From hoof to mouth, or why derivatives don’t kill people…

Despite the best efforts of the Obama administration to draw a clear line between Wall Street and Main Street, business owners, farmers, and everyday citizens recognize that there are overlaps that make the distinction irrelevant.

GILTNER, Neb.—Farmer Jim Kreutz uses derivatives to soften the blow should the price of feed corn drop before harvest. His brother-in-law, feedlot owner Jon Reeson, turns to them to hedge the price of his steer. The local farmers’ co-op uses derivatives to finance fixed-price diesel for truckers who carry cattle to slaughter. And the packing plant employs derivatives to stabilize costs from natural gas to foreign currencies.

Far from Wall Street, President Barack Obama’s financial regulatory overhaul, which may pass Congress as early as Thursday, will leave tracks across the wide-open landscape of American industry.

Designed to fix problems that helped cause the financial crisis, the bill will touch storefront check cashiers, city governments, small manufacturers, home buyers and credit bureaus, attesting to the sweeping nature of the legislation, the broadest revamp of finance rules since the 1930s.

Here in Nebraska farm country, those in the business of bringing beef from hoof to mouth are anxious, specifically about the bill’s provisions that tighten rules governing derivatives. Some worry the coming curbs will make it riskier and pricier to do business. Others hope the changes bring competition that will redound to their benefit.

“Out here we like to cuss the large banking institutions because of the mortgage mess, but we also know that without them some of these markets don’t work,” says Mike Hoelscher, energy program manager for AgWest Commodities LLC, a Holdrege, Neb., brokerage that provides derivatives services to the farming industry.

(Emphasis added. For the full article, click here.)

What does it mean for financial regulation when farmers are scared? While derivative regulation might be necessary, I don’t know that corn and wheat hedging is where we need to focus. Overall, the commodity complex represents the first financial instruments in history and futures and forwards have been utilized in some way since ancient times. This is not the area that caused the collapse, nor is it the derivative area that represents the systematic risk our politicians are trying thwart. In the meantime, the true culprits, namely, financial futures, CDS, swap agreements, etc. which dwarf the size of any of commodity futures markets will continue to be less regulated. It’s a sad state of affairs.

Position limits – have we learned nothing?

I can’t put my finger on it, but I know it’s all related. Writing about it definitely helps clarify, but then again, it makes me more flabergasted. I’m speak of the direction our policy – on multiple fronts - is headed.

From healthcare to contract law to trading, policy makers seem to believe that government and bureaucracies are the best allocators of resources, best sources of price discovery, and most efficient providers of services, while at the same time believing that increased regulation can encourage wage growth, competitiveness, and productivity. For fun, here’s an article, sent by a friend on the impact of some of these policies: http://victorhanson.com/articles/hanson071809.html.

Today, I won’t go into healthcare (although for those interested, there’s an interesting interview with Daniel Palestrant, CEO of Sermo, an online physician’s community, about the fact that the AMA is not accurately representing the doctors of this country: http://www.cnbc.com/id/15840232?video=1196233131&play=1. I spoke to Daniel and the interview doesn’t do their research justice, and his attack on Howard Dean only scratched the surface of the hypocracy of the current leadership.) Instead, I’ll mention that the current debates on The Hill about speculative limits in commodities scare me. In the 1970′s, with inflation running rampant, the Nixon administration, in its misdirected brilliance, decided to place price controls on everything from meat to lumber. Well, the small time players got hurt and the guys who were smarter went around the price controls and played in the futures markets. Now, we have a new administration thinking they need to control prices and better yet, control volatility. Well, someone should point out that speculators play on both sides; they provide better liquidity, more price discovery, and smaller spreads. Without speculators, hedgers wouldn’t be able to trade and everyone from small time farmers to large conglomerates like General Mills would face increased costs of business. In and of itself, more players do not lead to increased volatility – quite the contrary.

http://www.marketwatch.com/story//spotlight-on-goldman-as-commodities-hearings-begin-2009-07-28

So GS is on the hotseat again, this time for being too large a player in the hedging space. But that’s what they do. They provide an investment opportunity to pension plans and institutional players and then hedge. Should you place speculative limits? Fine, but let’s define speculation and hedging differently. Not all natural hedgers are pure hedgers. For example, many oil companies and airlines and producers take speculative risk beyond the positions their hedging. Same is true for “speculators”, some of whom are actually hedging different risks in their portfolios. The definitions, in my opinion, actually become so nuanced and convoluted as to be virtually irrelevant. I wish someone from GS would get up and say that and more importantly that someone in DC would listen.