Commodities and Other Futures

Commodity "futures" are contracts to buy or sell certiin goods at set prices at a predetermined time in the future. Futues traditionally have been linked to commodities such as wheat, Ire-stock, copper, and gold, but in recent years growing amo~untiof futures have been tied to foreign currencies or other fittanial assets as well. They are traded on about a dozen comrmocity exchanges in the United States, the most prominent of whch include the Chicago Board of Trade, the Chicago Mercanile Exchange, and several exchanges in New York City. Chi-cagi is the historic center of America's agriculture-based industries. Overall, futures activity rose to 417 million contracts in 1997, from 261 million in 1991.

Commodities traders fall into two broad categories: hedgers and speculators. Hedgers are business firms, farmers, or indi­viduals that enter into commodity contracts to be assured access to a commodity, or the ability to sell it, at a guaranteed price. They use futures to protect themselves against unanticipated fluctu­ations in the commodity's price. Thousands of individuals, will­ing to absorb that risk, trade in commodity futures as specula­tors. They are lured to commodity trading by the prospect of making huge profits on small margins (futures contracts, like many stocks, are traded on margin, typically as low as 10 to 20 percent on the value of the contract).

Speculating in commodity futures is not for people who are averse to risk. Unforeseen forces like weather can affect supply and demand, and send commodity prices up or down very rap­idly, creating great profits or losses. While professional traders who are well versed in the futures market are most likely to gain in futures trading, it is estimated that as many as 90 percent of small futures traders lose money in this volatile market.

Commodity futures are a form of "derivative" — complex instruments for financial speculation linked to underlying assets. Derivatives proliferated in the 1990s to cover a wide range of assets, including mortgages and interest rates. This growing trade caught the attention of regulators and members of Congress after some banks, securities firms, and wealthy individuals suf­fered big losses on financially distressed, highly leveraged funds that bought derivatives, and in some cases avoided regulatory scrutiny by registering outside the United States.

The Regulators

The Securities and Exchange Commission (SEC), which was created in 1934, is the principal regulator of securities markets in the United States. Before 1929, individual states regulated secu­rities activities. But the stock market crash of 1929, which triggered the Great Depression, showed that arrangement to be inadequate. The Securities Act of 1933 and the Securities Exchange Act of 1934 consequently gave the federal government a preeminent role in protecting small investors from fraud and making it easi­er for them to understand companies' financial reports.

The commission enforces a web of rules to achieve that goal. Companies issuing stocks, bonds, and other securities must file detailed financial registration statements, which are made avail­able to the public. The SEC determines whether these disclosures are full and fair so that investors can make well-informed and real­istic evaluations of various securities. The SEC also oversees trad­ing in stocks and administers rules designed to prevent price manip­ulation; to that end, brokers and dealers in the over-the-counter market and the stock exchanges must register with the SEC. In addition, the commission requires companies to tell the public when their own officers buy or sell shares of their stock; the com­mission believes that these "insiders" possess intimate information about their companies and that their trades can indicate to other investors their degree of confidence in their companies' future.

The agency also seeks to prevent insiders from trading in stock based on information that has not yet become public. In the late 1980s, the SEC began to focus not just on officers and directors but on insider trades by lower-level employees or even outsiders like lawyers who may have access to important infor­mation about a company before it becomes public.

The SEC has five commissioners who are appointed by the president. No more than three can be members of the same political party; the five-year term of one of the commissioners expires each year.

The Commodity Futures Trading Commission oversees the futures markets. It is particularly zealous in cracking down on many over-the-counter futures transactions, usually confin­ing approved trading to the exchanges. But in general, it is con­sidered a more gentle regulator than the SEC. In 1996, for exam­ple, it approved a record 92 new kinds of futures and farm commodity options contracts. From time to time, an especially aggressive SEC chairman asserts a vigorous role for that com­mission in regulating futures business.