GUEST COMMENTARY: Dodd-Frank net might ensnare family meal

2012-11-06T00:00:00Z GUEST COMMENTARY: Dodd-Frank net might ensnare family mealBy Don Coursey
November 06, 2012 12:00 am  • 

Federal regulators recently roiled America's farmers with the release of new rules for financial instruments. The Commodity Futures Trading Commission, one of the agencies charged with implementing the Dodd-Frank Wall Street Reform Act, officially announced the new requirements and said they would take effect by year's end.

Among the instruments covered by the commission's proposals are agricultural commodity "swaps." Basically, swaps empower farmers, ranchers, agribusinesses and other food suppliers to hedge against certain risks common to their trade, like bad weather or a crash in the price of a food item they sell.

Swaps play a key role in providing food producers with a basic level of financial security through tough times, which helps to ensure price stability for consumers.

Consequently, imposing Dodd-Frank rules on these instruments could have a profound effect on Americans' pocketbooks. Dodd-Frank could make risk management significantly more costly for America's farmers, driving up volatility in the market and potentially leading to huge price increases for consumers.

The commission's new rules affect agricultural commodity swaps that aren't sold on exchanges and don't run through third-party intermediaries -- so-called "over-the-counter" swaps.

Consider a bread baker who buys thousands of pounds of flour each year. Because of this year's droughts, he's worried that America's wheat supply will shrink, driving up flour prices over the next 12 months.

So, to hedge against a price spike, he buys $10,000 in over-the-counter flour swaps today to guarantee that next year he'll be able to purchase up to 10,000 pounds of flour for $1 per pound. In 12 months, if the price of flour is dramatically higher, he'll have saved himself a huge amount of money. The price could also be lower, of course, but that's the risk he runs in order to guarantee he won't go bankrupt.

Right now, over-the-counter agricultural swaps are mostly unregulated. But that shouldn't be a point of concern -- these instruments had nothing to do with the financial meltdown.

Nevertheless, this new round of Dodd-Frank rules would impose a slew of new requirements on these instruments. Buyers and sellers would have to trade them on approved exchanges, and they would need to have a certain level of capital on hand to trade. Reporting rules regarding profits and losses would be ratcheted up.

There would also be mandatory "clearing," meaning swap trades would be required to run through certified middlemen. Yet the over-the-counter agriculture swap market has been running safely and efficiently for years without mandatory middlemen.

On the other hand, the traditional futures market operating under mandatory clearing rules has been home to some of the biggest financial meltdowns of the last few years. This regulatory structure is obviously broken.

So implementing Dodd-Frank as planned means forcing agriculture swaps to move from a regulatory environment that is universally acknowledged to be working well to one that has failed repeatedly to prevent fraud and abuse.

Don Coursey is Ameritech Professor of Public Policy Studies at the Harris School of the University of Chicago. The opinion expressed in this column is the writer's and not necessarily that of The Times.

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