Farmgateblog.com - Where farm decision-makers start their day

« Back to main

Tuesday, December 27, 2011

You Are Closer To MF Global Than You Think.



 

How close are you to the MF Global collapse and bankruptcy?  Was your grain elevator one of hundreds that hedged through MF Global, and your elevator manager is now out of some of his or her margin money?  Did you have an MF Global account and are you short hundreds, or thousands, or tens of thousands, or hundreds of thousands of dollars?  Or were you totally insulated from the MF Global collapse until you read further.

MF Global was a commodity brokerage, trading house, and clearing house that handled millions of transactions per year from agricultural commodity accounts, and held billions of dollars worth of accounts at any given time.  That was until it declared bankruptcy on October 31 and a series of actions by the CME Group, the bankruptcy trustee, and the court froze accounts until everything could be sorted out.  While money is still being recovered, many hedgers with commodity brokerage accounts may be out some of their investment, but some of the unreturned funds may represent money loaned by agricultural lenders as margin to hold hedges in place.

If lenders lose money in the bankruptcy process that will be significant for everyone, whether they hedged daily or not at all.  It could be even more significant than not having a safety net in the Farm Bill, believes Kansas State University risk management specialist Art Barnaby.  His contentions, if confirmed, could have a wide ranging impact on agriculture and its relationship with lenders in the process of hedging and managing risk through the use of commodity exchanges.

The Farm Bill has been around since the Agricultural Adjustment Act of 1933, providing a financial safety net for farmers, and a food supply safety net for consumers.  If the MF Global bankruptcy turns out to have more impact on agriculture than the Farm Bill, that would be unprecedented.

Whether that is widespread drought, foreign intervention in the role of markets, or a depression that would prevent farmers from planting a crop, the safety net mechanism of the Farm Bill has been the most important factor in agriculture since it was created.  But could the importance of the Farm Bill now be overshadowed by the colossal failure of MF Global?  Could that action be enough to outweigh a withering drought, an economic collapse of China, or a virulent disease that killed millions of acres of crops or millions of head of livestock?

While the US government could indemnify farmers and grain elevators from the MF Global impact with relative ease, it might have trouble neutralizing the aftershock, and that is the concern Barnaby.  Barnaby is concerned, and so should farmers and elevator managers be concerned with the morning after, when everyone gathers their senses and not only asks what just happened, but begins to take ultra conservative actions to ensure it does not happen again.  When conservative responses come into play, that usually involves the lending community, namely agricultural bankers and the Farm Credit System.

The interaction of lenders and the risk management system cannot be separated.  Every banker wants to know how their farmer-borrowers are going to manage risk, and if it involves hedging on the commodity exchanges, that requires the participation of a lender to post margin money that is needed to ensure the trade will occur.  The same is true for elevator managers, who may depend on lenders for millions of dollars to hold hedges that are required by law when most grain transactions are negotiated.

But the new post-MF Global environment could see many lenders backing away from loaning margin accounts, or in the alternative, charging premium interest rates for money loaned to farmers or elevators for their margin accounts.  With individual account holders only getting 60% to 70% of their money back, lenders will not be happy if that is their money which was loaned for the purpose of managing risk.

What sort of a risk management plan is that?

If elevators have to pay higher interest rates to banks to borrow money for the legally-mandated hedging activity, they will have to recoup the money some way.  The most likely way will be lower bids for grain.  Subsequently, the basis will widen, cash prices go down, and your grain just got cheaper without the market even being open for business.

While the collapse of MF Global will be a case study that will long be studied by students of the financial system, the aftershock could long be felt on Rural Route 4 where farmers will be paying a much higher cost to market grain, compared to any taxpayer cost for a food supply underwritten by the Farm Bill safety net.

Summary:
The collapse of MF Global could be felt as much by lenders as by farmers and elevators which had placed hedges, but have lost all or part of their margin account.  If lenders lose money as part of the bankruptcy, their future reluctance to loan money for risk management margins will be a significant loss.  If money is loaned, interest rates could be charged at premium levels.  Elevator managers will likely have to pay higher rates, and that will be reflected in lower cash bids and wider basis levels. 

Posted by Stu Ellis on 12/27 at 12:48 AM | Permalink

Comments

Finance run amuck The other day, not really sure when or where, someone said; “The problem with the world’s economy comes from finance running capitalism - not supporting it.” Finance as he defined it; “Is the business of making money with money.” In the “old days”, I am guessing prior to the 1980’s, money was used to provide capital for businesses. Loans were made. “Things” were much more regulated back then. The Depository Institutions Deregulation and Monetary Control Act of 1980 seems to be the first “crack” to the Glass–Steagall Act of 1932 which might have been the start of the current financial industry. A big unwind came in 1999. Since the first deregulations we have had: -A Savings and Loan Crisis of the 1980’s-1990’s; about 25% of the institution failed resulting in a US Government bail out -Leverage Buyout of the 1980; although not a crash in its own right, undermined US corporate financial strength -The Wall Street Crash of 1987 -1998 Long-Term Capital Management Failure -2000-01 Dot-Com bubble -2001 Enron Scandal -2001-02 WorldCom Scandal and Bankruptcy -2005 Refco Scandal -2005-07 Age of Mega-Buyout -2008-09 Sub-prime mortgage crisis -2011 MF Global Bad (I’m not sure what to call it other than Bad.) From a Global view point there was: -Latin American debt crisis; starting with 1982 Mexican Weekend, -The late 1980’s through early 1990’s Nordic Financial Crisis -Black Wednesday; the 1993-94 speculative attacks on currencies in the European Exchange Rate Mechanism -1994 Economic Crisis in Mexico -1997 Asian Financial Crisis -1998 Russian Financial Crisis -2000-01 Turkish Crisis -2001 Argentine Crisis -2010 European Sovereign Debt Crisis There are a lot more events that could/should be included. I have listed those closest to me. It seems all of these events could be traced back to finance run amuck. Finance is the only place I know, where one can place other people’s money at risk, with no or minimal personal financial risk, and amass huge wealth. This opportunity for riskless wealth may have turned finance from a tool of capitalism into a self-propelled force that can now “create its own wake.” For many it has become personal tsunamis. We will get through this as we have done in the past and will have to again in the future. We will be primed for another financial crisis as soon as a little inflationary “heat” is added to this liquidity flush, low interest rate environment. (Yes the pot will boil-over again.) Someone, somewhere, wearing of finance hat, will provide a solution that is “too good to be true”. Jib aka Gibberish PS Some have argued that there is no original thought. (Andy Rooney alluded to this idea in his last TV commentary.) Thoughts are built upon thoughts of others. So was the first original thought, the one all else in built upon, Eve’s; “Should I give this apple to Adam?” Or were Adam and Eve designed/corrupted to follow that apple exchange process and the first original mortally derive thought, the one all else in built upon; “Oh My God, we have no clothes!”

Posted by: Jib at December 27, 2011 1:01AM

This makes me wonder not just about MF Global but also about life insurance investment. I can't believe my eyes here. When will we ever know what the fallout will be?

Posted by: Sharon Squires at December 28, 2011 3:03PM

I think we will be primed for another financial crisis as soon as a little inflationary “heat” is added to this liquidity flush, low interest rate environment. (Yes the pot will boil-over again.) Someone, somewhere, wearing of finance hat, will provide a solution that is “too good to be true”. It seems all of these events could be traced back to finance run amuck. Finance is the only place I know, where one can place other people’s money at risk, with no or minimal personal financial risk, and amass huge wealth. This opportunity for riskless wealth may have turned finance from a tool of capitalism into a self-propelled force that can now “create its own wake.” For many it has become personal tsunamis. We will get through this as we have done in the past and will have to again in the future.

Posted by: GefferyMason at January 2, 2012 5:05AM

Post a comment

*Name:

*Email:

Location:

URL:

SPAM? Leave this blank unless you are a spam-bot.

*Comment:

Remember my personal information

Notify me of follow-up comments?

*Required