Would a Fed Surcharge on Warehouse Operators Create a Flood of Aluminum?

Earlier this week, the Fed announced it will consider placing a surcharge on banks with physical commodities businesses. For aluminum buying organizations closely following the LME warehouse saga (see our previous coverage here, our aluminum warehouse scheme info graphic here, and our most recent story on that here), this surcharge, if implemented, could impact aluminum prices along with load-out times, MW premiums and general aluminum supply via the LME system. We asked our own resident aluminum expert, Stuart Burns, to comment on the Fed’s most recent move:

MetalMiner: Does a Federal Reserve surcharge seem like a good solution in terms of a disincentive for banks to get involved in commodities markets?

Stuart Burns: If the object of the action is to dissuade the ex merchant banks from holding commodity assets, whether they be large positions or ownership of supply chain assets such as warehouses, then the surcharge sounds like a wonderful way to do just that. It can be dressed up as a capital reserves surcharge, a measure of the risk the banks are perceived to face by holding such assets and as such is consistent with Basel capital requirements.

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MM: It seems like the Fed would have no legal authority to levy any kind of surcharge on banks. How have central banks worked in other countries with regard to taxing schemes as a form of policy intervention?

SB: As Goldman Sachs and JP Morgan both own warehouses in Europe, I suspect the Fed serves as lead on this issue, and Europe, for example, does not have any method for taxing or controlling such activity.

MM: According to the Wall Street Journal article, “To avoid a bifurcated regulatory situation where some banks can own commodities while others can’t, the Fed is considering a surcharge that would make sure all banks are holding the appropriate capital to account for potential risks posed by the assets they own or lease.” Doesn’t this miss the point in terms of the banks’ double-dipping in which they have ring seats and trade in the underlying metal as well as warehouse the metal? I mean, isn’t that the real conflict of interest?

SB: It seems to me the Fed is using this technique to tackle the ex merchant bank’s involvement in this market activity. They can’t legally outright ban it, so they have come up with this plan as a method of making it unattractive. The Fed recognizes the ex merchant banks’ role is not a constructive one – it’s what to do about it that they are noodling over here.

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We will continue this interview in a follow-up post.

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