Complexity

“Complexity and Financial Panics” is the title of a working paper just released by the National Bureau of Economic Research (NBER).

The abstract begins, “During extreme financial crises, all of a sudden, the financial world that was once rife with profit opportunities for financial institutions (banks, for short), becomes exceedingly complex.” The summery concludes with, “At some point, the cost of information gathering becomes too unmanageable for banks, uncertainty spikes, and they have no option but to withdraw from loan commitments and illiquid positions. A flight-to-quality ensues, and the financial crisis spreads.”

Of course, the complexity of “innovative” financial activity was source of much profit. Likewise, the complexity of the current milk pricing system and the fact that dairy farmers cannot pay the costs associated with full transparency. No one can dairy and simultaneously be on the trading floor of the Chicago Mercantile Exchange (CME).

So today’s settlement price for class III milk futures for December 2009 of $14.78 is the result of a lack of transparency. For the rest of 2009, the $14.78 price is the highest. No milk can be produced for anything close to $14.78.

Will there be any bank with the “flight-to-quality” attitude willing to make farm loans based on $14.78 per hundredweight milk checks? Don’t bank on it.

Also, don’t bank on those who brought the smoke screen to farm milk pricing to solve the current crisis. At this point, complexity is still yielding a profit for some.