and it’s gone!

WealthCycles

PFGBest Segregated Accounts Vaporized

On March 28th we wrote MF Global Scandal Is Iceberg Tip of Vast Hidden Risk, and we meant it. MF Global was the tip of the iceberg, and vast, contiguous, hidden risk remained.

Part of the unfortunate base of the iceberg has now been revealed. The National Futures Association (NFA) has frozen all accounts at PFGBest, a commoditiesbrokerage based in the heart of farm country, Cedar Falls, Iowa. “Until further notice, PFGBest is not authorized to release any funds.” Over half of customer assets, some $200 million in client funds, has been stolen.

MFGlobal was the largest commodities brokerage in the U.S. The firm’s demise was the first big move that has limited the desire for speculation and participation in commodities markets. This move let people know that their segregated accounts did not mean their assets truly remained their own. After the scandal, 700 customer accounts were transferred in bulk to PFGBest. PFG put out a tweet at the time:

This is not what was meant to be.

What Service Did MFGlobal and PFGBest Provide?

A large majority of MF Global customers were farmers seeking to lock in a selling price for their crops. With their crops selling price locked in, they are then better able to plan cash flow, investments and other expenses. In this process, the farmers transfer price risk to professional speculators.

Eliminating volume and use in these markets will ultimately cost consumers in the grocery store, and the poorest, in the tummy. As speculators and farmers alike retreat from playing a part in price formation, prices become more unpredictable, volatile, and send less accurate and efficient signals to farmers about what to plant. There is also lower competition among speculators in getting farmers their best price.

As the old saying goes, “the solution to high prices is high prices.” If farmers see prices lower than they should otherwise be, they would be tricked into thinking that there is less of a need for the particular commodity. This type of price manipulation, a result of limiting the market breadth, creates shortages, and then much higher prices, as the shortage manifests itself. That is the point at which the poor begin to feel the costs.

The opposite is true as well: if speculators believe there will be a shortage of wheat, they will bid up the price today, taking on the risk of being early. The higher price will encourage farmers to plant more wheat now, and also signal to consumers to cut back on wheat today (as prices are high). This consumer cut-back helps to prevent a real shortage in which people go hungry over extreme prices or in which there is no supply at all in some regions.

PFGBust – Regulators Create False Security

As of January, the Commodities and Futures Trading Commission reported that it did not find any “material breaches of customer funds protection requirements.” The agency claimed to have completed a coordinated review of brokers in conjunction with the Chicago Mercantile Exchange (CME) and the National Futures Association (NFA).

The regulators did not even verify the bank account balances to make sure the client cash was where it was said to be. Instead they used internal documentation provided, not by the bank, but by the firm itself; essentially, the regulators are not doing their jobs.

Finally on July 9th, perhaps after it came out that “PFGBest recently laid off staff and cut other employees’ salaries by 20 percent,” the NFA made inquiry with US Bank and learned that, rather than the $225 million that PFG had reported as being on deposit at US Bank just days earlier, PFG in actuality had only approximately $5 million on deposit at U.S. Bank.

So the regulator did figure something out, eventually, but not from proactive measures. Rather, the regulator’s reaction came only after another $200 million in segregated client assets were Corzined.

There is a free market out there that can do better. There are firms such asAtlas Ratings that scrutinize the entire spectrum of brokers, (actually) looking for and publishing risks.

“People of privilege will always risk their complete destruction rather than surrender any material part of their advantage.” — John Kenneth Galbraith

What About Your Broker?

The main lesson of the MF Global event, applicable again today, is the whole idea that client funds and assets can be taken as the broker’s own and repledged in exchange for cash. The same repledged assets can then be repledged (hypothecated) yet again, creating collateral chains where many owners lay claim to one real asset–an asset that initially represented your hard work, your investment, and your family’s future. In our premium article on the collateral crisis, we pointed out the extent to which a selection of common brokers today are rehypothecating client assets, creating new capital and leverage in the process.

If you are still reading us here at WealthCycles, you understand the reality is not as we are told. There is no economic recovery; debt is rising, not falling; and the next big blow-out will be even more spectacular. What we ask is this: If you see a storm coming, why not prepare for the black clouds? Why not saveat a time with such risk, as opposed to investing?

It seems logical that, with more turbulence ahead, more firms that have custody of your family’s future, all of your hard work, can and will fail, whether deliberately or due to the trillions in derivatives and counterparty risk to which they are exposed. Why trust strangers, who have no accountability, and not even an incentive, to protect something so dear to you? Gold and silver coins are simply money, that you control. Holding and saving in this medium of exchange make you the boss over your wealth.

never gets old…

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