February 15, 2012
No matter what the business or sport, good decisions require confidence. A trader in the stock market will not make good decisions if he has lost his confidence. A professional basketball player or football player doesn’t perform as well if he’s lost confidence in his ability.
In recent history, there have been two good examples of how lack of confidence has destroyed some investments. In 2002 there was a sharp drop in the stock market, and hundreds of millions of dollars were pulled out of the stock market as a result of the collapse of Enron and WorldCom. As key executives from those firms were led away by FBI agents in handcuffs and were on the front pages of papers almost daily, the average investor lost confidence in the system and took the attitude of “if this is the way this system works, just get me out.”
A similar scenario unfolded in 2008 with a collapse of the residential real estate market and the banking system. People said, “Just get me out.”
In agriculture, a similar event occurred last November. MF Global, one of the world’s largest clearing firms of commodity futures and options, collapsed, and many of their clients lost substantial amounts of money – at least for the short term. While some readers may think this has not impacted them, I can assure everyone in agriculture has and will be impacted in some manner. MF Global cleared trades for many introducing brokers in rural America where farmers had hedge accounts as well as many grain elevators and co-ops throughout the U.S. Agriculture was impacted.
But more importantly, the impact is felt in the confidence of producers and grain-elevator operators to continue participating in the system. The open interest (number of contracts outstanding) in corn and soybean futures declined substantially – almost 25% – since this incident. As I travel across the country giving speeches this winter I continuously hear the statement from producers: “I don’t know if I want to hedge anymore. Is my money safe in a hedge account?”
Repeat?From what I know of the industry, and I’ve been in this my entire life, the odds of an MF Global repeat are slim to none, and slim left town. What the president of that firm did was unconscionable (too much to explain in this article), and no other firm has invested segregated funds the way MF Global did. But for me or anyone else to say that this is not going to happen again, for many producers, is not enough.
My concern is this: The lack of confidence in the system could have far-reaching results. First of all, over the next several months it could be a very major influencing factor on pushing commodity prices lower, just as the other examples above pushed the stock market lower. All very possible.
What’s more concerning to me long term is the resulting changes in the U.S. marketing system. If you do away with the futures and options market, you take away the ability for independent farmers and grain elevators to hedge risk. The two or three largest grain companies can likely get along well without a futures and options market, and in my opinion, possibly may be wishing in the back of their mind that the futures and options markets go away. If you’re large enough and in the processing side as well you have as many buyers as you do sellers, and you can offset your risk internally. Farmers and local co-ops cannot do that.
So the bottom line is, if we see a continuing weakening in the structure of the futures and options market, the long-term result will be less volatility, which means less profit margin and lower incomes. Let’s hope this does not happen. Futures and options markets are extremely important to the agricultural economy. We all need to do everything possible to keep them alive.
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