A nice discussion of just some problems that will be created by the new financial regulation bill

Derivatives are evil. Well, go ask some farmers why they use them.

Farmer Jim Kreutz uses derivatives to soften the blow should the price of feed corn drop before harvest. His brother-in-law, feedlot owner Jon Reeson, turns to them to hedge the price of his steer. The local farmers' co-op uses derivatives to finance fixed-price diesel for truckers who carry cattle to slaughter. And the packing plant employs derivatives to stabilize costs from natural gas to foreign currencies. . . .

But it's the derivatives portion—the part of the bill aimed directly at Wall Street—that might end up touching most lives in rural America.

The new law requires most derivatives transactions be standardized, traded on exchanges, just like corporate stocks, and funneled through clearinghouses to protect against default.

Faced with intense lobbying, Congress partially exempted businesses that use derivatives for commercial purposes. So, farmers and co-ops probably won't face new collateral requirements, for instance—although there remains a dispute over that section of the bill. Those that trade derivatives on regulated exchanges, such as the Chicago Board of Trade, are less likely to see immediate impacts than those conducting private over-the-counter deals, which will face federal regulation for the first time. The goal is to make such deals transparent.

The question for these farmers is whether such rules will make hedging more expensive. Some say new requirements on big players will create higher costs for small players, including the cash dealers will have to put aside to enter into private derivatives transactions. Some brokers think restrictions on big-money banks and investors will drain the amount of money available to the everyday deals farmers favor. . . .

Here's how Mr. Kreutz does it: Say in early summer he sees that the price for a Chicago Board of Trade futures contract on corn for delivery later in the year is $3.56 a bushel. If he likes the price, and wants to lock it in, he calls AgWest and sells a futures contract for 5,000 bushels. The futures contract is a derivative in which the price for corn is set now for exchange in the future, though no kernels will change hands. Instead, when the contract nears expiration, Mr. Kreutz and the buyer of his contract will settle—in effect—by check.

By fall, when Mr. Kreutz is ready to deliver his crop to the local co-op, the market price might have fallen by 50 cents. He'll sell his actual corn for that lower amount. But he'll make up the difference through his financial hedge. (Mr. Kreutz buys a new futures contract at the lower price to make good on his earlier promise, making up the 50 cents.) In all, he'll have hit the price target he locked in earlier in the year, minus brokerage fees.

If the price rises during the summer, as it did during the food crisis two years ago, Mr. Kreutz has to pony up extra cash for his broker—a margin call—to maintain his positions. He recoups that by selling his actual corn at a higher price, but has to take a loss to meet the futures contract he signed earlier in the year, missing out on a windfall but ultimately meeting his target price.

Mr. Kreutz does this type of operation dozens of times a year, hedging about 70% of his 345,000-bushel corn harvest. . . .

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