Financial reform: How to fix Wall Street without damaging farming?

Rep. Collin Peterson
Rep. Collin Peterson

WASHINGTON — At its core, agriculture futures’ trading is a largely boring exercise in price stability.

Sometime before the growing season, a crop farmer must decide what plants to plant, based largely on what the crops would eventually sell for and what the ground will currently bear. The biggest and scariest variable in all that, aside from Mother Nature, is a volatile pricing market. If the market swings violently upward, prices soar and demand could drop. If the market plummets enough, the crop could wind up not worth the expense to harvest.

But if you could agree on a price per unit for whatever you’re growing ahead of time, then the only question that determines how much money you’ll make in a given year is how much you can pull out of the ground. That’s why most crop companies are willing to hedge their bets on their harvest, taking a lower price today to ensure stability tomorrow.

However, if you pervert those trades, add layers of risk and rules so complicated as to make them unauditable — and in some cases, deliberately design the futures to fail while betting against them — then you’ve got the sort of credit default swaps that almost brought down the financial sector in late 2008.

“Agriculture, we’re the people who created this thing in the first place,” said Rep. Collin Peterson. “The futures were used to try to manage the price risk for people who use commodities, whether it was agricultural commodities, then it became oil, natural gas, then financials got into this and that’s really what the issue is.”

Peterson, the chairman of the House Agriculture Committee who represents a rural western Minnesota district that’s about as far from Wall Street as one can get, has ironically become a major player in the debate over financial regulatory reform. The goal: Fix Wall Street without harming a trade vital to the survival of rural America.

“The people who caused the risk were the financials, not the agriculture folks,” Peterson said, “and what we’re trying to do in here is reign in the financials and not screw up what the agriculture people are doing.”

The good, the bad and the ugly
Futures, or derivatives as they’re also known, are common across other industries — airline companies, for example, purchase jet fuel in single transactions that cover months or years of operations so that fuel becomes a static cost, no matter what the market might do.

“When you step back and look at the financial reform, the problems that led to this [economic crisis] didn’t take place in agricultural commodity exchange, it took place on Wall Street,” said Mark Bagan, president and CEO of the Minneapolis Grain Exchange. “Everything that happened at the agricultural markets has been supply/demand related.”

That’s not to say massive price fluctuations don’t happen, he said, they do. But when Minneapolis spring wheat jumped from its normal range of $3 to $8 a bushel up to $25 a bushel a few years ago, analysts said it was fueled by speculation surrounding the supply and demand of wheat itself.

Unlike, say, the hedged bets that some on Wall Street stand accused of profiting off of.

“A free market was never meant to be a free license to take whatever you can get, however you can get it,” President Obama said in a speech aimed at Wall Street executives last week. “That’s what happened too often in the years leading up to this crisis. Some — and let me be clear, not all — but some on Wall Street forgot that behind every dollar traded or leveraged there’s family looking to buy a house, or pay for an education, open a business, save for retirement.”

Day traders, as I write this, are literally betting vast sums of money on whether or not the United States will fail — not betting the U.S. will fail to pay its debts because they think the U.S. will fail to pay its debts (it won’t), but because there’s money to be made by taking a bet on price fluctuations.

A county in Alabama is now teetering on insolvency because of the refinancing and refinancing and refinancing again of their brand new, state-of-the-art comprehensive sewer system, which now costs Jefferson County taxpayers more in debt payments on the system than it cost to build.

And no list is complete without mentioning the boom-and-bust bubbles that Goldman Sachs has made a seeming art form out of profiting from, going back to the Great Depression. Rolling Stone reporter Matt Taibbi, who has investigated Goldman thoroughly and produced more truly damning reports, summed up the investment bank as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

The SEC is now investigating Goldman Sachs for charges, which TIME has a comprehensive write-up here) that basically boils down to this: Goldman set up a toxic fund betting on homeowners’ defaulting on their mortgage that regulators charge were designed to fail, hiding the risk then betting against them and cashing in. Goldman Sachs, it should be noted, is contesting the allegations.

It would be unfair to call this stuff casino gambling, because you couldn’t get away with this stuff in Las Vegas.

Regulation coming
All the transactions that are matched and eventually cleared through the Minneapolis Grain Exchange are under the jurisdiction of the Commodity Futures Trading Commission, which began in 1974 — back when agriculture still dominated futures trading. And while Wall Street may see whole businesses erased or fundamentally altered, the way agriculture is traded would be far less impacted.

The largest change the Minneapolis exchange may see is a proposal that requires all over-the-counter swaps to be cleared on regulated marketplaces, where you don’t know just what the final transaction cost was, but you know every bid placed and who placed it.

“It has the potential to increase costs, but it would bring greater transparency to the markets,” Bagan said.

“I look at it and say the line in the sand for me is transparency,” Bagan added, “and that’s what I think Congress is pushing for is more transparency in the marketplace.”

Two Senate committees have approved financial reform bills, and both are expected to be merged so they can be considered by the full Senate as early as this week. Peterson said derivatives language in the Senate’s package and House approved bill are “very close,” and he said he expects that they’ll be relatively simple to merge in a conference committee.

Republicans have charged that the new rules aren’t enough, that they don’t adequately regulate Fannie Mae and Freddie Mac, among other things, but it appears they don’t currently have the votes to block a new bill.

“I think [President] Obama is engaged on this, he’s turning up the heat, and I think Republicans have realized they can’t vote against this — some of them anyway,” Peterson said, referring to Iowa Sen. Chuck Grassley’s lone vote on the GOP side to move a financial regulation bill out of the Senate Agriculture Committee. If his vote holds, Democrats will have enough votes to break any filibuster attempt that might emerge.

Barring an unexpected hiccup, new rules could be in place before Memorial Day.

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Comments (5)

  1. Submitted by Richard Schulze on 04/26/2010 - 06:34 am.

    The real story is how many more banks or individuals will jump on the bandwagon after realizing the vampire squid has sucked out their blood. This is just the beginning and it will trigger legislation in other courts. People need to go to jail over this. The players have demonstrated they have no ethics so we need simple, ethics based regulations. The “super-smart” always seem to squirm around the rules otherwise. We need the investment pros to ask themselves “How can I make money FOR my client?” rather than “How can I make money OFF my client?” when they make a decision and give advice. Until that happens, the waters will never be safe.

  2. Submitted by Paul Scott on 04/26/2010 - 08:13 am.

    Farmers could protect themselves against price fluctuations the old fashioned way. They could diversify their crops.

  3. Submitted by Gerald Abrahamson on 04/26/2010 - 08:51 am.

    Plow all of Wall Street under and replant using higher-quality seed.

  4. Submitted by William Levin on 04/26/2010 - 02:52 pm.

    Collin Peterson did a good job of explaining the unintended consequences of regulation, and Derek Wallbank covered that part of the story well. However, there was no history of agricultural futures trading offered. “The old fashioned way,” Mr. Scott, is futures trading! Rice futures were traded in Japan in the 1700s and grain futures were traded in Chicago well before the Board of Trade was established in 1848. Without agricultural futures trading, assuring many people of enough to eat would be harder than it is today, even in this country.

  5. Submitted by Richard Schulze on 04/26/2010 - 08:39 pm.

    Derivatives were originally created to help farmers and commercial purchasers of farm products manage risk, although it has been demonstrated that quantity risk, to which farmers are highly vulnerable, makes price risk harder to hedge.

    The farm-product origins of derivatives explain why the Ag committee supervises their trading, and why both the MERC and the Chicago Board of Trade are located in Chicago. Well, I guess the CBOT had little choice in the matter on account of their name.

    Unfortunately, you don’t have a lot of farmers on agriculture and a bunch of bankers on banking- you have a bunch of graft-snorkeling supple-handed politicians on both, and the politicians on the agriculture committee have more experience regulating derivatives than those on the banking committee.

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