By Douwe Miedema and David Sheppard
WASHINGTON/NEW YORK (Reuters) - Wall Street's multibillion-dollar commodity trading operations came under the political spotlight on Tuesday as a powerful Senate committee questioned whether commercial banks should control oil pipelines, power plants and metals warehouses.
The Senate Banking Committee hearing comes as Goldman Sachs, Morgan Stanley and JPMorgan Chase - which generated an estimated $4 billion in commodity revenues last year - face growing pressure from a number of investigations into their operations, and as the Federal Reserve reviews Wall Street's right to operate in raw material markets.
Big aluminum buyers represented by MillerCoors, the second largest brewer in the U.S., told the packed hearing that the banks' control of metal warehouses that are part of the London Metal Exchange network drove up their costs by as much as $3 billion last year by distorting supplies.
JPMorgan and Goldman Sachs, which bought LME warehouses in 2010, "have created a bottleneck which limits the supply of aluminum," Tim Weiner, global risk manager for the brewer, the combined U.S. operations of Molson Coors and SABMiller, told the U.S. Senate banking committee.
The banks were not present at the hearing, but as it got underway Goldman Sachs issued its first public rebuttal of mounting criticism of its metals warehousing unit, denying that Metro International Trade Services has deliberately caused aluminum shortages and inflated prices.
The threat to Wall Street's physical commodity trading divisions has escalated abruptly across multiple fronts, putting an uncomfortable spotlight on a lucrative side of their business that has thus far fallen largely outside of regulators' sights.
Lawmakers also took the opportunity to criticize the Federal Reserve for allowing banks to expand their commodity activities, and once again questioned the wisdom of scrapping the Glass-Steagall law that separated corporate and investment banking, a decision that helped open the door to commodity dealing.
"We've have created a tangle and it takes time to undo that," said Senator Elizabeth Warren of Massachusetts, a Democrat. She said her recently introduced "21st century Glass Steagall" bill would help to "disentangle what has become a mess that is both hard to regulate and is creating additional risk."
Sherrod Brown, Democrat for Ohio, said after the hearing the Senate Banking Committee will ask the banks and the Fed to give testimony at another hearing in September.
WALL ST FRUSTRATIONS
Last Friday, the Fed raised the stakes dramatically, issuing a surprise statement to say it was reviewing a landmark 2003 ruling that first allowed commercial banks to trade physical commodities such as gasoline barges and coffee beans. Until then, the Fed had been thought to be only debating whether or not certain banks could own assets, not trade the raw materials.
At issue is not whether banks should be allowed to trade derivatives like corn futures or oil options, but whether they should be allowed to invest in infrastructure such as tankers and warehouses that can be integrated with their trading operations - and more broadly whether they should be allowed to continue holding title to the underlying physical commodities.
The Senate hearing will increase pressure on the banks commodities businesses at a time of growing frustration in Washington over the failure to complete reforms meant to prevent "Too Big to Fail" banks from endangering the wider economy.
Last week, the Commodity Futures Trading Commission (CFTC) also launched the opening salvo of a possible enquiry into the lucrative but controversial business of metals warehousing, which has become a potent political lightning rod.
Over the following years, a glut of aluminum and other metals piled up in these storage sheds, forcing companies to wait as long as 18 months to take delivery of physical supplies, MillerCoors' Weiner said at the hearing.
JPMorgan is also reportedly close to a more than $400 million settlement with the Federal Energy Regulatory Commission (FERC), as the bank tries to put to rest allegations that its traders manipulated power markets in the Midwest and California.
The bank's alleged activity in those markets was linked to its control over real power plants and energy supplies, a fact likely to sharpen questions over the rules for ownership.
The hearing was the first to address the oversight of banks in physical commodity markets since a Reuters report last year revealed that Goldman and Morgan Stanley were still awaiting a Fed decision on whether they can still own physical assets after becoming bank holding companies in 2008.
Commercial banks are prohibited from owning trading assets, but the two former investment banks argued that their commodity activities are permitted under a "grandfathering" clause in a 1997 law that effectively scrapped much of the Glass-Steagall act separating the commercial and investment banks.
The Fed has until a mid-September deadline to make that decision, and has never commented on the issue - a lack of disclosure that has fueled criticism over its transparency.
"We've talked about a lack of transparency on both the regulators and the institutions, we don't even know what the regulators seem to be doing," said Brown.
Separately, JPMorgan - which as a commercial bank has never been allowed to own assets - is believed to have reconfigured its Henry Bath metal warehousing business in order seek qualification as a "merchant banking" investment with the Fed, sources have said.
It is unclear whether that effort, which would require the warehouses to be managed at arm's length from the bank and divested within 10 years, was successful. JPMorgan has also floated a possible sale of Henry Bath, sources have said. The bank has declined to comment on the status of the unit.
Randall D. Guynn, a partner and head of the Financial Institutions Group at law firm Davis Polk & Wardwell, says the Fed's original 2003 decision to allow Citigroup Inc to trade physical commodities should not be lightly dismissed.
"Both Congress and the Federal Reserve have previously found that the public benefits of these activities outweigh their potential adverse effects," he said.
(Reporting by David Sheppard and Josephine Mason in New York, Douwe Miedema in Washington; Editing by Jonathan Leff, Marguerita Choy and Tim Dobbyn)