Wall Street in Cornfields

Derivatives in corn fields are nothing new. Futures contracts in agricultural commodities helped farmers protect themselves from variations in market prices. In March 2010, I visited Iowa State University to speak at the 25th Anniversary celebration of its management school. A faculty friend at the university told me this story. She was a shareholder of a biodiesel firm. It had reported a one million dollar loss on its derivative positions. She was unhappy and attended the shareholders’ meeting to ask how the firm incurred the loss. She was told that the firm had hedged its inventory of biodiesel using derivatives. She asked for a more detailed explanation and accepted the offer to meet the firm’s risk manager after the formal meeting ended. The twenty-something risk manager took a few shots at explaining the hedge by trying a few times, and failing, to illustrate the hedge by drawing a freehand chart on paper. Unable to explain the derivative positions the company had taken as an exercise to protect it from the risk of variations in price of biodiesel, the risk manager threw up his hands and blurted out: to tell you the truth, the guy from Goldman told me to do this. A director of the company who was kibitzing on this conversation turned to my friend and asked: are you in hedge funds? I had thought the boiler room and bucket shop operations were made illegal and closed long ago. Deliberately chosen complexity, beyond the comprehension of their targeted customers, seems to be a common theme between those old-style scams and the new-fangled ones. ProPublica report on Magnetar, issued a week before the Securities and Exchange Commission charged Goldman Sachs with fraud, was an eye-opener for me. Are we teaching the skill, and granting degrees for it?