The Federal Reserve Board yesterday backed away from a confrontation with federal commodity regulators and said it would not block the sale of controversial stock index futures contracts, to begin next Wednesday.
In a letter to the Commodity Futures Trading Commission, Fed Chairman Paul A. Volcker said the Fed had determined it had the legal authority to regulate the size of down payments on the new investments, but had decided not to do so immediately.
The board had demanded that the CFTC give the Fed six months to determine how to regulate trading in stock index futures if the commission decided to authorize them. On Tuesday the CFTC approved the first stock index futures contract without providing the six-month waiting period sought by the Federal Reserve.
As a result of the Fed's action yesterday, the Kansas City Board of Trade expects to proceed with a Feb. 24 start-up date on its futures contract based on the Value Line Index of 1,700 stock prices.
Stock index futures will work just like contracts for future delivery of soybeans, pork bellies or other farm products, except that the commodity to be delivered will be a hypothetical market basket of stocks. Speculators who buy the contract will make money when the Value Line Index goes up and lose when it falls.
Yesterday's Federal Reserve action followed intense negotiations last week between Volcker and CFTC Chairman Phillip McBride Johnson. After those talks, the Kansas City Board of Trade "voluntarily" increased the margin requirement on its contract from $4,000 to $6,500 and made other adjustments in its plan.
"These self-regulatory actions by the KCBOT would appear to alleviate the need for any immediate action by the board and, consequently, the board has decided not to specify at this time particular margin requirements on stock index futures," Volcker said in a letter to Johnson.
The increase in the Value Line Futures margin made the down payment on that contract roughly equivalent to the margins set by the Federal Reserve for stock options, apparently placating the Fed.
Volcker noted that the Fed's control over margins is needed "not only to limit the use of credit for speculative purposes, but also to assure competitive equality among functionally similar instruments."
Since shortly after the stock market crash of 1929, the Federal Reserve Board has had the authority to regulate the margin requirement, or down payment, on purchases of stocks, bonds and stock options.
The Fed never before has set commodity futures margins that are determined by the largely-self-regulating commodity markets, but there never before has there been a futures contract involving stocks.