To John Mack, it must seem like just yesterday that he received a $40 million bonus as chairman and CEO of Morgan Stanley, the largest bonus ever given on Wall Street at the time. That was at the end of 2006, a lifetime ago in the financial world, and things are much different now. Continued fallout from the credit crisis has forced Morgan into a corner and its chairman against a wall. It could be worse. Mack could have run Merrill Lynch, Lehman Brothers, or Bear Stearns.

Luckily, Mack is an oil man, in every sense of the word. Under Mack, Morgan Stanley has amassed a formidable group of companies involved in every aspect of the petroleum business, from refineries to home heating oil.

By exploiting regulatory loopholes and throwing caution and conscience to the wind, Morgan Stanley, along with Goldman Sachs, has artificially thrust oil prices to record levels. Mack has thus far been able to navigate through a storm that has brought three of the biggest American investment banks to their knees. And the whole world picked up the tab.

They don’t call him “Mack the Knife” for nothing.

There will be blood

One of the greatest economic disasters in modern history is unfolding before our eyes, but the runup spans 16 years and three presidents and has left millions of starving and poverty-stricken people in its wake.

Economists and theorists have already named the economic period that is ending as of this writing: It was the era of cheap oil, a time when multinational companies thrived on the global market as never before. Things have changed now: Oil prices are high and the cost of doing business, in every industry, continues to rise. Oil may never be cheap again; answers and inconsistencies abound as to why.

Before 2000, there were a few givens that affected the cost of oil and energy in the world—mainly war, weather, supply, and demand. The latest Russian aggression in Georgia, hurricanes in the Gulf, and the spectacular display at the Beijing Olympics that placed China on the world stage would normally have put prices through the roof. If nothing else, China’s grand coming-out party exhibited the largesse of the Chinese economy and population. This alone should have caused a spike in oil prices. Instead, they fell from the summer’s earlier stunning highs.

This counterintuitive behavior in the market suggests some other significant determinant of oil prices at work, beyond traditional forces of supply and demand.

In stark opposition to the oil crisis of the 1970s, which left Washington in a state of panic and Americans lined up at the gas pumps, the seeds of the current condition may well have been planted not in the Middle East by the OPEC nations but right here at home, by the same lawmakers now scrambling to undo what they set in motion.

One of the central villains in the story has become an all-too-familiar symbol of corporate malfeasance. The ghosts of Enron, the defunct Texas-based energy company, and its now-deceased former president, Kenneth Lay, still haunt the market today. Most are familiar with how Enron preyed on financial loopholes in the marketplace to fabricate a phantom energy market and create false gains on its balance sheet throughout the 1990s. Enron’s grip on the energy market created spastic and turbulent movement in the marketplace, resulting in events like California’s rolling blackouts in 2000. By December 2001, when everything had unraveled, Enron was out of business, its accounting firm, Arthur Andersen, was no more, and Washington lawmakers issued a slew of promises to change the regulatory environment.

Devils in the details

During the final months of Bush 41’s White House in 1992, Wendy Lee Gramm, wife of Phil Gramm, who was then the Republican senator from Texas, was the head of the US Commodities Futures Trading Commission (CFTC). Wendy Gramm is an unabashed free-market advocate once described in 1999 by the Wall Street Journal as the “Margaret Thatcher of financial regulation.” She now sits as a distinguished senior scholar of the conservative think tank Mercatus Center at George Mason University in Virginia. Mercatus is a policy center on Capitol Hill that boasts board members such as Ed Meese—a central figure in the Iran-Contra scandal as attorney general under President Ronald Reagan—and Charles Koch, of Koch Industries, who has been investigated for stealing oil from federal property and tribal Indian lands, indicted for environmental crimes, and fined $30 million by the Environmental Protection Agency for numerous spills throughout the United States.

The CFTC oversees the commodities market and applies the regulations set forth under the 1936 Commodities Exchange Act (CEA), a measure enacted by Congress to prevent another collapse on the scale of the 1929 crash. One of Wendy Gramm’s final acts as chairwoman in January 1993 was to create an exemption that allowed Enron to trade energy futures contracts and essentially hide these trades from the CFTC itself. (An energy futures contract is an agreement to deliver energy commodities such as oil or natural gas at a set price in the future.)

Gramm left the CFTC, and five weeks after creating this exemption, she became a board member of Enron. In return for her work deregulating the market for Enron to exploit, she racked up millions as an Enron board member prior to the company’s collapse.

Wendy and Phil Gramm were just getting warmed up.

At the end of President Bill Clinton’s second term and the waning days of the 106th Congress, it was then-Senator Phil Gramm’s turn to dust off a bill, now commonly referred to as the “Enron loophole,” and attach it to an 11,000-page appropriations bill on December 15, 2000. The bill had previously died on the House floor, but Gramm resurrected it, found a new sponsor, became a co-sponsor, changed the bill number, and turned it into an amendment. That’s a lot of work for one little loophole. As a rider to a much larger bill, the Commodities Futures Modernization Act was no longer subject to the normal vetting process in Congress that a stand-alone bill would receive. Lawmakers, undoubtedly feeling the pressure of the holidays and lacking the time to review thoroughly the voluminous document, quickly approved the bill for the president’s signature.

On December 21, 2000, on a cold and blustery Washington evening, Clinton signed the bill with the Enron loophole rider. Gramm’s amendment deregulated all energy futures trading. For Lay and Enron, the rest is history. But it would take another six years, another President Bush, and a new Congress to open the floodgates of rampant speculation and really give it legs.

Phil Gramm, you might recall, was until recently Senator John McCain’s top economic adviser. You know, the one who called America “a nation of whiners.”

Commodities explained

The easiest way to think about commodities is that they are things—physical things that can be measured in size, quantity, or volume: fruit, oil, grains, metals, currency. All have unique characteristics and trade against one another on commodities exchanges throughout the world. For example, one barrel of oil might equal three bushels of corn, which may equal six bushels of wheat, and so on.

It is a complicated system and not for the faint of heart. Few traders on Wall Street have the acumen and desire to deal in this sector, an exchange that had been efficiently regulated by the CEA since 1936. Commodities traders were highly specialized in their fields and their discipline was so narrow that it was largely misunderstood. Michael Greenberger, an outspoken critic and former employee of the CFTC, described these as “backwater markets,” but ones that recently have become “as important to understand and regulate as the securities and debt markets are.”

An important aspect to the commodities market is that there has always been a ceiling to the transactions, and every investment made in the US, for example, must be overseen by the CFTC. This market cap and theoretical transparency kept the commodities market in relative obscurity against its much bigger counterparts, the stock market and the bond market.

But in January 2006, the CFTC, under President George W. Bush’s administration, upended the regulatory practices held in place since the 1930s and created a virtual frenzy by recognizing a new commodities exchange—ICE Futures—that had been formed in 2001, primarily by investment banks and oil companies.

On May 20 of this year, Michael Masters, the managing member of Masters Capital Management LLC, a hedge fund that invests in private equity, testified before the Senate’s Committee on Homeland Security and Governmental Affairs. His testimony is now widely quoted by the antispeculation critics who decry the lack of oversight created by the Enron loophole.

“Commodities futures markets are much smaller than the capital markets, so multibillion-dollar allocations to commodities markets will have a far greater impact on prices,” Masters stated.

Essentially, introducing investment banks and hedge funds that have deep pockets and no one looking over their shoulders has the singular ability to move the entire market. It’s like allowing professional athletes to compete in the Olympics. Masters called it “demand shock.”

Morgan Stanley and Goldman Sachs: the mechanics behind high oil prices

Two primary tools have restrained zealous speculators in the commodities markets since the CEA’s adoption: transparency and position limits. The transparency came from federally regulated markets like the New York Mercantile Exchange (NYMEX), which tracks and oversees the transactions of commodities. Position limits were enacted under the CEA to keep any one investor, or group of investors, from overwhelming the exchange and flooding it with money. The Enron loophole essentially permitted the trading of energy futures on over-the-counter markets, thereby allowing a new set of investors—hedge funds and investment banks—to trade energy futures. But the US exchanges still saw relatively little activity as compared to their European counterparts, where the oversight was far more lax. Because commodities trade in real time and US-based companies have the most money to invest, the investment banks and hedge funds were still slow to drive great sums of capital into the market. What they needed to really make this thing soar was the ability to invest serious capital within the United States, like their counterparts could on the London Exchange, for example.

In 2000, Goldman Sachs, Morgan Stanley, and British Petroleum became the primary founders of a little-known exchange based in Atlanta, known as the Intercontinental Exchange (ICE). A year later, it purchased the London-based International Petroleum Exchange (IPE), and was renamed ICE Futures. It was an acquisition that was fairly straightforward until 2006, when the CFTC—seemingly out of nowhere—officially recognized the ICE as a foreign-based exchange because it had purchased the IPE.

Even though the ICE is based in Atlanta, backed by US banks, and now traded publicly on the New York Stock Exchange, the CFTC somehow decided to treat it as if it were based in London and thereby no longer subject to federal trading regulations. Now the investment banks could trade every type of commodity, especially crude oil, without any spending limits or federal oversight. Greenberger calls it one of Wall Street’s “most successful ventures,” because the ICE was now “competitive to NYMEX.”

It was here that the wheels began to fall off the commodities market.

Mack’s Morgan

John Mack, the chairman and CEO of Morgan Stanley, has had an illustrious career, holding some of the most lucrative and prestigious positions on Wall Street.

Nicknamed “Mack the Knife” because of his hard-edged, no-nonsense approach and hardcore cost-cutting measures, Mack ran Morgan Stanley through the 1990s before accepting the job as co-CEO of Credit Suisse First Boston, a leading investment bank, in 2001. Mack left CSFB in 2004 to pursue options outside the large investment banking world but was wooed back to run Morgan Stanley in 2005. Upon his return, Mack’s Morgan Stanley went on an aggressive oil-buying spree—but not necessarily the kind you might expect.

On May 24, 2006, Morgan oil analyst Douglas Terreson announced that integrated oil equities were “15 percent undervalued,” and in a research report he wrote that “Independent refining and marketing remains the largest sector bet in the global model energy portfolio.” Soon after, on June 18, 2006, Morgan Stanley acquired TransMontaigne, Inc. and its subsidiaries—a half-billion dollar group of companies operating in the refined petroleum business.

How convenient: After their oil analyst decided that this portion of the industry was looking up, Morgan Stanley got into the oil business and bought a refining company. It must have taken more than 25 days to conceive and work out the TransMontaigne transaction. This had to have been a long-planned, well-thought-out takeover—one that worked for the great benefit of Morgan Stanley’s future oil plans.

This type of freewheeling environment, with little separation between the proprietary desks at the banks and their investment analysts, has been the subject of much scrutiny and concern of late.

“[There must be] a verifiable and hardened wall between analysts and the investment entities,” Greenberger says—it’s the only way to maintain integrity. But the CFTC was essentially dismantling that wall, right under everyone’s noses.

Morgan’s investments in the oil business continued aggressively into the far corners of the industry over the next year. In short order it closed the circle of the supply chain by acquiring Heidmar, a shipping company, and various stakes in foreign-based energy supply companies. It even snagged a contract from the US Department of Energy to store 750,000 barrels of home heating oil at its corporately owned terminal in New Haven, Connecticut. Morgan Stanley, which was at the time the largest trader in oil futures, was now a serious international oil company.

Speculation takes center stage

The Masters testimony brought speculation into the light and sent shockwaves through the halls of Congress. Masters was able to simplify the exchange and put the issues in a context that lawmakers could grasp. One of the telling examples he gave was that “Index speculators [companies such as Morgan Stanley] have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States has added to the Strategic Petroleum Reserve over the last five years.”

This belies the claims made by investment banks that demand from China and India was solely responsible for the increase in oil futures prices. However, there are some theorists who still vehemently deny that this is the case.

James Howard Kunstler, author of The Long Emergency and creator of the popular blog Clusterfuck Nation, believes that the effect from the speculative market is “basically witch-hunt stuff.” A peak oil theorist, Kunstler, on the phone from his home in Saratoga Springs, says he believes that the root of the problem lies in our global dependence upon a commodity that is quite simply disappearing.

American scientist M. King Hubbert predicted in the 1950s that American oil production would peak by the early 1970s. His predictive model was the basis for peak oil theory, which, when applied to the global market, indicates that the world may hit peak oil production within the next 20 years or sooner. Kunstler says that “the biggest thing that’s going on right now is the oil export problem or crisis.

“What that means,” he adds, “is the countries that we depend on for imported oil are less and less able to send it out and they’re using more of their own oil even as they’re in depletion. Two of the biggest cases of this are Mexico and Venezuela.”

While America imports the vast majority of its oil from Mexico, Venezuela, and Canada—not the Middle East—and there is evidence to support the peak oil predictions in some of these areas, it seems to speak more to the long-term crisis that mature and developing countries face. But it doesn’t fully explain away why oil prices would increase exponentially during the summer months and then decline shortly thereafter.

“Instead of oil going up,” Greenberger says, “oil is going down. Has India and China dramatically cut back? Nothing has changed and, in fact, the supply-demand factor has probably gotten worse because of Russia’s aggression [and] the severe weather, but oil is sinking, sinking, sinking. How can that possibly be?”

So if oil prices could be so easily manipulated, why didn’t it happen more severely and immediately when restrictions were lifted in 2006? While oil prices did indeed climb between the time the ICE was created in Atlanta and the regulations were lifted in January of 2006, they didn’t skyrocket until late in 2007.

Enter Douglas Terreson.

The Terreson timeline

Terreson, the Morgan Stanley analyst who said that independent refining and marketing companies were undervalued, was the bank’s chief oil analyst. The award-winning, nationally recognized Terreson had fielded questions in relation to oil prices and futures since the mid 1990s. On March 14 of this year, he said that oil would settle in at around $95 per barrel for the remainder of 2008. Moreover, Terreson also concluded that oil would retreat to around $83 per barrel for 2009.

That would be Terreson’s last forecast for Morgan Stanley.

Two short months later, Dow Jones Newswires reported that Terreson had been ousted in a round of layoffs. Two weeks after that, Richard Berner, Morgan Stanley co-head of global economics and chief US economist, issued a statement saying that crude oil could easily reach $150 a barrel. This prediction set off a round of speculative fervor never before seen in the market. Goldman Sachs immediately followed suit by forecasting oil to roar beyond $150, saying it could hit $200 a barrel in the near future. Oil prices were off to the races, with the investment banks in full lobbying mode while pointing the finger at China and India.

On September 19, 2007, Morgan Stanley’s stock price was $67 and oil was at $78. This was the day that Morgan Stanley began to trickle out the bad news. The worse the news coming out of the investment banks, the higher oil prices would climb. By the time Morgan announced that Terreson was gone, Morgan’s stock was at $41 and oil was at $134.

In retrospect, the turning point appears to be Morgan’s $150 forecast by Berner. It fueled the apprehension of the media and Wall Street alike. Americans were quick to do the math and knew that the spike would mean $5 per gallon at the pump. Maybe more. Suddenly everyone recalled the 1970s, and new terms such as “stay-cation” were on everyone’s lips.

So, where did this $150 number come from? Who better to answer that question than Richard Berner, the man behind the prediction?

Unfortunately, a spokesperson for Morgan Stanley tells the press that Richard Berner “doesn’t do interviews on oil stuff.” In fact, “he doesn’t deal in oil” at all, says his assistant matter-of-factly. That’s because for more than a decade this had been the exclusive domain of Terreson.

A month after the report that Terreson had been laid off, Morgan Stanley issued a statement claiming that Terreson voluntarily had left his position at Morgan for the promise of higher pay from a hedge fund.

Not so, according to a Morgan Stanley employee familiar with the circumstances surrounding Terreson’s departure, who asked not to be identified in this story. Taken aback by the confusion surrounding Terreson’s reason for leaving, he says, “I knew they had a rightsizing, but he said he was retiring. He was getting ready to head off into the sunset.”

Morgan Stanley no longer has a spokesperson for oil. Nor are they willing to comment on the decision to forecast crude oil futures at $150 per barrel by someone who “doesn’t deal in oil.” Terreson, once an integral part of the Houston community and a rising star in the financial sector, seems to have disappeared from the city altogether. His home phone has been disconnected. His former co-workers are unsure of his whereabouts. And almost no one from the firm at which he spent years as a superstar in his field wants to discuss why.

When the press finally reached Terreson at his present residence in Alabama, he simply said, “I’m retired. I’m not with Morgan anymore and can’t talk about any of this.” When asked for a brief comment on current oil prices, Terreson responded, “I don’t feel comfortable talking about it,” and hung up the phone.

The smell coming our way

Still, the question persists: If the market conditions surrounding the price of crude oil futures remained unchanged, why were the analysts at the world’s largest banks determined to drive up the price of oil at a historic pace?

Was it merely dumb luck that this rampant speculation occurred at a time when the major investment banks were reporting record losses and write-downs due to the sub-prime mortgage meltdown? It is Greenberger’s assertion that “a lot of people were very upset that they were in a sense humping their own product—not only their physical holdings but their future holdings.” What he’s referring to is the fact that Morgan Stanley doesn’t just trade oil futures; it’s also very much in the business of oil. This fact is “unseemly,” according to Greenberger and other observers of the financial markets.

One such observer is Gary Aguirre, a former staff lawyer and investigator for the Securities and Exchange Commission (SEC), who has testified several times in front of Congress and is considered a leading authority on financial markets.

“The way it ran up had all the earmarks of manipulation,” says Aguirre from his office in San Diego. “It looked like somebody was playing a game. I don’t know what the game was or how they did it but that was…the smell drifting my way.”

As far as Morgan Stanley and Mack are concerned, Aguirre knows firsthand just how powerful the Wall Street tycoon is.

In 2005, Aguirre headed an investigation into an insider trading claim involving Mack and a hedge fund named Pequot Capital Management. Mack’s involvement came during the period between his tenure at Credit Suisse First Boston and his return as chairman of Morgan Stanley. There were allegations of insider trading on the part of Mack by the SEC, but just when the investigation seemed to be gaining momentum, Aguirre was told to back off by his bosses at the SEC. After a glowing review from his superior, Aguirre went on vacation. When he returned, he got a pink slip, not a raise.

Aguirre insists that his own experience is merely part of a larger and much scarier problem running rampant on Wall Street.

“What we have are the markets highly leveraged, highly speculative and without any regulation, effectively, of the abuses,” he explains. “In short, it’s not much different than it was just before the crash in 1929.” This sentiment is echoed throughout Wall Street and the Beltway as the news from Wall Street grows more desperate with each piece of bad press about the economy.

The cozy relationship between oil companies and the US government is nothing new to people like Aguirre who are familiar with the system. Aguirre explains the “you scratch my back” culture in monetary terms by saying, “These people are sponsored by the industry. Paulson’s straight out of Goldman. We have the fox guarding the henhouse.” (He’s referring to US Treasury Secretary Henry Paulson, who was chairman of Goldman Sachs until June 2006.)

This was certainly true for Wendy Gramm, leaving the CFTC for the Enron board, and for her husband, who received nearly $100,000 in financial contributions from Enron while in office.

“These Enron traders were highly sought after,” says Greenberger. “Enron showed in its dying days how you could make a lot of money trading unregulated energy futures products.”

The fallout

By jacking up oil prices, these banks may have temporarily staved off the collapse of our financial system. Skyrocketing oil prices have also highlighted our complete dependence and addiction to oil and brought the debate to the surface in the upcoming presidential election. For better or for worse, people are talking about oil, and not in favorable terms.

When Terreson’s oil price forecast was less than what Richard Berner believed it should be, his career at Morgan Stanley ended abruptly. When Berner predicted $150 oil, the entire world market responded to this claim. Did Terreson tire of shilling for Morgan and decide to retire at the tender age of 46? Or was he unceremoniously axed after refusing to alter his forecast on oil prices? Was he part of the game all along and paid handsomely to ride off into the sunset, as one co-worker said?

Regardless of the reasons behind Terreson’s departure, there is still the question of motive: Why drive oil prices beyond practical limits?

Let’s say for a moment that you run Morgan Stanley. Over the past few years you made a couple of bad deals. Okay, so it was more than a couple, but not as many as your friends at Bear Stearns and Lehman Brothers. Thankfully, you have remarkable control over the price of oil—just by forecasting it. Heck, you don’t even have to “deal in oil” or do interviews “on oil stuff,” you just have to pick a number and watch the market try to hit it. Not to mention you also own companies that operate refineries. You control shipping routes. The government has handed you a contract to store 750,000 barrels of home heating oil for the Northeast United States. You founded and are still an owner in a public exchange that handles energy trades that no one can really see. Win. Win. Win.

It was all legal. The federal government, beginning with Wendy and Phil Gramm, cleared the way for tremendous systematic abuse in the financial markets to fatten the Gramm family bank account with blood money—Wendy Gramm’s multimillion-dollar take as an Enron board member and Phil Gramm raking in more than $335,000 in campaign contributions from the securities and investment industries.

Instead of being punished for these now well-documented actions, Wendy Gramm is still influencing Capitol Hill at the Mercatus Center and Phil Gramm has been advising McCain, the man who might be our next president.

People are beginning to contemplate peak oil and imagine that, while the world may have flattened out for a while, it’s getting a whole lot rounder again. Kunstler proclaims, “Globalism was a product of a certain time and place and special circumstances, namely, a period of very cheap oil and relative peace between the great powers.” It’s what he calls the “end of the happy motoring era.”

The “demand shock” that Masters speaks of also created a hunger shock that reverberated around the globe. It’s awfully easy to manipulate the markets when you control so many pieces of the puzzle. Perhaps the analysts and speculators were acting to save their own banks in the short run, lest they wind up like Bear Stearns or Lehman Brothers. But does saving a bank and focusing our daily discussions on renewable technology really excuse thrusting millions of people into poverty and pushing price increases on the global food markets?

Congress has the ability to seize control of these markets even before the upcoming presidential election. The new president will decide whether and where we drill or not, but that decision has nothing to do with restoring the oversight and stability that existed in the commodities arena from 1936 until 2006. If it weren’t for federal oversight and regulation, Morgan Stanley—which was created in 1935 from the ashes of the 1929 crash—wouldn’t even exist. But history is readily forgotten, or ignored, by greedy corporate raiders who are destined to repeat it.

This story was originally published by Long Island Press and made available through the Association of Alternative Newsweeklies.