Speer: LRP Needs Measured Approach
LRP Review: Following four previous columns on Livestock Risk Protection last fall, this is the third in a subsequent series meant to systematically review and assess LRP’s influence on the business. And based on some feedback, there’s still interest in LRP (it’s not a dead horse). One reader emailed stating, “I’m glad that you are still writing about it.”
The first two columns (see one and two) addressed (mis)perceptions of market impact resulting from LRP coverage. Nevertheless, there remains one topic not addressed in the preceding two columns – subsidy harvesting.
Subsidy Harvest: I explained the practice in a previous column quoting one reader who details best: “…someone buys an LRP in feeders…the put the insurance company buys [costs] $10, the government subsidizes about 35%, so he pays roughly $7. He turns around and sells the same put in his commodity account for $10. He collects $3 with no risk.”
But it’s never “no risk”. One reader rightly noted, “When a producer sells a put to offset the LRP cost they become a speculator,” thereby undermining and/or negating the purpose of purchasing LRP insurance in the first place. (See: 1. Explanation of futures/options risk disclaimer here, and 2. Don’t Try This At Home.)
Subsidy harvesting inherently makes the producer / LRP holder (who’s trying to avoid risk) simultaneously a speculator. CIH explains the imbalance like this:
There is also the belief the two [purchasing LRP and selling put] cancel each other out [in terms of cost] without any associated risks. While this may appear to be true at first, there are many hidden risks and consequences which may be deliberately not well-explained or factored in for those who choose to participate in this practice.
(Also reference CIH’s White Paper on the topic)
Stress and Success (or Lack Thereof): All that invokes some thoughts from a column last month entitled, Some More Most Important Things. Joe Vaclavik (on Damian Mason’s podcast, The Business of Agriculture) points out speculating serves to be an additional stressor, and is rarely successful:
99% of the US population has no business ever trading a futures or options contract unless they've got a physical position that needs to be hedged…Most people who trade, especially smaller traders, lose money…
Markets can remain irrational longer than you can remain solvent. Just last week, a reader shared with me this thought: “Shorting options works good, until it doesn’t…”. And traders with limited working capital, potential margin calls associated with subsidy harvesting can prove especially perilous.
Moral Hazard: Undoubtedly, subsidy harvesting introduces a form of moral hazard to the business. It effectively enables individuals to use tax-payer dollars to trade the market – certainly, that’s not the intent. None of this is surprising. There are always people who abuse government programs (moral hazard). My favorite analogy being college students who take out student loans and then purchase a new car – well outside the good intentions tied to student loan interest deferment.
As to the occurrence, I noted in a previous column it’s impossible to know in real-time the volume of LRP policies that have been sold (and subsequent level of coverage tied to those policies). Accordingly, there’s also no mechanism to track LRP paired with CME order flow. For instance, there’s no way to know IF X-broker sells LRP policy for 300 head of feeder cattle on X-date and then simultaneously sells 5 puts with similar expiration date.
However, given LRP is subsidized and regulated by RMA and CME trades are regulated by the CFTC, it would be possible for regulators to assess the occurrence (if it’s occurring and by whom) in the rear-view mirror. Such an exercise would provide the industry some additional knowledge about the practice and subsequently explore options (no pun intended) to effectively prevent the practice in the future.
Measured Approach: Previously, I highlighted Elaine Kub’s appearance on Market-To-Market. She addressed the LRP question with this: “…we always seem to have some type of a conspiracy story in these livestock markets.” And to that end, LRP has become needlessly divisive; given some of the unfounded finger pointing, it’s a little like saying, “Hey neighbor, your LRP caused the market to break.”
LRP is an important and useful tool for producers contributing to the stability and sustainability of the beef industry. Bottomline: it’s important the industry and regulators approach some of the outstanding issues in a measured, thoughtful, and logical manner to ensure the program remains valuable for producers.
Nevil Speer is an independent consultant based in Bowling Green, KY. The views and opinions expressed herein do not reflect, nor are associated with in any manner, any client or business relationship. He can be reached at nevil.speer@turkeytrack.biz.
