For those readers who are enrolled in frequent flier programs, you have probably received an electronic letter that makes allegations of "excessive ... unchecked market speculation and manipulation." The CEOs of 12 major carriers have jointly signed this letter, which apparently are being sent to all regular customers. (The electronic letters I received from United and Delta are online here and here. If you had not receive such a letter, check your spam filter.)
To my mind, this letter is extraordinary because (a) the CEOs, who are busy people, are acting in concert, (b) the letter contains empirical claims that involve serious allegations of market manipulation, and (c) the CEOs frankly state that current federal oversight is completely ineffectual. In their own words:
[N]ormal market forces are being dangerously amplified by poorly regulated market speculation.
Twenty years ago, 21 percent of oil contracts were purchased by speculators who trade oil on paper with no intention of ever taking delivery. Today, oil speculators purchase 66 percent of all oil futures contracts, and that reflects just the transactions that are known. Speculators buy up large amounts of oil and then sell it to each other again and again. A barrel of oil may trade 20-plus times before it is delivered and used; the price goes up with each trade and consumers pick up the final tab. Some market experts estimate that current prices reflect as much as $30 to $60 per barrel in unnecessary speculative costs.
Over seventy years ago, Congress established regulations to control excessive, largely unchecked market speculation and manipulation. ... [O]ver the past two decades, these regulatory limits have been weakened or removed.
The usual defense of speculators is that they add liquidity to the market, which permits stability in pricing. Although I believe that market forces often have a immensely curative power, my position is not ideological. It is empirical and sensitive to the facts of each situation. (For the record, I see too much ideology in the academy. This tendency causes intelligent people on both the left and right to gather facts to support a theory they love. This is totally backwards; facts should drive theory. But that rant is for another day.)
The SEC has a long record of aggressive enforcement of market manipulation in the securities market. The rapid emergence of the hedge fund industry represents a major challenge to the SEC because, frankly, the agency is still grappling with how these heavy traders influence the market. The Long Term Capital Management debacle, which involved Nobel Prize winners as principals, remains a cautionary tale that rightly worries the SEC.
In recent years, however, hedge funds have increasingly migrated to the commodity markets. In the oil markets, the regulator is the Commodity Futures Trading Commission (CFTC). In our article, From Insull to Enron: Corporate (Re)Regulation after the Rise and Fall of Two Energy Icons, Judge Cudahy and I examined Enron's lobbying efforts to influence how the emerging electricity market would be regulated. We were left with the impression that the company, and its industry peers, were quite successful in holding off aggressive CFTC regulation; between the SEC, the FERC, and the CFTC, the latter was viewed as the most friendly venue. A few years later, it was revealed that Enron traders were at least partially responsible for the huge price spikes in the California electricity markets. That debacle saddled California taxpayers with a huge bailout bill and effectively ended deregulation in California.
I don't have any answers on the alleged manipulation in the oil markets. But these are important questions. Because of the network economics of the airline industry, the major players are saddled with high fixed costs in the form of airplane leases and hub charges. So they routinely operate at a loss in the hope that occasional boom times will provide a modest offsetting profit. But wildly fluctuating variable costs, such as rising fuel prices, can push these companies over the brink. Hence, this extraordinary letter pleading for adequate federal regulation.
In the comments, please spare me the observation that the airlines could have locked in cheaper fuel costs through long-term contracts; a few airlines did this, while others missed the boat. In the airline industry, LT contracts can be a brutal double-edged sword. And by definition, an entire industry is unlikely to make the right bet. Someone has to get the short end of the deal. It may not be reasonable to expect airlines to outsmart hedge funds.