I’m simply attaching these as a .pdf here. I’m slowly getting better at figuring out to post in different places. JulyOutlookNewsletter
Let’s cut to the chase: PFG makes the futures industry look really, really bad. The best thing that can be said about this debacle is that missing client funds are denominated in millions instead of billions. That’s about it. From MFG, we learned that rehypothecation means that brokers can use client funds as margin for their own trading activities (see here and here), as long as they kept them ‘segregated.’ Such segregation is likely pretty easy right up until the margined trades start losing money, at which point settlements have to be made. In fact, it is worry about those settlements that causes firms to require collateral in the first place. This brings to mind the quote in the latest Economist about the LIBOR scandal, “With traders, if you don’t actually nail it down, they’ll steal it.” But in MFG’s defense, all indications are that the violation of segregation happened pretty shortly before the firm’s collapse. This is little consolation to account holders, but at least we can say that under the (admittedly ridiculous) regulations permitting rehypothecation in place at the time, many parties, regulators included, got blindsided.
But PFG is entirely different. According to recent press reports, in 2010, they claimed to have over $200m in segregated deposits at US Bank, and PFG sent a confirmation to the NFA to that effect. Now it turns out that, in fact, PFG had less than $10m on deposit at the time, and that was in 2010! How does that number go unchecked for at least a year and a half? Did they submit a note from their mother with it, too? Maybe they used nice words like ‘Please’ or ‘Ma’am’? Starbucks gift cards? At the very least, shouldn’t the external auditor have checked it? The NFA? The CFTC? The CME? Anyone? I’m not sure where to start describing my confusion about this. This just seems so simple to catch, and yet it wasn’t caught.
Which leads to the obvious question: how can anyone trust the futures markets? How far have we really come from the bucket shops that featured so prominently in ‘Reminiscences of a Stock Operator?’ Yet these markets are vital to the operation of the modern economy. Without modern futures markets, the amount of risk borne by everyone in the commodity chain would increase dramatically. Farmers couldn’t hand their risk off to elevators through forward contracts because elevators wouldn’t be able to hedge the risk arising from the forward contract. Tyson’s wouldn’t be able to offer forward prices on their chicken to Wendy’s because they not only couldn’t hedge the feed exposure, but they wouldn’t even know what future feed prices will be. The result would be much higher operating costs for everyone.
What can be done? For the time being, I think that the CME and the ICE should once again open their wallets, first as a sign of bona fides to those who lost money; second to lobby for the extension of SIPC-like protection to futures and options accounts. I have to admit that I was shocked to learn that those protections don’t exist. Second, could everyone (CME, ICE, clearinghouses, NFA, CFTC, auditors) please sit down around the same table (I bet Senator Grassley could arrange a table…) and figure out whose responsibility it was to pick up the phone to US Bank and why it didn’t happen? Third, could that person, their co-workers, or someone please lose their job? Fourth,could someone from PFG go to jail?
Sadly, only the fourth will happen.
The February crop reports released this morning were pretty boring. While the revisions were somewhat on the bearish side of expectations, the directions were all as expected.
One of the biggest areas of concern has been the continued drought in South America. Over the past few days, and even up to last night, various official and semi-official sources in Brazil, Argentina and Paraguay have been reducing soy crop estimates. As of the latest reports that I’ve seen, the current in-country estimates (Feb USDA) are Brazil 69.2mmt (72), Argentina 47 (48.9), Paraguay 4.6 (6.4), for a total difference of 5.6mmt, or 205m bushels.
Global Soybean Production, Use & Stocks/Use
As you can see in the plot of global soy production, usage and stocks/use, if one incorporates the newly lowered production figures, and assumes that about 40% of the lowered production will be offset by rationed demand, we move to a 23.5% stocks/use from a 24.5%. This is slightly above 07/08. The WAOB expects that the drought will increase US exports, and it is reflected in the February revisions by the fact that even though exports are currently running below the 11/12 levels forecasted in the January report, the US should book additional exports in the coming months based on lower availability out of SAm. I agree with this, but I think I’m less optimistic than many in the trade. With some luck, I think that we can increase our exports 60m bushels from the current estimate of 1275m bushels, which would tighten US ending stocks, but, in my opinion, only enough to justify the price move that we’ve seen in the past month in beans, and not more.
Heritage Foundation Vice President David Addington, who first reported on the rule on his blog Tuesday evening, said there are two problems with the new fee. First, he said it’s likely the 15 percent fee will be passed on to consumers. Second, he said it’s inappropriate for the government to be putting its “thumb on the scale,” helping out the fresh-tree sellers and not the artificial-tree sellers.
“If it’s one thing I think the free market could handle, it’s letting people decide what kind of tree they want to buy for Christmas,” Addington told FoxNews.com.
Source: Fox News.
While it sounds ominous and like a (hide the children!) tax increase, this is simply a marketing program, like the Milk Board, producers of the ‘Got Milk?’ commercials, or any one of a number of other marketing boards. While Addington above is correct, in that tree producers could promote purchasing live trees by themselves, there is a strong incentive not to do so because of free-riding.
Imagine that there are two producers of live trees, Dasher’s and Dancer’s. Both firms believe that such a marketing campaign is beneficial, and therefore agree to start running commercials that promote live vs. synthetic trees. But Dancer realizes that he benefits from not only his own commercials, but Dasher’s as well. Therefore, if Dancer reduces spending by 10% on his own campaign, but the loss in sales is shared, Dancer is better off in reducing spending on the campaign, assuming that Dasher continues his campaign. Soon, Dasher will make the same realization, and probably also be quite angry at Dancer’s shirking, causing Dasher to reduce his marketing spending. The result is a spiral to zero.
Now, imagine that instead of only two firms, there are thousands, and the incentive to free-ride off the campaigns of others is even greater. That is why such marketing boards are created, they are a mechanism to force all firms to participate in activities with broad benefits.
Producers of cotton, wheat flour and livestock feed are searching for ways to avoid losing U.S. Census Bureau reports critical to their industries that are slated to be discontinued due to budget cuts.
A coalition of agricultural trade associations met Wednesday with the top economist of the U.S Department of Agriculture to discuss attempts to save the reports. Time is running out to find a solution, as some will be stopped after next month.
I agree that these reports are very important to the markets. I’ve long said that the abundance of USDA and Census information on agricultural production and consumption greatly levels the playing field between the largest traders and other participants in the markets. Because of these reports, and others that NASS is now having to reconsider, there is a huge amount of data available to even the lowliest, brokest, land-grant university-based analyst. Nevertheless, the major players still have more information.
But reading the article brings two thoughts to mind. First, if these reports truly are so important to such major actors in the industry, then how can they not be worth $80,000/year to an industry association as a whole? That is the cost of one secretary in their DC office. Alternatively, if these are so important, why doesn’t the United Soybean Board (who receives the national check-off for soybean sales, $82m in 2010) or a coalition of state wheat associations and/or marketing programs fund these?
More fundamentally, why is agriculture different? While I know that the Energy Information Administration provides copious amounts of data on oil and other energy markets, other commodity markets (base & precious metals) seem to function fine without the large investment in public data generation and dissemination. This is not to say that I’m opposed to these reports, or think that they are a bad idea. Just some questions and observations.
I’m back, and part of being back is the monthly newsletter. I’m in the process of trying to improve the newsletter (along the lines of Dr Tufte, but I don’t think he ever had to write a periodical with a staff of 0). Its not there yet, but I’m working on it. In the meantime, if you have any comments or requests, please let me know, either via email or comment (below).
- Harry Potter and the Order of the Phoenix (over breakfast…I’ve never actually read the series before, but my kids talked me into it and I’m enjoying them thoroughly.)
- Results from the 2011 Youth National Climbing Championships…my younger son didn’t make it past the first round, but he learned some valuable lessons about how hard he’ll have to work if he wants to swim in the biggest ponds.
- Debt Ceiling Options at Econbrowser. I’m sickened that there are those suggesting that the President can just ignore the debt ceiling…however, based on this President’s track record of respect for established law (Automaker bankruptcies, War Powers Resolution), it wouldn’t surprise me in the least if that were the course he chose. Don’t misunderstand, it’s Congress that has created this mess, and if the debt ceiling doesn’t get extended, I hope Congress is hoisted on its collective petard. I would just hate to see this Administration take another step toward further strengthening the executive at the expense of our nation’s laws. Related good reads on the debt ceiling: Bartlett, and Tribe.
From the inbox:
The CFTC has just released two new reports looking at volume in various commodity futures and confirming what most have already known, namely that under 10% of daily futures volume in the most popular products comes from Large Trader position changes. The balance or well over 90% in most cases, originates from “daytrading” accounts, or said simply, speculators dominate price formation on the margin for the bulk of products, which also means that longer-term equilibrium levels, those determined by supply and demand, are largely washed out when all the daytrading, and thus short-term pricing, mania is factored in. This also explains why moves such as the recent desperate SPR release by the IEA are generally doomed to failure. The CFTC’s Gary Gensler said that “The data shows that, in many cases, less than 20 percent of average daily trading volume results in traders changing their net long or net short all-futures- combined positions. The balance of trading is due to day trading or trading in calendar spreads.“
(original source here)
- Does anyone know if such data was collected previously, say, twenty or thirty years ago? I’m just curious how this would compare. Many people seem to think that this number is obviously much too high, but with neither context nor empirical/theoretical justification.
- What is the Large Trader database? Simply that, it is the data from the daily submission of Form 102 and Form 40 submissions by firms with ‘large positions,’ based on open interest. The current minimum levels are here. According to the CFTC’s “This Month in Futures” such large traders account for about 94% of OI on CL, 90% on C-, 94% on W-, and 75% on SP.
- The ‘Large Trader Volume’ that is quoted in the slides will be biased downwards because it only accounts for changes from at a weekly frequency, but it is comparing it to all volume.
- Why is spread trading so wrong? Last I checked, it was an integral part of physical hedging. But maybe things have changed in the past 12 months…
In the last 11 months, of which eight have been at the CFTC, one in Colombia, and the month of June spent travelling around the country, I’ve accumulated:
- A new child
- The ability to climb about 3 grades harder
- A new tattoo (needs some touch-up before the reveal, sorry)
- Way more insight into how government regulators work than I ever wanted
- 3 speed camera tickets (I love you, too, Maryland)
- 4 working papers
- A full set of Edward R. Tufte’s books
- A near death experience
- A new teaching responsibility
And after all that…I’m back and ready to go. So I guess this marks the official second post of the new blog!