 
could be significant negative consequences.
    First, a large number of index investors are based outside 
the United States. Given that there are equivalent contracts 
traded on non-U.S. exchanges, much of the activity generated by 
these investors would likely migrate offshore.
    Second, the proposals currently being suggested would not 
actually restrict the aggregate size of the positions taken by 
U.S. investors. Instead, these positions would likely be 
splintered across multiple brokers, multiple ETFs, and multiple 
mutual funds so that each of these vehicles would remain below 
individual position limits. In stressful market conditions, 
such a splintering would likely lead to even greater market 
volatility as the sale of large positions tends to destabilize 
markets under stress. When these positions are in the hands of 
a single party or a small numbers of parties, their orderly 
sale is possible. However, when these positions are in the 
hands of multiple dealers or funds, each dealer or fund manager 
is incentivized to sell quick before the others do. This is 
especially true for dealers running smaller trading books or 
for fund managers who compete for the best relative 
performance. For these participants, a faster sale is best. 
This can lead to disorderly markets and extreme volatility. 
Thus, it is our view that splintering existing positions could 
lead to greater price volatility and increase the likelihood 
that prices overshoot underlying fundamentals.
    Attempts to regulate volatility have rarely, if ever, 
succeeded. Yet they often have unintended and significant 
consequences. Therefore, as we look to the future, we think the 
harmful volatility that has been observed in markets in the 
recent past begs us to focus on the question of which types of 
market rules and oversights allow participants to best manage 
their risk at a reasonable cost.
    Thank you for taking the time to listen to our prepared 
remarks, and we look forward to answering your questions.
    Senator Levin. Well, thank you all very much for your 
testimony. Let us try a 10-minute round here for this first 
round of questions.
    Let us start with you, Mr. Coyle. Your testimony as fairly 
dramaticly that producers have been frustrated, cash forward 
contracts were impaired because the relationship between cash 
and futures markets deteriorated. You are hopeful that contract 
changes will help, but you said that they may not be enough. 
And you indicated that if the contracts do not achieve 
convergence quickly, intervention may be necessary. I am trying 
to summarize your testimony.
    How quickly do they need to converge in order to meet your 
standard?
    Mr. Coyle. I would say that we would want them to converge 
this crop year. It takes a certain amount of time to make these 
changes, but there have been changes implemented already, and I 
would expect that sometime between September's expiration and 
December, the CME can roll out their next change in contract 
specs if they do not see that the current changes have had the 
impact.
    While the changes they have made are very positive, there 
is a certain amount of skepticism that it will actually achieve 
the goal. Certainly it is in the right direction.
    Senator Levin. Do you believe that the dramatic increase in 
the investment by the index traders, contributed to the lack of 
convergence?
    Mr. Coyle. No, sir. I believe it caused it, singlehandedly. 
Not a contribution. It is the single issue that has caused the 
problem in convergence.
    Senator Levin. You go even beyond the CFTC director.
    Mr. Coyle. Yes, sir.
    Senator Levin. Mr. Wands, do you believe that the huge 
investment by index traders is either a contributing, major, or 
exclusive reason why we have seen convergence fail?
    Mr. Wands. Well, we feel that their presence and their size 
has exacerbated the problem dramatically.
    Senator Levin. Is it fair to say that you feel it is a 
major factor in the failure of convergence?
    Mr. Wands. It is a predominant factor, yes.
    Senator Levin. All right. Mr. Cooper.
    Mr. Cooper. I actually agree with Mr. Gensler, and 
certainly when I testified in oil--fundamentals matter and so 
they do play a role here. But excessive speculation matters, 
too. That is the important point, and as I saw it, at least $40 
a barrel, it grew to $65 or $70 a barrel. That is enough money 
to get your attention even if fundamentals count for something 
else.
    Senator Levin. All right. Now, Mr. Strongin, do you agree 
with Mr. Coyle and Mr. Wands that the influx of these index 
funds into the market, which now results in them controlling 
about 50 percent of the market, is either the factor, as Mr. 
Coyle said, in terms of the loss of convergence or a principal 
factor, as Mr. Wands said, in terms of loss of convergence? 
Would you agree with that?
    Mr. Strongin. I would not, Mr. Chairman, respectfully.
    Senator Levin. That is all right. Now let us get to the 
point that the contract was not significantly changed until 
recently. Is that not true, Mr. Strongin?
    Mr. Strongin. It has not changed effectively at all.
    Senator Levin. And yet we see this huge spike in the 
futures contracts and the huge gap that now exists between 
futures and cash prices. And the contract did not cause that, 
presumably, or the shortfalls in the contract did not cause 
that, because that spike took place while the contract did not 
change.
    Mr. Strongin. The problem is that there is an embedded 
option inside of the futures contract for below-market cost of 
storage, meaning that if you own the futures contract, you can 
avoid paying the full price of storage and store wheat.
    Senator Levin. That was true for 5 years, wasn't it?
    Mr. Strongin. Absolutely true.
    Senator Levin. All right. So that has not changed.
    Mr. Strongin. No. But the value of it did change. There are 
two things that drive the value of it: one, the cost of 
storage; and, two, the volatility of the prices around that 
storage. And as we saw in many markets in this environment, the 
volatility picked up a lot, and options increase in value when 
volatility goes up.
    Mr. Gensler referred to this--the cost of storage went up 
because the grain elevators were full, and the shadow price of 
the grain elevator storage, because they had run out of space, 
was even greater. As a result, that value of below-market 
storage went way up. So the option value went way up, and that 
is effectively what we are applauding when we look at the 
basis.
    Senator Levin. Let me go back now to Mr. Coyle. Can you 
comment on storage prices and whether or not the change in 
storage prices can explain this increase in the basis gap?
    Mr. Coyle. Yes, sir, I can explain it, and I would say with 
certainty that is not the case. Yes, storage costs have gone 
up, and, yes, I will agree with Mr. Strongin that there is a 
contract design issue. I will even agree that storage changes, 
like the variable storage rate the CME will next consider, can 
have an impact. And recent changes in the storage rates are a 
move in the right direction.
    However, at this moment we have a record number of shipping 
certificates that have been issued against the----
    Senator Levin. I am sorry. Record number of----
    Mr. Coyle. Shipping certificates. That is a representation 
of inventories. A record number of shipping certificates issued 
against the CME futures contract, and that has not solved the 
problem. And we do not have consumers taking ownership of those 
shipping certificates and those inventories because they think 
it is a good value because it is a cheaper source of cash.
    Senator Levin. Well, I am not sure I understand your 
explanation as to why you disagree that the storage cost shift 
cannot explain this increase in the gap between futures and 
cash prices. Try it again.
    Mr. Coyle. While it may be more costly to build today, we 
have always had the issue of storage, of full carry. In the 
current environment, we have a market that is full carry, which 
means it currently pays all of the costs of storage, even the 
higher Board of Trade storage rates, and we still have a 70-
cents-per-bushel convergence problem.
    To suggest that the optionality of owning the Board of 
Trade Futures, which means it gives you the opportunity to have 
the access to this cheaper storage, is a reason that the 
futures price is higher is just something that we would 
disagree with.
    Mr. Cooper. Chairman Levin, I would take another tack at 
his answer because you focused on the cost of storage and the 
value of storage, but he hypothesized an increase in 
volatility. I would submit, as I do in my testimony, that the 
presence of these indexed funds is the cause of that increase 
in volatility. So at that level, the answer is too cute by a 
half.
    Senator Levin. All right. Let me go back to Mr. Coyle. You 
are something of an expert, I believe, in terms of elevators, 
are you not?
    Mr. Coyle. Yes, sir.
    Senator Levin. What is your expertise?
    Mr. Coyle. Well, I manage a business that happens to own 
the largest Board of Trade delivery elevator for corn, beans, 
and wheat, so we specialize in grain storage, and I am a member 
of the grain industry, so I have spent most of my career 
managing grain elevators and the risk around those.
    Senator Levin. Now, when there is a lack of convergence, 
who is hurt? You are an expert. Tell us.
    Mr. Coyle. The first person that is hurt is the grain 
elevator operator because, by definition, the convergence 
problem increases the amount of basis risk. A grain elevator 
that buys grain, whether it is Michigan, Wisconsin, Ohio, 
Indiana, anywhere, buys grain assuming a relative relationship 
to the Board of Trade, finds that as the prices go up after he 
bought the grain that the basis is lower 6 months down the road 
after he has paid the cost to store that grain. So that would 
be the initial cost.
    But then there are the other factors. The farmer, of 
course, is then hurt, because as the grain elevator operator 
has more risk, he has to pass that along to the farm community 
through lower basis levels. In addition, as you have got this 
basis convergence problem, banks are more concerned about 
loaning money, so your cost of money goes up. And maybe you 
even get into a situation, as we did last year, where there is 
a concern that there is not enough capital at all, and so you 
stop offering bids to farmers.
    I would say in the last 12 months, probably the single 
biggest person harmed would be the farmer, because, in fact, 
the grain elevators stopped bidding for grain 6 months out, 7 
months out, 8 months out because they were afraid they would 
not have the capital to margin their accounts.
    Now, this is not 100 percent of the problem with 
convergence. The fact is, in 2008 when the market rallied, 
there were a number of issues that made the market higher. It 
could be the biofuels, the fight for acreage. There are a 
number of things that made the market go higher, but this 
convergence problem does put at risk the availability of 
capital to run your business.
    Senator Levin. In addition to the elevator operator and the 
farmer, tell us about the consumer. How does that get passed 
on?
    Mr. Coyle. We have heard the comments that costs have gone 
up, and I think that is true, but again, a number of issues 
have had an impact on why the price of commodities is higher. 
But the whole issue of convergence is that the basis levels 
actually went lower to offset the price of higher futures. 
While the price of futures went from $5 to $6, basis levels 
went from $.25 under to a $1.25 under. In reality, the price 
that the farmer was selling grain at, and the price that the 
consumer was paying, was the fair value for wheat, right? So I 
wouldn't argue that there was so much volatility and so much 
unknown and so much risk that overall prices were higher. But, 
by and large, the higher futures price was offset by a drop in 
the basis.
    Senator Levin. Finally, let me just ask one question of 
Goldman Sachs' representative Mr. Strongin. You have indicated 
you don't think there should be position limits on index 
traders at all, is that correct?
    Mr. Strongin. I said that position limits would likely not 
fix this problem, sir.
    Senator Levin. Do you oppose position limits on index 
traders?
    Mr. Strongin. I don't think it will help the problem, and 
yes, I do oppose it.
    Senator Levin. How about other types of folks who you have 
said have a bigger impact on futures than index traders. Should 
anyone have limits?
    Mr. Strongin. Actually, we have argued generally that the 
position limits should be on speculative positions. They should 
be generally applied. And probably the most important notion 
would be what some of our internal people would sort of say, 
look to, look through, which is putting the position limits on 
the end users.
    Senator Levin. Would that include your customers?
    Mr. Strongin. That would include our customers.
    Senator Levin. So you do believe there should be position 
limits on index traders' customers?
    Mr. Strongin. Yes. We don't think--index positions on the 
index traders or the hedgers--not going through all the terms 
that were used to describe the hedgers here--really is about 
form of investment as opposed to actual position limits, where 
if you put it on the customers, it is actually changing the 
position limits and the positions.
    Senator Levin. Let me just be real clear. You believe there 
should be position limits on the customers of index traders?
    Mr. Strongin. Yes.
    Senator Levin. Thanks. Thank you. Dr. Coburn.
    Senator Coburn. Let me ask this question of Mr. Coyle. What 
has the price convergence problem been for wheat at 
Minneapolis?
    Mr. Coyle. We have not had a convergence problem in the 
Minneapolis----
    Senator Coburn. Do they trade index funds there?
    Mr. Coyle. I understand very little.
    Senator Coburn. Very little. What about Kansas City?
    Mr. Coyle. They do have index trading there. I am not aware 
that there is a convergence problem in Kansas City.
    Senator Coburn. So they have index trading there, but they 
don't have a convergence problem yet. Our position on the 
Chicago Exchange is that there is a correlation between index 
trading and price convergence.
    Mr. Coyle. Yes.
    Senator Coburn. Explain that to me.
    Mr. Coyle. Yes, sir. I think the issue is magnitude. We 
have a large index trading in soybean and corn futures, as 
well. But as Mr. Wands mentioned, you have a much smaller 
share, all right, on a relative basis if you compare that----
    Senator Coburn. You mean less than the 50 percent?
    Mr. Coyle. Yes, less than 50 percent, 35 percent, let us 
say, rather than 55 percent. But also, if you look at the 
magnitude of the crop, as Mr. Wands said, the open interest 
held by index funds is 13 percent of the size of the corn crop. 
In the case of soybeans, it is 22 percent. In the case of 
wheat, it is 195 percent. It has just out-balanced the size of 
the crop relative to size of the market participation.
    In reality, that has actually gotten worse, because last 
year, we had a huge production in the United States, 600 
million bushels of wheat. This year, it is only 414 million 
bushels. So in reality, a year ago, that same number was 145 
percent. This year, it is 195 percent. It is a function of just 
too much for the market to handle.
    Senator Coburn. OK. Does the higher volume generated by the 
commercial index traders actually increase liquidity or 
decrease liquidity, in your opinion?
    Mr. Coyle. In my opinion, it decreases liquidity. It 
actually increases volume, but it actually drains liquidity. If 
you have half of the trade that won't sell, then when the next 
buyer wants to buy, they can only buy half of what is out 
there.
    Senator Coburn. Well, but they do sell. They just roll.
    Mr. Coyle. They roll, but they buy and sell it the same 
day.
    Senator Coburn. Yes.
    Mr. Coyle. If we have a business, someone wants to buy U.S. 
wheat and the price rallies 50 cents a bushel and the farmer 
has already sold most of what he wants to sell this month, 
where does the next sale come from? At this point, it comes 
from a speculator that wants to be short because it is not 
going to come from the primary long. So in a normal market 
situation for----
    Senator Coburn. Fifty percent of the primary long?
    Mr. Coyle. Yes, sir.
    Senator Coburn. OK, and not--some primary longs will sell, 
but 50 percent of them won't.
    Mr. Coyle. Fifty percent of the open interest--56 percent 
of the actual flat price related open interest is held by 
somebody that will not respond to short-term economics.
    Senator Coburn. OK. So let me go to you, Mr. Strongin. Have 
I got this right, that I could actually buy an index fund, pay 
the storage cost, and net about 4 percent versus the cost of my 
money, if nothing changed in terms of the price of the contract 
and I just kept rolling the contract?
    Mr. Strongin. I am not sure I understand the question 
because there is not a free lunch in that process.
    Senator Coburn. Well, if, in fact, I can get half of one 
percent for my money in a CD and there is minimal price changes 
but high volatility on contracts for wheat and I can make money 
off the storage differential, can I not, in fact, markedly 
increase my yield versus the half-a-percent or quarter percent 
that I could get for my money somewhere else?
    Mr. Strongin. So the index investor is only holding the 
investments while it is in futures and in no time takes 
advantage of the reduced storage costs.
    Senator Coburn. So who makes the money off that?
    Mr. Strongin. Well, the person who takes advantage of it is 
the person who needs wheat in the future and this way can store 
it below market cost and they are simply willing to pay for 
that. In other words, you can think about it almost like 
prepaying a discount card. If I can get below-market storage 
for a certain period of time, I am willing to pay up front for 
that below-market storage. So they are not actually going to 
make money. They are just paying money now. That is why the 
futures costs more than the cash because they get the right to 
store it at below-market rates after that.
    Senator Coburn. OK. Does everybody at the table agree that 
there needs to be changes in the contract on wheat?
    Mr. Coyle. I certainly do.
    Senator Coburn. Mr. Cooper.
    Mr. Cooper. I am--as I understand it, it will help, but it 
won't solve the problem.
    Senator Coburn. What would solve the problem?
    Mr. Cooper. I think more aggressive position limits, 
conflict of interest properly classifying traders, a whole 
series of steps are necessary to reform this and other 
commodity markets.
    Senator Coburn. If you do all those things, won't this 
money go to an overseas market?
    Mr. Cooper. Well, as Mr. Gensler pointed out, the United 
States is a big place and people want to be able to trade in 
U.S. instruments and U.S. markets. So there will be plenty of 
liquidity in this market. There is excess liquidity in a 
certain sense in this market, this huge influx of capital. So 
it is my belief that the United States can, in fact, establish 
a set of rules that will make for an orderly market and plenty 
of traders will come here to preserve the liquidity of this 
market.
    Senator Coburn. So you think there is minimal risk for us 
of losing capital in this country by making these changes?
    Mr. Cooper. I think there is a minimal risk because of the 
commodities that people want to trade in. West Texas 
intermediate is a U.S. commodity designated for trade in U.S. 
markets, and as I understand it, foreign boards of trade 
desperately want to be able to trade that stuff. So if they 
refuse to conform to our statutes and they can't trade here, 
they will basically be unimportant. So this is a big place and 
I firmly believe that if we organize our markets, we won't be 
at a competitive disadvantage.
    The interesting thing is that when you talk about London 
and Paris, those governments are looking very carefully at much 
more strict regulation than we actually are. If you look at the 
conversation, they are sort of pulling the Americans along. So 
it may well be that those markets are not going to be less 
regulated and therefore more attractive. I think the world is 
moving towards a much higher level of prudential regulation in 
all the major exchanges.
    Senator Coburn. Mr. Strongin, your comments on that?
    Mr. Strongin. Different activities have different mobility. 
In this case, you have a large number of non-U.S. investors who 
have easy access to non-U.S. futures contracts. That activity 
would exit the United States very easily.
    I do not think it would imperil the functioning of our 
futures markets because we do have in truth large domestic 
individuals on both sides. But it would reduce the liquidity. 
It would shift--it could potentially source the center point of 
liquidity away from the U.S. markets in some cases. It is a 
cautionary tale, but German bonds now trade almost entirely out 
of London for similar reasons. So it is not automatic that the 
activity will be here. But the United States is an important 
enough market that it would continue to function afterwards.
    Senator Coburn. But there is some risk?
    Mr. Strongin. Of significant activity leaving.
    Senator Coburn. Yes. OK. Mr. Coyle, you don't think that we 
ought to eliminate index trading on the Chicago Board, is that 
correct?
    Mr. Coyle. At this time, that is correct.
    Senator Coburn. Can you foresee a time when you would think 
that should be done and why?
    Mr. Coyle. Well, I would say first, we would like to see 
the results of the current major changes in the Chicago Board 
of Trade's contract, allow them to come out with a next set of 
changes if they are necessary, and I would say a good 
percentage of people think that probably will be required to 
see if that can restore the balance and it converges as the 
market needs.
    If by some chance that can't be done, then we don't rule 
out that something will need to be done, some other step. But I 
would question whether or not a change in the limits or the 
exemptions would actually solve the problem.
    First, and it relates to a comment that was made earlier, 
the current limits of 6,500 contracts, that is $162 million. 
Any individual in this room could actually buy 8 percent of the 
U.S. wheat crop with the current limits. That is one comment.
    Second, if capital really wants to deploy in commodities, 
then there are a lot of ways even within those limits that you 
can restructure your product so that you can find other ways to 
deploy that capital. It is certainly not as efficient as they 
can do it today in a futures market where the costs of 
execution are so cheap, you don't have counterparty risk, and 
so on. But it can be done.
    And then there is the risk of the unintended consequences, 
I would say particularly if, in fact, this same capital decided 
that it wanted to pursue the physical market instead of the 
futures market. We would fix the convergence problem 
immediately because they would actually buy the physical 
bushels which they are not buying today. But if they did that, 
we would lose a lot of transparency that we enjoy today because 
we get to see those contracts.
    My company has been contacted by two funds in the last 
month alone, looking for ways to now participate in the 
physical market. You can imagine if 195 percent of the 
equivalent of the crop is owned today in futures contracts, 
what would happen if they wanted to buy physical bushels? You 
would have the physical price go up, all right. The convergence 
problem would go away. You wouldn't know where it is at and we 
actually would have an inflation problem and millers, when they 
needed to buy the wheat, couldn't buy it.
    Senator Coburn. Mr. Strongin, what do you attribute the 
tremendous increase in activity in index funds, especially as 
related to commodities? I know they are everywhere, but what do 
you attribute that to? Is that an increased sophistication of 
the American investor? Is that the American investor who is 
wanting to get hard commodities to hedge against the future? 
What is the overall reason why we are seeing this tremendous 
shift to index funds, away from specific assets?
    Mr. Strongin. Part of it has to do with the way the word 
``fundamentals'' has been used here. Fundamentals can apply to 
two very different things. One of them, which is the way it is 
normally used in this conversation, is today's cash market. How 
much supply, how much demand, what price balances at.
    The second has to do with investment. Today when investors 
look at the global economy, when they look at the emergence of 
China, when they look at the emergence of India, when they look 
at what is going on in Latin America, they see incredible need 
to invest and they believe that they need prices that are high 
enough to drive that investment and they believe that commodity 
prices will rise and commodity industries will become more 
valuable.
    And so across the board, whether it is in terms of 
investing in Brazil or investing in emerging markets in 
general, investing in oil companies or in hard commodities, you 
see investors trying to protect themselves from the pressures 
that will create. As you look at the necessary demand of the 
emerging market, you want to have exposure to basic 
commodities. You want to have exposure to energy. You want to 
have exposure to grains. You want to have exposure to all raw 
materials.
    And they have increased their exposure to those things in 
all ways, whether it be through index participation or direct 
equity investing. You can see it in the percent of the S&P made 
up by commodity companies. You can see it in how the emerging 
markets are priced relative to the developed markets. People 
want that exposure because when they look at future demand and 
the need to invest, they see that as a key central element of a 
forward economy and forward fundamentals.
    Senator Coburn. Right, and that is why we see China doing 
what they are doing.
    Mr. Strongin. That is right. And to the point I made 
earlier, they are actually buying physical commodities and that 
has a lot more power to move prices than these futures do.
    Senator Coburn. OK.
    Mr. Cooper. Senator, could I try a slightly different 
answer? And I don't disagree with the fact that physical assets 
are important, I believe, in market fundamentals. But the other 
thing we have done is we have distorted the incentives in our 
country to over-reward short-term financial rewards and under-
reward long-term investment in the real economy through a long 
series of policies that make it easier to make money by 
flipping things than by investing in hard physical assets, and 
I mentioned that in my testimony. It is really important that 
we rejigger those incentives so that you can make as much money 
with a real good investment in the real economy as you can by 
getting into short-term financial gains.
    Senator Coburn. The difference there being is that if you 
are doing it in the short-term, you are going pay regular, 
ordinary income tax rates versus capital gains rates, which is 
a disincentive to flip----
    Mr. Cooper. And we used to have taxes on short-term capital 
gains which----
    Senator Coburn. We still do. They are at your ordinary 
income tax rate.
    Mr. Cooper. And they were higher before and they were 
lowered and that has helped this shift.
    Senator Coburn. I guess your testimony would be that we 
should raise taxes?
    Mr. Cooper. I actually believe we should raise taxes to 
promote investment in the real economy, absolutely.
    Senator Levin. Mr. Wands, who is representing the American 
Bakers Association, you have testified that contract limits 
need to be restored, I believe. Is that correct?
    Mr. Wands. Yes. Well, what we are asking for is that index 
funds be termed speculators and they fall under those type of 
contract limits.
    Senator Levin. All right, and that there not be waivers or 
exemptions?
    Mr. Wands. Correct.
    Senator Levin. And what is the effect of lack of 
convergence on bakers?
    Mr. Wands. Well, it is not--as Mr. Coyle commented, I think 
it is more significant on the production side, starting with 
the country elevator and then falling to the farmer. The lack 
of convergence on the bakery side, typically, we lock in our 
prices fairly well in advance so we don't have the 
ramifications that the production side does. One thing that can 
hurt us is if we lock in our basis, which we can do from time 
to time, and the market rallies severely, as Mr. Coyle said, 
then the basis falls significantly and then we will be--if you 
chose to lock in your basis early, you will be at a significant 
disadvantage to, say, your competition who waited. So there is 
volatility for us in the basis depending on when we lock it in. 
But again, it is more on the production side and the producer 
side.
    Senator Levin. But the volatility in the basis has had an 
effect on you. What is the cause for this huge fluctuation in 
the price of flour?
    Mr. Wands. Well, if you break down the price of flour, for 
the most part, when we look at our risks, about 70 percent of 
the defined risk, roughly about 70 percent of the risk that you 
can hedge either by buying basis or selling mill feed or buying 
futures price, 70 percent of it is related to futures. It is 
not an exact correlation, but as futures rise, that is going to 
reflect significantly on the flour price, more than the basis 
or the other ingredients in pricing flour.
    Senator Levin. So the price of futures going up is what has 
that effect?
    Mr. Wands. Significant, yes.
    Senator Levin. And we have shown the correlation between 
the huge influx of money from the index funds to the increase 
in the futures prices.
    Mr. Wands. Yes. That is correct. Somebody earlier asked 
about Kansas City. While the index funds do have a presence in 
Kansas City, it is significantly less than in Chicago, and you 
have to remember that while you are dealing with a 400 to 450 
million bushel soft wheat crop, you are looking at a billion 
bushel hard wheat crop--hopefully bigger this year--so their 
presence in Kansas City, while it is there, is not nearly as 
significant as Chicago and you don't have the convergence 
problem in Kansas City.
    Senator Levin. It is not nearly as significant as in 
Chicago----
    Mr. Wands. Correct.
    Senator Levin. You are all set. Thank you very much. You 
have been a fine panel. We appreciate your presence.
    We will now call on our third panel. Finally, we call on 
Charles Carey, Vice Chairman of the CME Group. Thank you for 
your patience, first of all, Mr. Carey.
    The CME Group was formed by the recent merger of the 
Chicago Mercantile Exchange (CME), and the Chicago Board of 
Trade and the New York Mercantile Exchange.
    Pursuant to Rule 6, all of our witnesses must be sworn, so 
we would ask you now to stand and raise your right hand.
    Do you swear that the testimony that you will be giving 
will be the truth, the whole truth, and nothing but the truth, 
so help you, God?
    Mr. Carey. I do.
    Senator Coburn. Mr. Chairman, I would like to just insert a 
comment into the record from our last panel. I got to thinking 
what the Consumer Federation of America said. He wanted to 
raise taxes to spur investment. I am not sure many people 
recognize that as a legitimate economic policy.
    Senator Levin. OK, thank you.
    Under our timing system today, Mr. Carey, we ask that you 
limit your oral testimony to 10 minutes, but your entire 
statement will be made part of the record. Please proceed.

  TESTIMONY OF CHARLES P. CAREY,\1\ VICE CHAIRMAN, CME GROUP, 
                       CHICAGO, ILLINOIS

    Mr. Carey. I am Charles P. Carey, Vice Chairman of the CME 
Group. Thank you, Chairman Levin and Ranking Member Coburn, for 
inviting us to testify today, respecting the June 24, 2009 
staff report titled, ``Excessive Speculation in the Wheat 
Market.''
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    \1\ The prepared statement of Mr. Carey appears in the Appendix on 
page 143.
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    I was Chairman of the Chicago Board of Trade, the home of 
the soft red winter wheat market, prior to the merger that 
created CME Group. I trade wheat, corn, and other agricultural 
products and I am the point person on the Board of Directors 
for dealing with the grain markets. I deal with the concerns 
respecting the impact of index traders on our markets expressed 
by our members and the agriculture industry and have been 
directly involved in the Chicago Board of Trade's ongoing 
efforts to modify the wheat contract to assure better 
convergence.
    As you are aware, some of our commercial customers believe 
that index trading may be having unwarranted impacts on our 
wheat market. We responded to these concerns by arranging for 
an independent analysis of this thesis across grain markets. We 
also cooperated with the others conducting such studies and we 
analyzed all the studies of this subject that preceded the 
report prepared by this Subcommittee.
    None of the relevant studies that we dealt with supported 
the conclusion that index traders or swap dealer participation 
in our markets was the cause of volatility, high commodity 
prices, or lack of convergence. Indeed, in our corn and soybean 
markets, there have been no significant convergence issues even 
though there is substantial participation in those markets by 
index traders and swap dealers. Despite the clear conclusions 
of these independent professional studies and our own 
experience in other grain markets, the concerns remain.
    Those who are not professional statisticians or economists 
continue to focus on the confluence of unexplained price 
behavior in the large share of open interests held by non-
commercial participants. It is difficult to ignore that 
coincidence and some of our traders and customers assumed that 
there was a strong chance that the two were connected. 
Professional economists and statisticians explained to us, 
however, that it was necessary to show causation, not just 
coincidence, and that it is a common logical error to attribute 
cause based only on correlation.
    Many had hoped that this Subcommittee study and report 
would add new evidence and clarify the relationship between 
index trading and the lack of convergence or any other 
unexplained price effect. The Chicago Board of Trade is 
absolutely committed to solving the convergence problem. Like 
you, we would have been pleased if the report had provided a 
simple explanation and easily deployed solution. Unfortunately, 
economists and the informed critical response to the report 
tell us that it does not explain the lack of convergence and 
that its proposed solutions are more likely to be harmful to 
the functioning of our markets than helpful.
    You asked us to answer five questions and to discuss the 
Subcommittee's recent staff report, ``Excessive Speculation in 
the Wheat Market.'' My written testimony provides extensive, 
well documented and reliable answers to those questions. I 
don't intend to use this limited time to restate those answers. 
Instead, I want to focus on our efforts to deal with the likely 
causes of the lack of convergence between futures prices for 
soft red winter wheat and the reported bid prices for that 
commodity.
    In our efforts to eliminate this divergence, we share a 
common goal with the Subcommittee. We differ only on how to get 
there. We absolutely agree with the Subcommittee's concern that 
the lack of convergence impairs the value of our market and it 
needs to be corrected. We share the concern of knowledgeable 
economists who have examined this market and who have carefully 
reviewed the Subcommittee's report that the evidence produced 
in support of the conclusion that index traders are the 
principal cause of the lack of convergence and persistent 
contango has not been validated by any of the statistical 
measures that are accepted by experts in the field. Our 
analysis of some of the report's conclusions is included in my 
written testimony.
    In particular, we are concerned with the measure of cash 
price used to calculate the value of the cash and futures 
converge. Neither the price of the actual transactions nor the 
midpoint of actual purchases and sales was used. Instead, the 
report used a national average price as represented by the 
MGEX-DTN soft red winter wheat index as the cash market price. 
Basis was then calculated as a futures price minus the MGEX 
software index price. At best, this number represents the price 
at which some elevators, most outside the delivery area, claim 
they were prepared to purchase during a relevant period.
    The choice of this measure does not reflect true delivery 
market economics. Economists and traders expect futures prices 
to converge to the price of the cheapest to deliver based on 
location and grade. There is no theory supporting the implicit 
claim that futures prices will converge to the average 
hypothetical offer prices in multiple locations.
    We are concerned that the report's focus of blame on index 
traders and speculators directs attention away from appropriate 
efforts to identify any structural problems with the contract 
specification and impairs our ongoing efforts to cure the 
problem by fixing those terms. Assigning responsibility for the 
convergence problem to the wrong cause will only delay its 
solution and may result in greater problems.
    The Chicago Board of Trade has implemented very significant 
changes to the delivery specifications of the soft red wheat 
contract. We have acted in accordance with our obligations 
under the CEA respecting the timing of changes to enumerated 
futures contracts with open interests and have attempted to 
take account of the suggestions of all segments of the industry 
to whom this contract is important. We have also implemented 
the changes in an orderly fashion so that we will have 
sufficient time to judge their effectiveness and so that we do 
not in haste overshoot the market and risk damaging the 
liquidity on which the market users depend.
    We have authorized a wide-ranging addition of delivery 
points and facilities. We had 58 new locations for delivery 
that will provide an additional 90 million bushels of capacity 
on the Ohio and Mississippi Rivers and in a 12-county area of 
Northwest Ohio. We expect that this will relieve any congestion 
issues that prevented arbitrage from driving the convergence 
within historic ranges and better align our delivery locations 
with the primary flow of soft red winter wheat in the domestic 
cash market into the New Orleans Gulf for export. Similar 
changes made to the corn and soybean contracts in 2000 greatly 
enhanced the performance of these contracts and we expect 
similar results from these changes in the wheat contract. We 
have also implemented seasonal storage rate adjustments that 
are intended to incent shorts who want deliverable wheat or who 
can acquire deliverable wheat to make delivery when the basis 
moves to unjustifiable differentials.
    The higher futures storage rate during the July-December 
period reflects the higher seasonal storage rates in the cash 
market when wheat that has just been harvested competes with 
the upcoming corn and soybean harvests for storage space and 
will allow wider carrying charges, if needed, throughout the 
country elevator system for producers with on-farm storage. The 
higher futures storage charges will also encourage buyers who 
stand for delivery and must pay the storage rate to the seller 
to either load out or redeliver the wheat, both of which will 
enhance convergence.
    On September 1, a reduced level of allowable vomitoxin will 
be implemented which will convert the contract from a feed-
grade wheat contract to a human consumption grade. We expect 
that this change will have a positive impact on convergence for 
the following reasons. The estimated cash market discount for 
wheat with four parts per million of vomitoxin is 12 cents per 
bushel and that differential will be applied to four parts per 
million wheat delivered against futures contracts. Par delivery 
will require no more than three parts per million of vomitoxin, 
which is expected to improve the cash futures relationship by 
12 cents per bushel.
    The second reason is the industry standard for vomitoxin in 
the domestic milling and export markets is two parts per 
million, and we will implement this level in delivery 
specifications for the futures contract in September 2011, with 
three parts per million remaining deliverable at a 12-cent--
actually, it is a 12-cent discount, at four parts per million, 
a 24-cent discount. This final change in the quality 
specifications for the wheat contract will align our par 
quality specifications with industry standards while providing 
the flexibility to deliver lower-quality wheat at a significant 
discount when higher quality is not available.
    It is possible that we will see some significant 
improvement in contract performance by mid-September and 
certainly by the end of the year. The basis has already 
strengthened. It was $2 last year, and as we have seen, the 
charts have gotten better, and as we checked it today, it was 
somewhere around 80 under, so----
    If the results fail to meet our expectations, we have 
additional modifications at the ready and are prepared to 
continue to modify the contract or to introduce a new contract 
to provide a safe and effective environment to permit producers 
and users to hedge their needs and to provide effective price 
discovery to the remainder of the market. We respectfully 
suggest that this is a more reasoned approach than the one that 
discourages market participation with the attendant risk of 
damage to market liquidity.
    We are committed to dealing effectively with the lack of 
convergence by attacking the structural problems regarding 
specifications in delivery. In this regard, we are aligned with 
the report's recommendations. We do not, however, believe that 
restrictions on index traders beyond those that we already 
impose are anything but a distraction from our efforts.
    Thank you very much.
    Senator Levin. Thank you very much, Mr. Carey.
    Exhibit 1,\1\ which has been put up, and I think it is in 
your book, if we could put that up again, tracks the number of 
wheat futures contracts purchased by commodity index traders 
from 2004 to 2009. We obtained this data from the CFTC on index 
trading in the wheat market. It shows that commodity index 
traders have dramatically increased their purchase of wheat 
futures from 30,000 contracts in 2004 to 220,000 in 2009. You 
have indicated in your prepared statement that from 2006 to the 
present, the percentage of long open interests held by 
commodity index traders fluctuated between 51 percent in 
January 2006, to 32 percent in October 2006. The most recent 
data for July indicates the percentage to be 46 percent.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 1, which appears in the Appendix on page 425.
---------------------------------------------------------------------------
    So I am correct, I believe, that you agree as a factual 
matter that since 2006, commodity index traders have typically 
held almost half of the outstanding wheat futures contracts on 
the Chicago Exchange, is that correct?
    Mr. Carey. Yes, sir.
    Senator Levin. Would you also agree that prior to 2004, 
commodity index trading was not a big factor on the Chicago 
wheat futures exchange?
    Mr. Carey. Commodity index trading?
    Senator Levin. Yes, in the Chicago wheat futures prior to 
2004.
    Mr. Carey. It has experienced tremendous growth. We didn't 
have numbers prior to 2006, but according to these numbers, 
yes.
    Senator Levin. So you would agree that it was not a big 
factor prior to 2004?
    Mr. Carey. But it existed. To what extent, I don't have the 
numbers.
    Senator Levin. Do you believe that it was a big factor 
prior to 2004?
    Mr. Carey. No. I would expect that this chart is pretty 
accurate.
    Senator Levin. All right. Now, Exhibit 3 \2\ is a chart 
showing the basis or the gap between the futures and the cash 
prices for wheat on the expiration date for each of the five 
wheat contracts that were traded on the Chicago Exchange from 
2005 to 2008. We obtained the final futures prices on the last 
day of each contract, then went to data compiled by the U.S. 
Department of Agriculture showing what the cash price was on 
that day in Chicago. The U.S. Department of Agriculture 
obtained its cash prices by asking elevators in the Chicago 
area to report their bids to buy wheat on that day. It then 
produced a daily price report which is available on its 
website.
---------------------------------------------------------------------------
    \2\ See Exhibit No. 3, which appears in the Appendix on page 427.
---------------------------------------------------------------------------
    Would you agree that this data shows a significant jump in 
the basis since 2006?
    Mr. Carey. Absolutely. Yes. There has been a lack of 
convergence, which is what we are trying to tackle right now.
    Senator Levin. Right. So you would agree that the basis, 
the price gap, is larger than has been historically the case, 
is that correct?
    Mr. Carey. Yes, sir.
    Senator Levin. Now, were there changes in the contract that 
were made between 2004 and 2009?
    Mr. Carey. Well, recent vomitoxin changes. I can't remember 
the first time we went from five to four, but now we are going 
from four to three. But most of the changes have just taken 
place in the most recent July contract, sir.
    Senator Levin. And yet we see this major change in the 
basis while the same contract was in effect, is that correct?
    Mr. Carey. Yes, sir.
    Senator Levin. So it can't be that the contract is the 
problem, or can it be?
    Mr. Carey. Well, it could be.
    Senator Levin. You say no expert says, for instance, that 
the increase in investment by index traders is the cause of the 
lack of convergence. You said no expert says that.
    Mr. Carey. According to the reports that we had, that might 
have been a factor. But the reports----
    Senator Levin. It might have been a factor?
    Mr. Carey. Some part of it. I think there were other 
factors, too, as we recognize.
    Senator Levin. How big a factor is it?
    Mr. Carey. I would leave that to the experts, and they 
didn't----
    Senator Levin. Well, we had three experts here today. We 
had one who was the head of the Commodity Futures Trading 
Commission. He said it is a factor. We then had the elevator 
operators representative here, Mr. Coyle, who said it is 
probably the principal, almost the exclusive factor. I would 
think he is an expert. He knows firsthand. Mr. Wands, of 
American Bakers, says that it was a significant factor in the 
lack of convergence. Are they not experts? They are out there 
every day in that area of work, are they not?
    Mr. Carey. They have an opinion.
    Senator Levin. Is it an expert opinion?
    Mr. Carey. From where they stand.
    Senator Levin. And they say that index trading is either 
exclusively or significantly a cause, or in the case of Mr. 
Gensler, a cause in the lack of convergence. And would you 
agree with any of those experts?
    Mr. Carey. Would I agree with them? Not exclusively. We all 
have our own opinion. I would say that we have a global 
benchmark and a correlation of 92 to 96 percent to world wheat 
prices and that is why we are tackling the design issues, sir. 
And I think that they have the opinion that this is the cause, 
the sole cause. I believe that there are a fair amount of 
causes to create this lack of convergence.
    Half of the conversation I heard today revolved around 
volatility versus lack of convergence. So there were a lot of 
issues being discussed and debated here, but this is a cause 
and I would agree with Mr. Gensler. It is a cause, but it is 
not exclusive.
    Senator Levin. Well, the only one who said it was 
exclusive, and that was the first time he testified, the first 
time around, was Mr. Coyle, and then he said a principal cause. 
I don't think anyone ended up saying it is an exclusive cause. 
Is it a significant cause, and if it is a significant cause, it 
seems to me something has got to be done about it. We have 
either got to get position limits back on, or we have to do 
something which addresses that part of the cause.
    Now, if the contract is part of the cause, you will find 
out pretty soon, won't you?
    Mr. Carey. Yes, sir----
    Senator Levin. By when?
    Mr. Carey. Well, we heard Mr. Coyle, who is more involved 
in the cash grain market on a daily basis than I am, but he 
said that he would give it a couple of delivery cycles, and the 
vomitoxin change is September, and he said that he would hope 
within this cycle. And I think we are working hand-in-hand with 
him. We have a similar interest. Convergence is key and 
providing contracts that work is key. I think we also share the 
same opinion that just limiting participation without examining 
the problem and fixing the problem. If that is the sole 
problem, fine. But we want to remain a problem as the global 
benchmark for commodity trading and we want this convergence 
issue to be handled properly.
    Senator Levin. Well, I am glad to hear you acknowledge at 
least that it is a contributing factor. That is more than we 
got out of your printed testimony. Where in your printed 
testimony does it say it is a contributing factor to the lack 
of convergence?
    Mr. Carey. I don't believe it says that in there.
    [Pause.]
    Senator Levin. You said you should know whether any changes 
in the contract have a significant effect on the convergence 
issue and that would be two cycles, is that what you said?
    Mr. Carey. Well, we are coming up to one more change in 
September, sir, and we hope to get through. I would echo Mr. 
Coyle's remarks that we need to go through a couple of delivery 
cycles, whether it is December or whether it is March delivery. 
By that time, we should know whether or not this convergence is 
going to take place with these changes or if additional changes 
need to be put in. I believe that our staff is working with the 
Commission and with the industry to come up with a solution 
that does place convergence at the forefront of our changes.
    Senator Levin. Thank you very much. I will be right back.
    Mr. Carey. Thank you.
    Senator Coburn [presiding]. Well, thank you for your 
testimony. You all do want the convergence problem fixed?
    Mr. Carey. Absolutely.
    Senator Coburn. It is not really good for your business in 
the long term, is it?
    Mr. Carey. That is correct, Senator.
    Senator Coburn. It is not good for you as a market, either, 
is it?
    Mr. Carey. That is correct, Senator.
    Senator Coburn. So people are going to start loading out of 
CME to somewhere else in the world if it is not fixed?
    Mr. Carey. Yes, they will find another place. I think I 
disagree with ideas in some of the testimony that took place, 
that money can't move offshore or to different marketplaces. 
Today, the Dalian Exchange in China trades more volume than the 
Chicago Board of Trade soybean, meal, or oil contract. Today, 
there is a wheat contract in France. I know that there has been 
rhetoric that says they are going to suppress this excess 
speculation, but I will tell you to look at what is going on in 
the world. There was an article Monday morning that oil trading 
is growing in London, where it doesn't agree necessarily with 
what we are hearing. So yes, I think that we have to recognize 
that we live in a global environment.
    Senator Coburn. And do you agree with the gentleman from 
Goldman Sachs that people are looking to invest in assets that 
are hedging for their future and that one of the things they 
invest in is commodities, both hard and soft commodities? Do 
you agree with that?
    Mr. Carey. Clearly. These swaps dealers exemptions, most of 
them aren't speculators. Most of them are investors.
    Senator Coburn. OK. I am going to ask you a question as if 
I were a purist. If we have commodity markets, we have 
producers and we have end users, but those markets never really 
function very well unless you have a certain amount of 
speculators in there to help create the market, is that 
correct?
    Mr. Carey. That is true.
    Senator Coburn. There is no question, and you would agree, 
I believe, that we have had a marked increase in activity in 
speculation, either through index funds or some other way, on 
these commodities?
    Mr. Carey. We have had an increase in interest. We have had 
some extreme volatility, and we have had some very unusual 
situations that I think were a big part of the cause of this 
volatility, whether it is the ethanol you cited or whether 
these investors are coming into this area for a reason.
    Senator Coburn. Right. And so the gentleman from Goldman 
Sachs said he didn't think position limits would solve the 
problem for a couple of reasons, and extrapolating from what he 
said, do you agree that there will be just more firms with 
smaller positions that will do more of that that ultimately 
might have more damage to the market, as he testified?
    Mr. Carey. Yes, they could. The fact of the matter is, I am 
more concerned about exporting a business that we have here in 
the United States than I am about how people are going to try 
to access these markets.
    Senator Coburn. But if they can't access your market, then 
you are not going to be able to export that business.
    Mr. Carey. No, what I am saying is that somebody takes the 
business offshore----
    Senator Coburn. Yes.
    Mr. Carey [continuing]. Or into a dark pool of liquidity, 
because investors will seek the marketplace and that asset 
class in a different way.
    Senator Coburn. The profitability--and I want to be fair in 
this hearing and I think the Chairman will agree--there is no 
question you have a financial interest in increased trading on 
your exchange, correct?
    Mr. Carey. Yes, but we also know that if there is no 
integrity in our contracts, that people will leave. But yes, 
clearly, we get paid fees per contract.
    Senator Coburn. So if we eliminated tomorrow all index 
trading on your exchange, that would have a significant 
financial impact on CME Group?
    Mr. Carey. Yes. Clearly, it could have some impact.
    Senator Coburn. I want to go back to this idea of 
convergence. I believe it is multifaceted and I believe index 
does have something to do with it. Tell me what you think are 
the factors that you have identified, as consistent with your 
testimony and anything else, that you think are the factors 
that have led to this lack of convergence. What do you think is 
going on? I mean, just flat out, what are all the variables 
that you all see, and after you tell me those, what do you see 
as the answer to fixing that? I know we have talked about the 
timing of getting some of these changes through, modifying the 
contract, but what do you see as the factors that are 
influencing this lack of convergence?
    Mr. Carey. Well, I think that it was identified here by 
both Mr. Gensler and Mr. Coyle, in that it is a 400-million-
bushel crop this year. It was 600 million bushels last year. 
Yet people come here because it is the global benchmark and it 
is where the liquidity is and so people want to trade it. And 
so we correlate more to a world price than we do to a Toledo or 
Chicago price, and so this is what is causing some problems in 
the marketplace and we have to find a way to bring convergence. 
But we are a financial services company and we want to be able 
to offer these products to the world. We want to remain the 
global benchmarks for grain trade.
    Senator Coburn. So one of the problems, you think, is 
because you are trying to----
    Mr. Carey. It is contract design, sir, and deliveries and 
these are the things that we are addressing.
    Senator Coburn. And you told the Chairman that you think 
that index does have some influence on it?
    Mr. Carey. Yes, obviously, we have----
    Senator Coburn. So we have contract design and index 
trading. What else?
    Mr. Carey. Well, I think you had a period of tremendous 
volatility caused by factors, not just by speculation, but by 
world factors. The fact that last year, the wheat stocks in the 
world were the lowest since 1947, with the Marshall Plan. They 
were 60-year lows, and that is when President Truman was pretty 
angry about trading in wheat futures. So I think that and the 
ethanol pulling acres out of wheat production, I think we 
suddenly ran into the worst planting conditions last spring on 
top of energy prices, and we don't control our destiny when it 
comes to energy prices in this country, so that while there can 
be short-term surpluses and we look at these reserves, the 
world knows that we don't produce enough oil to support our 
demand over time.
    So there are a lot of factors that would lead people into 
investing, but overall, there is still a fair amount of open 
interest in these contracts by these investors that we are 
talking about, and yet the markets have come down dramatically. 
So I think the markets are trying to work.
    Senator Coburn. Well, I would add a fifth factor. One of 
the reasons people were investing there is fear of not getting 
a return in other investment vehicles.
    Mr. Carey. Absolutely.
    Senator Coburn. So we listed five, fear of not getting a 
return, ethanol and the shift in plantable acres, decreased 
worldwide reserves, index trading, and contract design. So are 
you all looking at the things that you can have a play on, the 
things that you can influence, do you have a plan, a design so 
that you address the ones that you can address?
    Mr. Carey. We do, and we are meeting with the Commission 
and we are meeting with the industry and it goes back over a 
year. When we went to $12 or $13 a bushel in Chicago and 
farmers couldn't sell, part of it was the banking crisis at the 
time. It was a strain that nobody had anticipated----
    Senator Coburn. And the elevators couldn't borrow money to 
buy wheat.
    Mr. Carey. That is right, and suddenly the only place 
people could go was to the futures market, and so they went to 
the futures market. And so it took some time for this to settle 
down. But the market has converged. It has come back 
dramatically and we hope the changes will have it converge even 
better so that these kinds of problems don't exist for these 
short hedges, because there was----
    Senator Coburn. Well, I was just going to point to that 
chart. We are now--I think the end one on the last contract 
there was what, $1.20?
    Mr. Carey. It could be. It was a little bit--yes, it is 
between----
    Senator Coburn. And we are now, 80 cents?
    Mr. Carey. Yes, somewhere between 80 and a dollar.
    Senator Coburn. What would you expect the convergence to be 
after these next two contracts close?
    Mr. Carey. I would hope it would be well under 50 cents or 
40 cents. You have to take into account that prices are higher, 
the dollar is lower. All these things have taken place since 
these charts were first drawn.
    Senator Coburn. But that is still historically very high, 
you agree?
    Mr. Carey. It is high, but the price went up because of the 
other problems. The fact that it is fulfilling, I think whoever 
said that should look at the price of grains today, and look at 
the price of corn today, because it is not a self-fulfilling 
investment. It just is not.
    Senator Coburn. All right. Mr. Chairman, thank you. I 
appreciate this hearing.
    Senator Levin [presiding]. Thank you very much, Dr. Coburn.
    Let me close by thanking, first of all, our last witness. 
Mr. Carey, thank you for coming.
    We obviously have identified a problem here that the amount 
of index trading has created volatility, has contributed, many 
think in a major way, but has contributed, I think, by 
consensus to the lack of price convergence. That has had a very 
negative effect on a whole host of people. It doesn't have to 
be that way.
    The CFTC has told us they are going to review these 
exemptions and waivers to see if they should be eliminated, and 
we look forward to that. That is going to happen hopefully in 
the next few months. Also in the next few months, you are going 
to redesign or continue to redesign your contract, Mr. Carey. 
We are going to see what kind of effect that has.
    And then there is the financial reform bill which is in 
Congress to regulate over-the-counter and derivative dealers, 
and that all is going to come into play in the fall, as well. 
So a lot of things are going to converge. There may not be 
price convergence in your wheat market, but there is going to 
be convergence of a lot of factors in the fall.
    We may have additional questions for our witnesses, so we 
will keep the record open for 10 days.
    We very much appreciate the cooperation of all of our 
witnesses and the hearing is adjourned.
    [Whereupon, at 5:49 p.m., the Subcommittee was adjourned.]


                            A P P E N D I X

                              ----------                              


                PREPARED STATEMENT OF SENATOR MCCASKILL

    I want to first thank the Subcommittee for their truly 
comprehensive investigation and leadership on this issue. This 
report hits home. For over the past year I have received 
numerous calls from farmers across Missouri who are seeing 
their livelihoods fade. Now volatility is nothing new in Ag 
markets, and frankly investment interest in the wheat markets 
does help to provide price discovery. But from 2007 to 2008 the 
average daily basis for wheat traded on the Kansas City Board 
of Trade rose by 51 cents per bushel. During 2008, the maximum 
basis reached to about 90 cents. The market just doesn't seem 
to be working and as the gap between futures and cash prices 
widens, the chances for our farmers to get a fair shake quickly 
declines. In this economy, price convergence is essential.
    My farmers are telling me that right now the price is 
holding at $5.42 a bushel--the grain elevator takes $1.20 and 
minus the cost of seed, fertilizer, rent, etc., they're losing 
about $50 per acre. Multiply that by 3,000 acres or so and 
that's a lot of money. The negative basis was much higher this 
time last year--as much as $ 2.29. What it boils down to is 
that this money comes out of the pocket of the farmer. It's 
been likened to just giving away a third of your crop.
    As long as the negative basis keeps increasing, so does a 
farmer's ability to turn a profit. Ultimately, if the vicious 
cycle continues, farmers are saying they just won't plant as 
much wheat. That's clearly not a solution any of us are looking 
for.
    I know I don't have to remind my colleagues it's not just a 
Missouri issue. Price convergence is critical for farmers to 
stop treading water everywhere.
    I implore the CFTC to work with the relevant exchanges and 
find sensible ways to establish convergence in the market. 
Missouri farmers need help and they need it quickly. With 
escalating input prices and the extreme volatility in these 
markets our farmers must have a quick solution.
    Thank you again for the Subcommittee's work. I'll be 
interested in hearing from the panels on how we can come to a 
compromise to restore natural order to these markets.

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