Saturday, March 29, 2008

Throw one more factor in...

[The response from Kirk below tied into this post as well. And also this comment:

I understand your frustration in being unable to forward contract as you would like. I manage a relatively small grain merchandising operation. We have offered forward contracts to our farmer customers for up to three years into the future. We still do.

Our greatest problem in going forward with this service has been the very large drain on capital caused by excessive margin calls. The secondary problem is the interest cost drain on our P & L. The last, but definitely not the least issue is the lack of convergence between cash and futures.
In our area, we typically think that we can buy a harvest basis postion with some predictability and merchandise that postion going forward without undue risk to balance sheet and P & L. Lately, it appears that any thought of convergence has been lost on the CFTC and that they have allowed the CBOT to become more of a momentum and sheer power game instead of the price discovery vehichle that I have defended for the last thirty years. I feel somewhat betrayed by the system and wonder if we do not have much greater problems ahead.

Renewable fuels have created tremendous opportunity for wealth creation in the rural areas, however, I am concerned that if we allow the marketing system to be swayed by sheer volume and tremendous, outside, non-agricultural interests we will lose the main assets that this economic system has always offered. Namely, stability, confidence and rule of law.

I don't pretend to have the answer, but I feel sometimes that the system is somewhat out of control.
]

As the administration works to avert even more serious economic problems, the call for tighter market regulation has come from all sides.
"I think the response to the disaster of the credit crunch is going to be clearly some increase in regulation," said Alice Rivlin, a former board member of the Federal Reserve. "The key is to do it well and not overdo. I think everybody is in agreement that the subprime mortgage market needs more regulation."

Indeed, mortgage lending is likely to be scrutinized more closely as a result of the new mood in the country over financial regulation. And several proposals are gathering support in Congress that would allow Americans facing foreclosures on their homes to have their mortgage reduced at a lower and federally insured interest rate.

Lyle Gramley, another former Fed board member, agreed, saying "it is widely recognized that regulation now has to be tightened somewhat" after years of innovations that produced complex investing products like swaps and derivatives of all sizes and shapes that can be traded almost worldwide, instantly.

"There is going to be more regulation regardless of whether people like it or not," said Raghuram Rajan, a business professor at the University of Chicago and former chief economist for the International Monetary Fund. "Once you've drawn the Fed into an expanded role, you have to ask how to prevent that thing from occurring again." [More]
But note the casual reference to merging the CFTC and SEC. The explosive growth of derivatives have left the government referees trying to figure out how to call the game, and it looks like they want one set of rules all over the gym.

This suggestion will not be attractive to the agencies involved I would guess. Crimony, we can't get airline pilots to agree on merged seniority, let alone the turf-guarding GS bureaucrats. Some preliminary steps to do so have already provoked truculence from all sides.
The CME Group wants to preserve the existing system, while the Chicago Board Options Exchange favors replacing the two agencies with a single regulator as new derivative products have blurred the distinctions between futures contracts and equities.

CBOE Chairman and Chief Executive William Brodsky was appreciative of the agencies' promised cooperation, but he is waiting to see whether their words are matched by substantive action. [More]
But just like 9/11 left us with the ghastly and freedom-diminishing Patriot Act, the hasty overreaction to this this credit crisis may undo years of patient deregulation which I believe played a big part in the longest run of prosperity in our history.

Perhaps the line between government control and free enterprise will always have to wander back and forth as new players have to learn the perils of not meeting in the reasonable middle. But I fear ideas like Sec. Paulson's look like vigorous government action, but shackle growth significantly for years to come.

1 comment:

Kirk Kreikemeier said...

Regarding the sweeping changes to regulation that will likely be proposed tomorrow, I take comfort in the fact that Paulson, former Goldman Sachs CEO, is the current Treasury Secretary and will not overdue the regulation but rather attempt to make the regulation we have more consistent across entities and more competitive globally. Heck they may even propose a federal insurance regulator instead of the current 50 separate ones.

It is not a knee-jerk response to the current crisis and will take years of Congressional compromise to be put into action. The WSJ notes "The revamp process began early last year before the credit crunch and was initially aimed at improving American competitiveness." My initial reaction to the proposed combining of SEC and CFTC was more about combining regulators for entities and markets that use derivatives in both exchange-traded and over-the-counter swaps. Both tools are very effective at managing risk and providing liquidity to the markets. Sometimes sane and steady; othertimes temporarily overwhelmed by the technicals and less about fundamentals over the near-term.

Which leads to my comment on the agricultural marketing system to be swayed by the outside forces. That is here to stay. Clearly different problems lie ahead and you need to recognize them and manage the added technicals. You absolutely won't lose the rule of law, but instead get the strictly enforced rule of supply and demand with larger participants. As far as stability, probably less so going forward. Regarding confidence, that will only come if past practices are adjusted for the new technicals in the free markets.