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 Oct. 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 60-70% 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.