Farming Magazine - April, 2012
Opinion: MF Global
Black Cloud, Silver Lining
Because popular language goes where most academics won't (think the St. Jerome 4th century Vulgate Bible, a feat not repeated afterward for more than a millennium), it probably wasn't a good idea to label a commodities trading firm with the letters MF; but that unfortunate "slanguage" doesn't harm the basic principle of free trade in commodities, with both growers and users enabled to forward contract for their production and requirements and, along with short-term traders, create a market for output far more reliable than government promises. The recent misdeeds - primarily the illegal use for other purposes of supposedly segregated client-investor cash balances - ascribed to MF Global are already being used by government-management advocates to discredit the basic principle, private sector freedom of contract, which is one of the foundation stones of individual liberty on the economic side of that role of government structure. As farming began to go more large-scale commercial by the mid-19th century, both growers and wholesalers saw the value of price and volume-based forward contracting, and the new trading market thus created invited day traders and speculators who had no interest, ever, in actual commodity possession, but created more purchase and sale liquidity, benefiting both growers and users through their willingness to put their own capital at risk. The first formal exchange/trading floor, the Chicago Board of Trade, opened in 1848, in a village with a population of 4,000 that had become a "city" in 1837. A very readable (11 pages) history of ag futures trading can be found on the Economic History website, under the Joseph Santos (South Dakota State University) byline (http://eh.net/encyclopedia/article/santos.futures).
As the country has urbanized, government has responded to the changing voter clout calculus by extending regulation to areas like commodity trading that were formerly left alone. For farm commodities, it was approved by both an anti-Wall Street Populist streak in the farming sector - growers opposed to both forward contracting and outright speculating - and by a keep-my-food-cheap streak in the urbanite sector, convinced that commodity trading always raises retail food prices. It doesn't, as "The Struggle for Legitimacy" paragraphs in Santos illustrate, but those beliefs remain. They helped enrich Progressive novelist Frank Norris in 1903, when he quite profitably published "The Pit," an "exposé" of wheat trading mixed with heated romance, to an eager buyer urbanite audience. He also took after the railroads in "The Octopus," just when fellow muckraker Upton Sinclair was taking after meat packing in "The Jungle." Those beliefs were the grower basis for approving the relatively recent ban on futures trading in onions, adopted in 1958 with strong producer support and still in effect. Under the Commodity Exchange Act of 1936, depending on how you choose to read the legal language, the ban on grower involvement may extend to more than just onions. And they're the urbanite basis for new criticism of the overall futures market, this time because of MF Global. Old criticisms found legal voice in the Capper-Tincher Act of 1921, which sought to hobble futures trading by imposing burdensome fees, and the Grain Futures Trading Act of 1922 (same legislative sponsors as the first), which sought to hobble futures trading by imposing burdensome regulations. Then, during the Great Depression, Congress moved again. Some legal readers more skilled than your humble scribe have reported bans on commodity growers' involvement in commodity trading originally written into the several Agricultural Adjustment Acts of the '30s, now gone, but the 1936 Commodity Exchange Act language still defines "Eligible Contract Participants" as "a group or individual allowed to engage in financial transaction not open to retail customers." It states that such traders must have "sufficient regulated status or a specified amount of assets" and describes Eligible Contract Participants as "financial institutions, insurance companies, commodity pools, and wealthy individuals ... authorized to engage in complex stock or futures transactions such as block trades" and so on. It doesn't mention growers, but they're allowed to forward contract their own production anyway, which explains why so many of them were client-customers of commodity trading firm MF Global for just that purpose. It was their liquid funds, supposedly safely segregated in their own private customer accounts, which were somehow tapped by Chief Executive Officer John Corzine to help backstop some MF Global currency, bonds and interest rate trades in Europe. Those trades failed, and now he "doesn't know" where the missing $1.2 billion of "backstop" money is. As I draft this column, The Wall Street Journal reports that MF Global and all connected Wall Street firms claim ignorance. Are those lost and/or misappropriated funds insured? There is, after all, precedence for just such insurance. The answer, if any, depends on whom you ask.
In a (mostly) free market economy, you'd expect that a private-sector seller of just such insurance would exist; for example, a firm entitled All Weather Insurance will insure, for a fee, even against adverse weather events. In the public sector, government entities insure against flood, crop failure, nuclear power emergencies, and, of course, any loss to depositors' funds in their bank accounts (via the Federal Deposit Insurance Corporation) or investors' cash (and even account values) in their stocks and bonds accounts to protect against firm failure or improper funds use (via the Securities Investors Protection Corporation), so you'd think that similar "retail" traders in commodities would be similarly protected. Maybe or maybe not. In a recent humble scribe query to several local bankers and stockbrokers, all professed that they "didn't know." Similarly, humble scribe inquiries to the Commodity Futures Trading Commission (CFTC), the Chicago Mercantile Exchange and the Chicago Board of Trade, all of which promise next-day answers to questions from the public, have gone unanswered for more than a month. Interviewed on Fox News (December 28) CFTC Commissioner Robert Chilton said there was no formal insurance, and a few days later argued that "customers haven't lost money heretofore" and "most of the money will be recovered" and a few days after that (January 12) Montana farmers and ranchers filed a class action suit against MF Global's executives. There are (maybe "were," because the firm has filed for bankruptcy and the corporate entity is therefore suit-proof) 38,000 of just such retail ag-producer clients who had been using forward contracts and "puts" to provide minimal pricing assurances. Why they did so on their own, individual, initiatives, and not through one of the many farm and ranch associations that provide this service for members, hasn't been discussed in press coverage of the unfolding sequence of events. Historically, we know that providing this service for producers has been legally hazardous for the organizations, as the government and industry lawsuits against the National Farmers' Organization and Yankee Milk have shown, but none of that history, which might partially explain why individual farmers have chosen to enter the arcane world of "forwards," where a producer contracts to furnish a commodity, and "puts," where he purchases only the future right to do so, at a fixed fee, but can opt not to, if weather and/or markets so dictate, has been touched upon in the press reports. Neither have the reporters picked up on the latest trend in commodity brokerage marketing for clients: it's called "we have in-house insurance," and it's been a major topic of discussion in the midmorning coffee shop breaks at which growers have traditionally met for news of the day purposes. Locally (humble scribe observation and opinion) no subject since the periodic furor over large-scale investment house and retirement associations purchases of farmland by deep-pockets organizations ranging from securities house Merrill Lynch to the Teachers Insurance and Annuity Association which has arisen on multiple occasions since the '70s, has claimed as much real farmer attention as this apparently fatal flaw in the agricultural futures markets. Or maybe not. Maybe the black cloud has a silver lining.
That's because what failed here isn't the basic forward contract concept, but a single rogue operation; and, just as puts and calls (a grower can buy the right to be on the purchase side of a put, to sell his commodity, or to be on the sale side of a call, by selling an agreement to deliver at some future data and price) are forms of insurance against unknowns, just so an industrywide trade association insurance against the occasional rogue operator's actions, or a government insurance like FDIC, could be forthcoming: perhaps just like FDIC, where the costs of operations and occasional (rare) payouts are funded by member banks and not taxpayers at large. Seen from a historical point of view, an Agricultural Futures Protection Corporation (AFPC) could furnish an essential safeguard with financial industry funding. The politics of it are more questionable.
That's because - easy web search - 75 percent of the population has bank accounts and benefits from FDIC, and about 50 percent has stock market accounts and benefits from SIPC, but fewer than 2 percent grows our food, and within the 98 percent urban consumer majority, a large fraction (judging from repeated Congressional "investigations" of commodity trading blamed for raising retail prices) believes consumers are harmed when food futures are traded, honestly or otherwise, and would like to see corn and milk futures made as illegal to trade as onions presently are under the Onion Futures Act, 7 USC Chapter 1. The Food and Agricultural Organization of the United Nations produced (June 2010) a Policy Brief on the subject. Predictably, most of it worried about adverse effect of futures trading on consumer pocketbooks, but the hedge (a little futures lingo, there) comes in the final paragraph: "Commodity futures have become an integral part of food markets, and they perform an important role for many market participants. Adequate regulation should improve, not ban, speculative trading in order to foster market performance." Presumably that would include insurance to remedy misbehavior by the occasional rogue trader(s) in the futures industry.
The author is an architect and former farmer.