Senator HUDDLESTON. But your responsibility certainly goes beyond self-regulation.

Mr. BAGLEY. Yes, sir.

Senator HUDDLESTON. It goes to the point of providing regulation. Mr. BAGLEY. There are two facets, though. It is rather obvious. The act does specify a number of places that the primary obligation is upon the exchange and we have this oversight role, plus we have the power to change rules of the exchange.

You start in hopefully with a well-run and well-supervised selfregulatory system; otherwise, we might have to assign CFTC personnel to every licensee and follow him around and that obviously would be ungodly. So we have two areas to perfect; self regulation, give it a chance to be perfected. No. 2, to assert ourselves when need be.

Senator HUDDLESTON. Now, the same question again to you, in retrospect.

How do you rate the performance of the Commission and the New York Mercantile Exchange at the various steps in efforts to protect all parties involved in the trading of futures?

Mr. BAGLEY. Let me start with the last part of your question first. All parties involved, rather happily in this instance, were a relatively few number of parties and they were, I think, all professionals. Perhaps one reason we did not step in as we have for example in a number of instances where you have ongoing allegations of fraud by fly-by-night option operators; we step in and enjoin. That is a different world.

Here we have professional traders who apparently did not affect the marketplace from a consumer standpoint. So we looked at the situation in that context, appraising ourselves I would be repetitive-I will say quickly, we should have, No. 1, investigativeSenator HUDDLESTON. Let me interrupt you.

There is a vote going on that I almost overlooked. I am going to have to leave.

I would like to come back and complete your testimony before we break for lunch and save our final witness for after lunch.

[A short recess was taken.]

Senator HUDDLESTON. The subcommittee will come back to order. Mr. Bagley, we interrupted you right in the middle of responding as to whether or not the Commission used the power available to it to the fullest extent as it relates to the Maine futures trading actions.

Mr. BAGLEY. Without running on at great length, in the abstract, the answer to your question is no, in the sense that we had other clout, most of which I have already testified to, the power literally to close down the market and the power to provide trading for liquidation only and the power to declare an emergency.

For the reasons testified to, it was felt, with the assurances that we already had, that it would be better to allow the market to give that marketplace a chance to work out its own problems as happens in 999 times and the percentage is even better than that, out of 1.000; more specifically, what we could have done more realistically rather than close down the market, because again we cannot force somebody to trade if he will not trade out-there is no way of doing that.

But we could have delved into the supply situation to a greater

extent.

In retrospect, it might not have made any difference because if it was the motivation of the parties to play chicken with each other, stare each other down, and that last day, it did not matter if there was a supply.

No. 2, perhaps more importantly, we could have-I could have personally-which I did not-inserted myself to do a lot more heavy jawboning.

Senator HUDDLESTON. The strike force that you ordered into action May 27, I believe 2 days after the actual default, is it still proceeding?

Mr. BAGLEY. Yes, sir.

Senator HUDDLESTON. It is part of the investigation that you have referred to?

Mr. BAGLEY. Yes, sir.

Very quickly, we have three major operating divisions: division of economics, division of trading and markets, which works on rules and practices and, division of enforcement.

Mr. Schief is in charge of the overall strike force but he is borrowing people from the economics division and the trading and marketing division, I would estimate, although certainly not all of them all the time; we propably have about 20 people involved from Washington, New York, and Chicago offices in the investigation.

Senator HUDDLESTON. Can you keep the committee informed on the progress of this investigation?

Mr. BAGLEY. We will logistically. I do not think you want us to specifically, from the standpoint of our preliminary findings. Senator HUDDLESTON. That is correct.

Mr. BAGLEY. Yes, sir.

Senator HUDDLESTON. And what actions may be indicated by the investigation?

Mr. BAGLEY. Yes, sir.

Senator HUDDLESTON. There is one meeting that you have referred to and Mr. Levine referred to on April 30 at which a discussion was held as to what actions should be taken I believe I am correct in saying that your representatives were urging the exchange to take more specific action, even to the extent of contacting the traders themselves in trying to ascertain what their intentions were.

They made the same suggestion of you. Is this a buckpassing situation or is it just simply that the Commission was more able to carry out this kind of function?

Mr. BAGLEY. I think-I am sure it was the latter.

The exchange, as Mr. Levine testified, has no direct hook on the trader; the exchange may not even know who the actual customer is. The exchange has an order from a broker.

We have much more pervasive jurisdiction. We, for example, can bar a given trader, a customer, somebody out there in the real world, from trading. The exchange does not have that power. They only have power by virtue of their rules, by virtue of contract with their members.

So we had to take over that obligation and did.

Senator HUDDLESTON. Do you have reports from the traders to give you some idea of what their position is?

Mr. BAGLEY. Yes, sir.

Senator HUDDLESTON. You do that on a regular basis.

Mr. BAGLEY. Yes, sir.

Senator HUDDLESTON. Are you looking into any possible conflict of interest? Are there any brokers in May of 1976 potato contracts who are also executives or members of enforcement committees of the exchange?

Mr. BAGLEY. The answer is yes.

Senator HUDDLESTON. Are there also producers involved that may be members of the exchange?

Mr. BAGLEY. I am trying to remember whether there are any producers; and I personally do not know; but answering your question, we are certainly looking into that.

Senator HUDDLESTON. That is an area?

Mr. BAGLEY. That is an area of inquiry and also as I raised here a moment ago, it is perhaps an area of more broad collective action that we might want to take in the future to at least assure you, the Congress and the public, that there will be some independence of these boards that are constituted as self-regulatory entities.

Senator HUDDLESTON. Mr. Bagley, I believe that completes our questioning.

I again welcome you before this subcommittee for your first appearance since the Agriculture Committee passed the CFTC legislation and confirmed you.

Mr. BAGLEY. I have got to say that Dick Clark has had me up here a couple of times.

Senator HUDDLESTON. We hope

Mr. BAGLEY. Which I welcome and enjoy.

Senator HUDDLESTON. We hope as you do that this instance will prove to be a catalyst for the kind of activity that the CFTC was empowered to perform and that it will result in improvements in the entire process of futures trading.

The record will remain open for 7 days and we may very well submit to you further questions and request that they be answered in writing.

Mr. BAGLEY. Yes, sir.

Let me just respond by first of all obviously thanking you for your concern and then adding one thought.

The fact that I have been talking about exchange practices and about some of the deficiencies in these marketplaces should not be interpreted by anyone-I'm really talking to the public-interpreted as a broad allegation of deficiencies in these marketplaces: because from my first year's perspective, that is not the case, nor should the industry, the other exchanges, interpret my remarks as indicating that I do not want to continue some cooperative effort to bring better selfregulation into play.

I do not mean to lean on that, but without that cooperative self regulation, we would have to increase our capacity 20-fold and I do not know that we are going to be authorized to do that.

Senator HUDDLESTON. Thank you very much, Mr. Bagley, and the subcommittee now will adjourn until 2 o'clock, at which time the witness will be Dr. Paul.

[Whereupon, at 1:13 p.m., the hearing recessed, to reconvene at 2 p.m.]

AFTERNOON SESSION

Senator HUDDLESTON. The subcommittee will come to order and we will resume our hearing.

Dr. Paul, identify yourself and your associate for the record and then please proceed.

STATEMENT OF DR. ALLEN B. PAUL, PROGRAM LEADER FOR PRICING, POLICY, AND PROGRAM ANALYSIS, NATIONAL ECONOMIC ANALYSIS DIVISION, ECONOMIC RESEARCH SERVICE, U.S. DEPARTMENT OF AGRICULTURE, ACCOMPANIED BY JAMES V. FAHEY, HEAD, PROGRAM ANALYSIS SECTION, VEGETABLE BRANCH, FRUIT AND VEGETABLE DIVISION, AGRICULTURAL MARKETING SERVICE, USDA

Dr. PAUL. I am Allen B. Paul, program leader, pricing, policy, and program analysis, Economic Research Service, U.S. Department of Agriculture.

I am accompanied by James V. Fahey, who is in the Fruit and Vegetable Branch-or is it division?

Mr. FAHEY. Fruit and Vegetable Division and that is the branch, the Agricultural Marketing Service, USDA.

Dr. PAUL. It would be most expeditious to read the statement, or is it too long?

Senator HUDDLESTON. Just proceed as you choose. Generally, I find reading is quicker than to summarize.

Dr. PAUL. Right.

Mr. Chairman and members of the committee:

In the last 18 years, I have been employed by the Department and have specialized, among other things, in the economics of futures trading.

A number of my studies have appeared in professional journals, in departmental bulletins and elsewhere. I am not a commodity specialist but I do try to maintain a working acquaintance with pertinent features of different commodities as they bear on the organization and functioning of exchange processes.

I have followed, along with others, recent newspaper accounts of the resolution of the May 1976, contract in Maine potatoes.

The episode appears to be a particular manifestation of the general problems associated with all organized futures trading, namely, how to achieve an orderly liquidation of maturing futures contracts. The problem in any seasonally produced commodity becomes aggravated toward the end of the shortage year when stocks are normally depleted. I will return to this important matter shortly.

Any well-functioning futures market invites wide participation. It provides low-cost access of buyers to sellers through its highly standardized terms and procedures, and security of contract through customer margin requirements and clearinghouse guarantees.

These sophisticated institutional arrangements evolved over many decades of trial and error and were in use about the turn of the century. Such trading devices result in a large structure of commodity debts, all of which need to be settled by their due dates.

The liquidation normally is done by entering offsetting contracts before the time one must deliver or accept delivery on his commodity debt.

Usually, neither party that wants to obtain or dispose of the commodity would find it suitable to do so in the futures market.

Standardized methods do not give each participant precisely what he wants. Yet, if someone wants to make or take delivery on futures, he is fully entitled to do so and the machinery usually does this expeditiously.

Invariably, some commodity debts are settled by delivery. All in all, there usually is little or no problem of achieving an orderly liquidation of all futures contracts despite their large numbers.

Thus organized futures trading takes on the characteristics of a purely financial institution, wherein there is a large structure of debt claims against commodity reserves to settle them. The issuance. sale and extinction of standardized claims occur relatively smoothly. The economic role of futures trading in commodities is to facilitate choice of asset holdings: The important point is that it facilitates the separation of responsibility for owning claims to commodities from the responsibility for owning claims to inputs required to physically transform the commodity in form, place or time, i.e., to grow, assemble, store, process or distribute the commodity.

Presumably each participant tries to increase his net worth by appropriate shifts in his asset-liability holdings.

For example, whether a claim to a commodity, or claim to the use of facilities to transform the commodity in some manner is a reasonably good addition to one's portfolio depends on all his other holdings, including the value of his personal skills.

Intelligent use of futures, whether used directly or indirectly, enables many businessmen to discriminate in their enterprise selections and thus concentrate their commitments of equity to particular endeavors.

This usually results in more specialized, more modern, and lower cost physical operations than otherwise-be this enterprise the growing, assembly, distribution, processing or warehousing of the commodity.

The alternative of allocating one's equity both to ownership of the commodity and to what it takes to conduct physical operations will suffer for lack of capital, or that he will have to take in partners to enlarge the equity fund in order to assume both kinds of responsibility.

The latter move is in the direction of the corporate business unit. On the other hand those who choose to own (or owe) commodities and let someone else perform the physical transformation on them, engage in forecasting the future price of the commodity.

They judge that the worth of these commodities will rise or fall relative to the worth of other things they might own. The result is the discounting of new information, arising from various quarters, into price.

It results in guiding production along lines of the forecast, be it the carrying of more or less stocks from periods of harvest forward, increased or decreased acreages planted, increased or decreased rates of feeding, or some other such change in the rate of physical transformation.