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Click on the link to read the rest of the article. This is about half of it, and the Globe and Mail is not some left-wing ideologue source: it is Canada's premiere business-oriented conservative newspaper.Feeding frenzy
One big culprit in the global food crisis has been overlooked: The money. Pension and index funds used a loophole to plow hundreds of billions of dollars into commodities markets
SINCLAIR STEWART AND PAUL WALDIE
sstewart@globeandmail.com; pwaldie@globeandmail.com
May 31, 2008
LARNED, KAN. -- Tom Giessel rubs the heel of his palm against his forehead, exhales a moment, and then begins again, trying to make sense of how the global food market has suddenly descended into chaos.
He is seated on a couch in his modest white farmhouse, surrounded by acres of wheat that in a few days will begin to flower, blanketing this central Kansas town with millions of tiny green beards. Beside him, a sheaf of dried wheat spills out of a vase, while across the room, a stylized crucifix looms above the entrance to the kitchen, a solitary stem writhing on the cross.
For three generations, grain has been his family's lifeblood, a source of sustenance and pride, reward and hardship.
Mr. Giessel, 55, lived through the Russian Wheat Deal in the 1970s, when a sudden rise in exports to the Soviet Union sparked a boom in prices. He has endured credit crises, political embargoes, and the vicissitudes of weather and drought.
Yet in the more than 3½ decades he has been farming, he has never seen anything quite like this. The prices of wheat, corn, soybeans and rice more than doubled in value in the span of several months, sowing equal measures of confusion and fear in the American heartland. Commodities markets, where these prices take their cue, have become so unpredictable that farmers now liken them to blackjack tables in Las Vegas.
At the same time, the costs of fertilizer, herbicides and fuel - all crucial to agriculture - have skyrocketed to record heights: Mr. Giessel's expenses alone jumped half a million dollars in the past year, twice what they normally are.
"It used to be that I could figure on things from year to year," shrugs Mr. Giessel, a stout man with dark eyes, thick forearms and a weathered countenance. "But now it's like driving down the road with no headlights. You can look out the window and see the white lines, but you don't know what the hell you're going to hit. This is the most risk I've been exposed to since I started farming."
The problems here go well beyond the Kansas border. The record escalation of food prices has played havoc with every link in the food chain, from grain merchants to futures markets, from publicly traded food companies to consumers.
Producers such as Mr. Giessel now find themselves on the front line of a mushrooming global crisis, one that has sparked violent protests in some of the world's poorest countries, prompting aid agencies to warn of a pending humanitarian catastrophe.
In the search for answers, pundits have attempted to pin the blame on the usual suspects: rising demand from China and India, bad crop conditions and booming ethanol production.
Yet one major culprit behind these gyrating markets and unprecedented price spikes has been largely overlooked: the deep-pocketed pension and index funds upon which most Canadians and Americans depend for their retirements.
These funds have plowed tens of billions of dollars into agricultural commodities as a way to diversify their assets and improve returns for their investors.
The amount of fund money invested in commodity indexes has climbed from just $13-billion (U.S.) in 2003 to a staggering $260-billion in March, 2008, according to calculations based on regulatory filings.
Michael Masters, a veteran U.S. hedge fund manager, warned a Senate hearing this month that this number could easily quadruple to $1-trillion, if pension funds allocate a greater portion of their portfolio to commodities, as some consultants suggest they are poised to do. Because agricultural markets are small - relative to stock markets - the amount of cash pouring in gives these funds substantial clout. Mr. Masters estimated that that these big institutional investors control enough wheat futures to supply the needs of American consumers for the next two years, and blamed the "demand shock" from these recent entrants to the commodities markets as arguably the primary factor behind the sudden take-off in food prices.
"If immediate action is not taken, food and energy prices will rise higher still," he told the hearing. "This could have catastrophic economic effects on millions of already stressed U.S. consumers. It literally could mean starvation for millions of the world's poor."
The massive influx of cash has only occurred in the past few years. But its roots stretch back to the Reagan era, when a court battle over oil price manipulation set off a domino effect that would ultimately transform the arcane world of commodities trading.
Beginning with the energy market, regulators made a series of far-reaching decisions that gradually loosened oversight of complex commodity derivatives and created loopholes for large speculators, allowing them to trade virtually unlimited amounts of corn, wheat and other food futures.
Only now, nearly two decades later, are the full consequences of those decisions being felt.
We're not in Kansas any more
For months, governments and international bodies have been struggling to avert catastrophe. The United Nations created a special task force on food security and called for emergency donations. Leaders of the world's wealthiest countries are expected to make the food crisis a priority when they gather for a G8 summit in July.
And the U.S. Congress has convened hearings into the matter, as have various other governmental and regulatory bodies around the world, all in an attempt to understand how markets and prices careened out of control.
They would do well to ask Fowler West. At a pivotal moment almost 20 years ago, Mr. West warned that a series of rapid-fire moves to deregulate commodities trading could wreak unintended - and perhaps calamitous - effects on these markets.
His alarms went unheeded.
In the early 1990s, Mr. West held a seat as a commissioner on the Commodity Futures Trading Commission, the U.S. regulator charged with overseeing trading in hundreds of staple items, from corn and wheat to oil and cotton. Mr. West was a lifelong Democrat; his boss, CFTC chair Wendy Gramm, was a devout Republican and a believer in the laissez-faire, free-market philosophy espoused by president Ronald Reagan, who once described her as his "favourite economist."
In the fall of 1990, the two clashed over the CFTC's response to a New York court decision involving a little-known Bermuda energy company called Transnor Ltd.
Long forgotten by most, Transnor paved the way for wide-ranging deregulation of commodities trading, an effort that helped to spur the rise of Enron Corp. and which has enabled the stampede of large fund speculators into food markets.
In the winter of 1986, Transnor filed suit against some of the world's largest oil companies, alleging that they manipulated prices on the Brent market, an informal oil trading system that at the time determined the daily price of oil.
At first, few paid attention to the lawsuit. That all changed on April 18, 1990, when Judge William Conner delivered a stunning ruling midway through the trial.
The case hinged on drawing a key distinction: Were the 15-day oil contracts that traded on the Brent market "forward contracts" or "futures contracts"?
In a forward contract, the buyer and seller agree to the price of a commodity and a fixed date for delivery. A farmer enters into a forward contract with a food company by promising to deliver a certain amount of grain on a certain date at a certain price. Lawmakers have shied away from regulating forward contracts under commodity trading laws because they are a fundamental part of how farmers and food companies do business - and each agreement is unique.
A futures contract is the same basic agreement, but it trades on an exchange, and the buyer rarely - if ever - takes delivery of the commodities. Instead, futures contracts are used mainly by farmers for hedging and by investors for speculating. These contracts have historically been regulated.
In the Brent case, the difference was crucial, since the Brent market contracts did not trade on any exchange and, in the U.S., were not regulated by the CFTC.
The oil companies, hoping to protect their cozy market, and avoid the red tape and transparency requirements of regulation, argued they were forward contracts.
Judge Conner ruled against the companies, effectively rendering all Brent trading in the U.S. illegal.
Within days, international oil companies stopped trading with U.S. companies and the entire Brent market was verging on collapse.
In Washington, oil industry lobbyists descended on the CFTC, seeking to get the regulator to mitigate Judge Conner's ruling. They found a receptive ear in Ms. Gramm, the commission chair. Ms. Gramm served as a director at the Office of Management and Budget, spearheading a variety of industry deregulation efforts before President Reagan placed her in charge of the CFTC in 1988.
She arrived with other political credentials: her husband, Phil, who is now a senior economic adviser to presidential candidate John McCain, was a Republican senator from Texas.
Even before the Transnor case, Ms. Gramm had started pursuing a deregulation agenda at the CFTC. A year earlier, in 1989, the commission quietly issued a policy statement on swap transactions, deals in which a buyer of commodities such as a pension fund acts through a middleman or a swap dealer - usually a bank. The CFTC declared that it wouldn't regulate swap dealers.
The Transnor case represented another crucial win for financial speculators such as swap dealers. When the court decision was handed down, Ms. Gramm moved quickly to soften the blow to the energy sector, and turned the Transnor decision from an obscure footnote in the history of oil trading into a critical launching pad for a wide-ranging redrawing of the rules of commodities markets.
On Sept. 25, 1990, a policy confirming that the Brent contracts were forward contracts - and therefore, outside the scope of CFTC regulation - was put to a vote among CFTC commissioners.
It passed 3 to 1.
Ms. Gramm faced one vocal critic in her push to keep the Brent market unregulated: Fowler West, the lone 'no' vote.
"It was the way we were doing it, the speed with which we were doing it," Mr. West recalled in an interview. "It was that kind of an attitude that did open the door up for a lot of problems."
Ms. Gramm defends the CFTC's actions, and says the commission faced pressure from Congress to act. Senior CFTC staff, as well as a majority of commissioners, agreed with the interpretation concerning forward contracts, she noted.
"I don't think it was done too quickly," Ms. Gramm, who now chairs the Regulatory Studies Program at George Mason University's Mercatus Center, told The Globe and Mail in an interview.
Mr. West, meanwhile, wasn't merely outvoted. He was muzzled.
Although he wrote an official dissent after the vote, Ms. Gramm and the other commissioners blocked his views from being published in the CFTC's official record.
Furious, Mr. West retaliated by voicing his concern about the CFTC's moves to the New York State Bar Association. The regulator, he told the lawyers' group, "may soon be paying a price for its politically expedient statutory interpretation. I doubt that its new forward contract exemption can be restricted to large international oil and trading firms represented by influential lawyers."
He concluded with an ominous warning: "The public, down the road, will suffer from this fit of deregulation, no matter how well intentioned."
Mr. West's remarks were published in a law journal, and the efforts by the CFTC to quiet him stirred a furor in D.C. legal circles.
Two years later, Congress amended the Commodity Exchange Act to require the CFTC to publish dissenting opinions.
Into the promised land of deregulation
Much as Mr. West predicted, the Transnor case proved to be a watershed event. The CFTC's embrace of a narrow definition of a futures contract built on the regulator's earlier promise that it would not police swap transactions.
Together, these moves opened up a new frontier of commodity trading, enabling financial speculators to buy and sell complex derivatives away from the prying eyes of regulators and exchanges.
For these dealers in the late 1980s and 1990s, the shrinking CFTC rulebook created a "virtually regulation-free promised land," Philip McBride Johnson, who was CFTC chairman from 1981 to 1983, later told a congressional committee.
The vast majority of this trading boom occurred in the oil and energy markets, both of which are sufficiently large and liquid to accommodate legions of traders.
It wasn't long before dealers began gravitating toward the smaller agricultural commodities markets as well.
To get exposure to a broad array of commodities, many institutional investors preferred to invest in an index that tracked the futures market. These indexes typically comprise a basket of products, from oil and gas to wheat, cotton, and precious metals, each given a weighting according to the size of its individual market.
As funds began making more and more index investments, their ownership of food futures increased correspondingly.
Yet the food markets are a somewhat different beast, with a different set of rules, and it wasn't long before this infusion of money hit another regulatory snag.
For almost 75 years, the CFTC has imposed limits on how much of certain agricultural commodities, including wheat, cotton, soybean, soybean meal, corn, and oats, can be traded by non-commercial players - that is, investors who are not part of the food industry. So-called "commercial hedgers," like farmers or food processors, can trade unlimited amounts in order to manage their risk.
The limits were designed to prevent manipulation and distortion in what are relatively small markets, and at the same time to allow for a small amount of speculative activity, in order to provide liquidity for trading.
For decades, the restrictions didn't pose much of a problem. And then, in 1991, as new money began pouring in, the playing field suddenly shifted.
Emboldened by the CFTC's laissez-faire approach, a bank approached the regulator and, for the first time, requested an exemption from speculative trading limits in an agricultural commodity.
The unnamed bank was acting as a "swap dealer" for a pension fund: Essentially, it was a middleman who helped the pension fund get exposure to commodities. A spokesman for the regulator declined to identify the bank or the pension plan, citing confidentiality requirements.
Understanding how a swap transaction like this works is critical to grasping why the CFTC ultimately granted an exemption to this bank - and in so doing, opened a loophole that has since allowed hundreds of billions of dollars worth of fund money to rush into the commodities markets.
Let's say a pension fund wants to make a large investment in commodities, but the size of that investment would violate the trading limits on wheat. Rather than invest directly in the futures market, the fund can invest its money with a middleman, such as a bank, in what is called a swap transaction.
The bank might agree to pay the fund a return on a commodity index - if the index rises 10 per cent in the next year, the bank will pay out that 10 per cent. But the bank doesn't want to be on the hook for 10 per cent, so it hedges its risk by wading into the commodities market, and using the fund's money to buy futures. Essentially, it is buying futures to mirror the performance of the index, so that if prices rise, it can pass that gain along to the fund without digging into its own pocket.
It is this notion of a middleman that swayed the CFTC. Had the pension fund invested all of its money directly in futures, it would not be allowed to exceed the trading threshold.
But the swap dealer was a different story. The CFTC ruled that it was only buying futures to hedge its risk with the pension fund client; therefore, much like a food industry hedger, it deserved to be exempt too.
The move was further evidence of the regulator's hands-off approach under Ms. Gramm. Since that time, the regulator confirmed it has approved 20 additional exemptions for swap dealers, some of whom may strike agreements with multiple funds.
"The underlying philosophy seemed to be that the big guy could take care of himself and there was no need for a lot of regulation," Mr. West recalled.
"It was actually told to me by the chairwoman that these [big companies] don't need us regulating them and hampering them, because they can take care of themselves. That missed the point. The point was, sure they can take care of themselves - but it wasn't them I was worried about."
Still, despite this apparently favourable treatment, many swap dealers and derivatives traders remained nervous: Although the CFTC had provided welcome assurances, the regulator did not have the formal power to enshrine these exemptions as binding rules.
Brokerage firms, energy traders and other financial players aggressively lobbied Congress on the issue, and in 1992, the U.S. government passed new legislation that enabled the CFTC to determine which derivatives could be considered forward contracts and receive exemptions.
Armed with this new power, the CFTC quickly handed out nine different exemptions for certain energy contracts. One of the recipients was a Houston-based pipeline entity called Enron Corp. that was branching out into the energy trading arena.
In January 1993, just as President Bill Clinton was being inaugurated, Ms. Gramm left the CFTC. Five weeks later she joined the board of Enron.
Congress, however, wasn't done. In 2000, it introduced an array of exemptions, including one for electronic trading of energy contracts. This new rule, which prompted the creation of numerous over-the-counter trading systems allowing buyers and sellers to avoid scrutiny, was later given a nickname: the Enron Loophole.
...
Long story short: much of the food crisis can be attributed to the same source of so many of our current woes: Ronald Reagan and his deregulation movement. Most of the money in the agricultural market is now from people who have nothing to do with the business, and don't particularly care what effect their buying and selling decisions have on the industry as long as their index values keep going up. Regulations dating back to the early 20th century which were expressly designed to prevent this outcome were scrapped during the wave of deregulation that started in the 1980s and reached its zenith at the beginning of the current Bush administration.
Toward the end of the article, Mr. Giessel comments: "We're commoditizing everything, and losing sight that it's food, that it's something people need," he said. "We're trading lives."
I think it's a very interesting angle from which to examine the problem. Obviously, increasing demand from developing markets and from ethanol production are factors as well, but they are relatively steady increases, and do not satisfactorily explain the extreme volatility we're seeing. Excessive amounts of speculative trading, on the other hand, will produce high volatility almost by definition, and the Republican Congress explicitly passed an act in 2000 designed to take the gloves off speculative traders in agricultural commodities.TIMELINE
1848
82 businessmen form the Chicago Board of Trade (CBOT) for producers, buyers and sellers of grain.
1865
CBOT develops futures contracts for grains. Hundreds of other futures markets spring up across the U.S., including the Butter and Cheese Exchange in New York (which later became the New York Mercantile Exchange) and Chicago Butter and Egg Board (later changed to Chicago Mercantile Exchange).
1887
Winnipeg Grain and Produce Exchange founded (renamed Winnipeg Commodity Exchange in 1972). Operated as a cash market only for the first 18 years before becoming a futures market.
1905
Grain Growers Grain Co. Ltd. created in Saskatchewan as a co-operative for farmers.
1917
Wheat futures trading suspended on the Winnipeg exchange, leading the federal government to create the Canadian Wheat Board two years later.
1920
Canadian Wheat Board disbanded.
1922
U.S. passes Grain Futures Act in response to widespread manipulation in the futures markets. The law cracked down on "excessive speculation" and established a framework for regulated commodity exchanges.
1923
Wheat pools created in Alberta, Saskatchewan and Manitoba to market grain for farmers.
1935
Canadian Wheat Board re-established by the federal government to market grain.
1936
U.S. enacts Commodity Exchange Act to broaden regulations to include trading in other agricultural commodities, including cotton, butter and eggs.
1943
The CWB is granted a monopoly to sell prairie farmer's wheat; wheat trading on the Winnipeg exchange suspended.
1958
Agricultural Stabilization Board created in Canada to provide price support to farmers in various commodities.
1972
Farm Products Marketing Agencies Act enacted in Canada, leads to the creation of marketing boards for dairy and poultry products.
1974
U.S. government creates the Commodity Futures Trading Commission (CFTC) to regulate commodity exchanges.
1989
CFTC issues a "swaps policy statement," saying it would not seek to regulate over-the-counter swap transactions.
1990
Transnor decision prompts CFTC to rule that Brent North Sea contracts are forward contracts and not subject to regulation.
1997
Ontario Teachers' Pension Plan becomes one of the first pension plans to invest in commodities, with a $100-million investment.
2000
Commodity Futures Modernization Act in the U.S. codifies exemptions and exclusions for various energy and financial derivatives from CFTC oversight.
Intercontinental Exchange created in Atlanta as an electronic energy trading platform.
2005
CFTC expands position limits in wheat, corn and soybean trading for speculators.
2006
CFTC grants index funds exemptions from position limits imposed on speculators.
2008
In February, prices for some wheat contracts surge 85 per cent on Minneapolis Grain Exchange. Trading is so heavy the contract hits daily limits 12 times, forcing the exchange to expand them.
And the person responsible is the wife of the guy who now serves as John McCain's economic advisor.
Just about anything from that would be "de-regulation", you know.
