Quick, which regulatory agency are Wall Street’s biggest banks most worried about right now?
If you answered that it must be the Securities and Exchange Commission, your response, while logical, is inaccurate. You’d also be wrong if you answered the Commodity Futures Trading Commission, the SEC’s sister organization policing the market for futures, options and most kinds of commodities trading, although you would be slightly warmer. The correct answer is a body best known for overseeing the construction of new pipelines and regulating rates of return at utilities: the Federal Energy Regulatory Commission, or FERC.
Wall Street became subject to the FERC, as well as the better-known financial industry overseers, as the deregulation of the energy market spread into the world of electrical power generation and transmission. Suddenly, as well as trading futures contracts on crude oil and natural gas, Wall Street institutions as well as companies in the energy business could trade electricity futures.
All too rapidly, however, it became clear that just because it was possible to make a profit from doing this didn’t mean it was necessarily a good idea. The ability to trade led to the temptation to run amok – a familiar Wall Street relationship – and a toxic combination of a shortage of generating capacity in California (caused by delays in regulatory approval of new power plants), uneven deregulation, market manipulation and other factors led to an 800 percent increase in wholesale power prices over the course of 2000, and even generated rolling blackouts in California.
One of California’s largest utilities, Pacific Gas & Electric, filed for bankruptcy as a result; the other, Southern California Edison, narrowly avoided that fate. And Enron first went from being just another big player in the energy industry to being infamous for its misdeeds.
When David Freeman, as head of the California Power Authority, testified to Congress in 2002 about the state’s electricity crisis and Enron’s role in causing it, his words should have been engraved somewhere for regulators and Wall Street institutions to ponder.
“Electricity is really different from everything else,” Freeman said. “It cannot be stored, it cannot be seen, and we cannot do without it, which makes opportunities to take advantage of a deregulated market endless. It is a public good that must be protected from private abuse. If Murphy’s Law were written for a market approach to electricity, then the law would state 'any system that can be gamed will be gamed, and at the worst possible time.' And a market approach for electricity is inherently game-able. Never again can we allow private interests to create artificial or even real shortages and to be in control.”
The FERC is now arguing some Wall Street institutions have been doing just this yet again. The regulatory body has levied a $435 million fine – a record – on Barclays PLC (NYSE: BCS), claiming that the bank and its traders manipulated the price of electricity prices in California and other markets to ensure that it generated a profit on its own positions in the electricity futures market. And another fine, one that is larger still, may be in the offing: JPMorgan Chase (NYSE: JPM) is said to be haggling with the FERC over an agreement that would settle a raft of similar allegations. (Barclays has said the FERC’s allegations are unfounded and that it will fight the matter in a federal court rather than pay the fine.) In another case, FERC collected $1.7 million in fines from a division of Deutsche Bank. Once again, the misdeeds involved the California electricity market, this time in 2010.
When it announced its second-quarter results this month, JPMorgan Chase revealed that it was able to recoup some of the money that it had set aside in case of losses on its portfolio of loans, helping to boost its second-quarter profits. But in a less-remarked on move, the bank also set aside $600 million more to bolster its litigation reserves. Market chatter pins the eventual size of the fine (assuming the two sides reach an agreement) at less than that, but the bank’s legal costs are mounting, too.
FERC contends that JP Morgan traders sold electricity generated by plants in both California and Michigan, but used misleading tactics to get commitments on the part of purchasers of that power, and ended up collecting “excessive” payments in the order of $83 million. Just as serious as these allegations is the FERC’s claim that some of the bank’s senior executives gave “false and misleading” statements under oath.
The FERC has grown teeth since the California energy crisis and is intent on showing that it is willing to use them. Some of its new powers are industry-specific: the Commission has new and stronger powers when it comes to ensuring the reliability of the nation’s transmission system (thanks to the Energy Policy Act of 2005; no one wants a repeat of the blackout of August 2003 in the U.S. Northeast). The same regulations gave the FERC the power to keep tabs on energy markets and apply civil penalties to anyone it believes violate its rules. And those penalties aren’t chump change: The agency can impose a fine of $1 million per violation, per day. That’s a bit more daunting that the previous scale, which topped out at $10,000 per violation, total.
Since the 2000 crisis, the California energy market hasn’t been cast back into the same kind of turmoil that it had endured, and while every heat wave still raises fears of blackouts or brownouts, that has more to do with weather and consumer behavior than it does to manipulation of the power market. Clearly, however, the FERC has taken to heart Freeman’s words that electricity is “a public good that must be protected from private abuse” on the part of financial institutions whose mandate is to generate profit for their shareholders.
Sometimes, when something greater is at stake – the integrity of a specific market, or the financial system as a whole – the pursuit of the maximum possible profit on the part of individual financial institutions needs to take a back seat. It’s unlikely that bank CEOs or their managers will ever share this view, or believe that some of their actions risk jeopardizing some of these “greater goods.” But that’s where the FERC – and other regulators – prove that they play a valuable role in the broader system of checks and balances protecting our vital institutions.
