UNITED STATES OF AMERICA 

 COMMODITY FUTURES TRADING COMMISSION 

 AGRICULTURAL MARKETS ROUNDTABLE 

 Washington, D.C. 

 Tuesday, April 22, 2008 

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 1 PARTICIPANTS: 

 2 WALTER LUKKEN 

 3 JEFF HARRIS 

 4 JOHN FENTON 

 5 DAVE KASS 

 6 JILL SOMMERS 

 7 MICHAEL DUNN 

 8 BART CHILTON 

 9 GERALD BANGE 

 10 MARK KEENUM 

 11 LELAND STROM 

 12 ESTHER GEORGE 

 13 EUGENE KUNDA 

 14 ANDREW JACOB 

 15 CHARLIE CAREY 

 16 DAVID LEHMAN 

 17 THOMAS FARLEY 

 18 LAYNE CARLSON 

 19 SAMUEL MILLER 

 20 JOHN KOWALIK 

 21 DOUG HEPWORTH 

 22 BOB GREER 

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 1 PARTICIPANTS (CONT'D): 

 2 BILLY DUNAVANT 

 3 ANDY WEIL 

 4 JOE NICOSIA 

 5 CHUCK COLEY 

 6 WOODS EASTLAND 

 7 TOM COYLE 

 8 JERRY McREYNOLDS 

 9 DIANE KLEMME 

 10 LUKE LIND 

 11 ROBERT ELLIS 

 12 GARRY NIEMEYER 

 13 STEVE WELLMAN 

 14 TOM BUIS 

 15 BOB STALLMAN 

 16 MIKE WALTER 

 17 DAVID BROWN 

 18 JOHN POPP 

 19 JIM BYRUM 

 20 JUSTIN TOWERY 

 21 

 22 * * * * * 

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 1 P R O C E E D I N G S 

 2 MR. LUKKEN: Good morning. My name is 

 3 Walt Lukken. I want to welcome the -- 

 4 MR. DUNN: You keep turning yourself 

 5 off. 

 6 MR. LUKKEN: Okay, I'm turning myself 

 7 off, I apologize. I want to welcome the 

 8 roundtable participants and members of the public 

 9 to today's discussion on the state of the 

 10 agricultural futures markets. If everybody could 

 11 take their seat, we do have cameras around the 

 12 room, so if you're standing, you may be blocking 

 13 one of the cameras for our web site presentation, 

 14 so I appreciate everybody taking their seats as 

 15 quickly as possible. 

 16 Specifically I want to thank Under 

 17 Secretary Mark Keenum from the U.S. Department of 

 18 Agriculture, as well as Board member Lee Strom 

 19 from the Farm Credit Administration for their 

 20 participation in today's proceedings. 

 21 We gather during extraordinary times for 

 22 our agricultural markets. Commodity prices across 

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 1 the board are at levels not experienced in many of 

 2 our lifetimes. In the last three months, the 

 3 agricultural staples of wheat, corn, soybeans, 

 4 rice, and oats have hit all time highs. During 

 5 the last year, the price of rice has increased by 

 6 118 percent, wheat by 95 percent, soybeans by 88 

 7 percent, corn by 66 percent, and cotton and oats 

 8 by 47 percent. These price levels, combined with 

 9 record energy costs, have put a strain on 

 10 consumers, as well as many producers and 

 11 commercial participants that utilize the futures 

 12 markets to manage risk and discover prices. 

 13 Protecting the integrity of these 

 14 markets, as well as the public that relies on the 

 15 accuracy of their prices, lies at the heart of the 

 16 CFTC's core mission, and today we'll endeavor to 

 17 identify the possible causes of these conditions. 

 18 This agency has brought together a broad 

 19 cross section of the agricultural markets in an 

 20 effort to learn from each other's experience and 

 21 help to form a collective understanding of what is 

 22 occurring. 

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 1 During such turbulent times, it is 

 2 tempting to shoot first and ask questions later. 

 3 But it's exactly at such moments that government 

 4 must endeavor to be informed and proportional in 

 5 its response. It is critical that we understand 

 6 the problem fully so we can get it right and 

 7 ensure the cure is not worse than the disease. To 

 8 do that, we must ask probing questions regarding 

 9 the causes of these unprecedented market 

 10 conditions. It is imperative that the affected 

 11 industry serve not only to help us identify 

 12 problems in the markets, but also partner with us 

 13 in finding solutions should it be determined that 

 14 the markets are not functioning properly. I know 

 15 that the CFTC's Agricultural Advisory Committee, 

 16 which serves under Commissioner Dunn's leadership, 

 17 is in attendance today and may provide a vehicle 

 18 for addressing issues that come to light today. 

 19 Thank you for your service here today. 

 20 On today's agenda, the roundtable will 

 21 first hear an overview from the CFTC and USDA 

 22 staff on the fundamentals and composition of some 

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 1 of the key agricultural markets. Do supply and 

 2 demand factors justify current prices, and if not, 

 3 what other factors may be in play? Do contract 

 4 terms and conditions need to be revisited by 

 5 exchanges? What is the impact of financial 

 6 players such as speculators and index traders on 

 7 the functioning of the markets and the commercial 

 8 players? 

 9 It is in the interest of everyone around 

 10 this table that these markets have vibrant 

 11 commercial participation, and I am hopeful that 

 12 these presentations will result in an informative 

 13 and lively debate. 

 14 Second, the roundtable will hear about 

 15 the work of the University of Illinois, as well as 

 16 supplemental analysis by the CFTC chief economist, 

 17 on the lack of convergence between the futures and 

 18 cash prices of commodities at certain times. Is 

 19 this phenomenon increasingly occurring, and what 

 20 are the most likely causes of these conditions? 

 21 This issue is fundamental to determining whether 

 22 proper hedging can occur in these markets. 

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 1 Lastly, the Kansas City Federal Reserve 

 2 Bank and the Farm Credit Administration will 

 3 present an overview of the credit markets in rural 

 4 America and whether high commodity prices and 

 5 resulting increases in margin levels are causing 

 6 problems for producers and agri-businesses during 

 7 this credit crunch. 

 8 We will discuss the central role that 

 9 margin or performance bond plays for exchanges and 

 10 how higher margin levels are impacting market 

 11 participants. The Commission is considering two 

 12 proposals to raise the speculative limits for 

 13 certain agricultural commodities and to create a 

 14 regulatory exemption from speculative limits for 

 15 certain risk management purposes. 

 16 While we have requested and received 

 17 public comment on these proposals, given current 

 18 market conditions and the uncertainty surrounding 

 19 additional speculative money on these markets, I 

 20 will be very cautious about moving forward with 

 21 such initiatives at this time. I believe that 

 22 before acting, this agency must be certain that 

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 1 additional speculative pressures will not 

 2 exacerbate the anomalies we are experiencing in 

 3 these markets. I look forward to any views that 

 4 the roundtable may have on these proposals. 

 5 Therefore, I'd like to announce that the 

 6 transcript from today's discussion, as well as any 

 7 written statements and subsequent public comments, 

 8 will be added to the public comment file for each 

 9 of these proposals. 

 10 We have a big agenda before us and we 

 11 will do everything we can to try to hear the many 

 12 concerns surrounding these matters. In maximizing 

 13 the public's access to this proceeding, given our 

 14 time and space limitations, as you can see looking 

 15 around you, for the first time we are providing 

 16 individuals access to this roundtable over the 

 17 Internet and through toll free phone lines via our 

 18 Web site, www.CFTC.gov. 

 19 In addition, last week we created an 

 20 email address to collect questions from the public 

 21 that we plan to post at the roundtable today. We 

 22 also welcome written comments from the public for 

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 1 two weeks after this roundtable's conclusion. 

 2 The period for submitting such comments 

 3 will remain open through May 7th. Public input is 

 4 essential to ensuring that this agency is properly 

 5 informed about these matters. After my colleagues 

 6 on the dais have provided remarks, I will ask each 

 7 of the roundtable participants to introduce 

 8 themselves and their organization before turning 

 9 it over to our presenters. 

 10 Don't worry, there will be plenty of 

 11 time later to give detailed views, but for the 

 12 sake of introductions, we want to try to keep 

 13 things brief, and so I'd appreciate it. All 

 14 written statements of participants will be made a 

 15 part of the hearing's formal record. With that, I 

 16 appreciate you being here this morning, and I'll 

 17 turn it over to Commissioner Dunn. 

 18 MR. DUNN: Thank you, Mr. Chairman. And 

 19 I commend you for calling this particular forum. 

 20 This is the second time in recent history, once on 

 21 energy concerns, and now on agricultural concerns, 

 22 that you have taken a leadership role and stepped 

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 1 forward to ensure that the consumers know that 

 2 this Commission is paying attention to what's 

 3 going on, so thank you for doing that. 

 4 And I would like to thank our two fellow 

 5 guests up on the dias today, Mr. Secretary, Mr. 

 6 Board member, I'm delighted to have them here, as 

 7 well. We're here really to talk about two 

 8 questions, are the agricultural future markets 

 9 working, if not, why not, and what needs to be 

 10 done to fix them. These are some of the questions 

 11 we'll be discussing today. Certainly there is 

 12 concern that the markets are not performing their 

 13 main function of price discovery and mitigation of 

 14 risk. 

 15 If that's the case, who's responsible 

 16 for fixing the futures market? Should Congress or 

 17 the CFTC draft new legislation or promulgate 

 18 additional regulations, or as I think is 

 19 appropriate, can the market participants make the 

 20 necessary changes to ensure that these markets are 

 21 functioning properly? 

 22 We're here today to see if you, the 

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 1 market participants, can agree on what ails the 

 2 agricultural futures markets. We're also here to 

 3 discuss potential solutions to those ailments so 

 4 that the agricultural markets can continue to 

 5 provide for price discovery and risk mitigation. 

 6 Each market participant will undoubtedly 

 7 have a unique perspective on what they believe 

 8 ails the agricultural markets. The producer is 

 9 concerned with their ability to obtain forward 

 10 delivery contracts and to hedge their production 

 11 risk. The grain elevator is concerned with the 

 12 rapid rise in price that is forcing them to make 

 13 margin calls far beyond their line of credit and 

 14 the expected cost of that credit. The providers 

 15 of credit are wary of the demand on their 

 16 resources in a single market area. Exchanges are 

 17 concerned that limit locks do not allow price 

 18 discovery and curtail the normal business of the 

 19 exchanges. Clearinghouses must collect margin 

 20 more frequently to ensure their financial 

 21 viability, but constant margin calls strains 

 22 business relationships. 

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 1 Processors are concerned that managed 

 2 monies, hedge funds, and commodity index traders 

 3 are skewing the market. In turn, these 

 4 non-traditional agricultural market users maintain 

 5 they provide liquidity to the market that helps 

 6 the market function. 

 7 Finally, end users and consumers 

 8 complain that prices rose too quickly and too 

 9 fast. Each of these concerns is legitimate, but 

 10 may not necessarily be held by the other segment 

 11 of the industry. Only by airing each person's 

 12 particular difficulty can we see the broader 

 13 picture and potential solutions. 

 14 Our agricultural markets do not operate 

 15 in a vacuum. And recently there have been a 

 16 number of extranalities that have impacted the 

 17 markets, a weak dollar, low stock levels due to 

 18 drought and other production problems, increased 

 19 demand from developing countries in ethanol 

 20 production, a flight to quality by capital, 

 21 shortage of storage, and increasing energy and 

 22 transportation cost have all contributed to an 

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 1 increase in the value of agricultural commodities. 

 2 We may already be working under or fast 

 3 approaching a new paradigm of higher agricultural 

 4 price. The way we did business in the past may 

 5 not be the way we can do business in the future. 

 6 We've raised a number of questions for 

 7 market participants to consider today, and many of 

 8 you will undoubtedly have suggestions fixing the 

 9 problems you've experienced. Your suggestions may 

 10 alleviate your particular problem. 

 11 However, individualized solutions may 

 12 cause bigger problems for the market as a whole. 

 13 That's why you were all invited here today, so we 

 14 can take a broad overview of the market and come 

 15 up with solutions that take into account the needs 

 16 of all the participants. 

 17 I don't think there's going to be a 

 18 silver bullet or single solution for what ails the 

 19 market place. And certainly the solutions that 

 20 come up cannot be implemented overnight. But I 

 21 firmly believe that the market participants are 

 22 the best qualified to come up with solutions that 

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 1 will ensure that we have a viable, fair 

 2 agricultural futures markets that will provide for 

 3 price discovery and risk mitigation. I'd also 

 4 like to thank the members of the Agricultural 

 5 Advisory Committee that are here today. They are 

 6 going to be listening to this and making 

 7 suggestions to the CFTC on these and other 

 8 problems in the future. I want to thank all of 

 9 you for attending today, but most of all for being 

 10 part of the solution. 

 11 MR. LUKKEN: Thank you, Commissioner 

 12 Dunn. Commissioner Sommers. 

 13 MS. SOMMERS: Good morning. I want to 

 14 thank Chairman Lukken for holding this event, and 

 15 I want to thank all of the participants for being 

 16 here today. I know this is a busy time, 

 17 especially for agriculture in Washington, so thank 

 18 you for being here. 

 19 In recent months, prices of futures 

 20 contracts for many agricultural commodities traded 

 21 on U.S. exchanges have been unusually volatile and 

 22 have reached or exceeded levels that have not been 

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 1 seen since the 1970's. 

 2 Problems with convergence between 

 3 futures and cash prices for certain commodities 

 4 have also been observed. Fundamental economic 

 5 factors such as the rising production of 

 6 corn-based ethanol and other bio-fuels, tight 

 7 grain supplies, and the declining value of the 

 8 U.S. dollar help to explain some of these market 

 9 developments. And while there may be many factors 

 10 contributing to the lack of convergence, it 

 11 appears that increased futures price volatility 

 12 and uncertainty about basis relationships has 

 13 raised the cost of hedging. 

 14 Some argue that increased futures market 

 15 participation by investors is driving prices above 

 16 levels that can be explained by economic 

 17 fundamentals. Economists generally agree that 

 18 high volume liquid futures markets provide 

 19 substantial benefits to the public. These markets 

 20 can provide opportunities for the public to 

 21 diversify investment portfolios by adding 

 22 commodities to the traditional mix of stocks and 

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 1 bonds through funds that track the futures 

 2 markets. 

 3 I believe this is a positive 

 4 development. So we should gather all the facts 

 5 before taking steps that might discourage this 

 6 type of participation. Our primary responsibility 

 7 at the CFTC, though, is to make sure that the 

 8 agricultural futures markets are discovering 

 9 prices efficiently and are providing an 

 10 opportunity for commercial entities to hedge price 

 11 risk. This is a complex situation, and I think it 

 12 is important that we consider all the objective 

 13 evidence carefully before we reach conclusions 

 14 about what, if anything, should be done. We have 

 15 with us today an extremely distinguished group of 

 16 presenters and roundtable participants who have a 

 17 great deal of experience and knowledge in 

 18 agricultural futures markets. 

 19 Your background and expertise will help 

 20 us explore the topics that are before us today. I 

 21 look forward to listening to the discussion and 

 22 working with all of you on these important issues 

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 1 in the future. 

 2 MR. LUKKEN: Thank you, Commissioner. 

 3 Commissioner Chilton. 

 4 MR. CHILTON: Thanks, Mr. Chairman. 

 5 Good morning, everybody, happy Earth Day. I won't 

 6 be redundant from what my colleagues have said, 

 7 because I agree with most of it, but make no 

 8 mistake about it, this is an issue which is really 

 9 hitting hard at home in the heartlands. I'm sure 

 10 Le can tell us, and I see some other farmers and 

 11 ranchers in the audience with us here, so welcome. 

 12 To say that it's our responsibility to 

 13 ensure that these ag markets are operated honestly 

 14 would be a gross understatement. It's our sworn 

 15 job to protect price discovery and to root out any 

 16 fraud abuse manipulation, whether or not it's 

 17 speculators or hedgers, people long or short in 

 18 the market, that's our job. And finally, it's our 

 19 job to use the Commodity Exchange Act, and the 

 20 tools that are contained therein to ensure that 

 21 these are viable markets, that they actually work 

 22 for people, that they're efficient, and that 

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 1 they're effective, and that's -- not just 

 2 important for hedgers and speculators, it's 

 3 important for consumers, because these markets 

 4 greatly impact what goes on in peoples' everyday 

 5 lives. 

 6 It's our job to make sure these are 

 7 honest markets. It's our mission, it's our 

 8 mantra, and it's our mandate, and that's why we 

 9 take it very seriously, all of us. 

 10 And that's also why it's important that 

 11 you -- each of you -- are here. And one of the 

 12 questions I have is, is there something that we 

 13 may not be looking at, something that's off of our 

 14 radar screen that is impacting these markets. I 

 15 look forward to the issue expertise that all of 

 16 you to this dialogue and the discussion. Thank 

 17 you all who are in this room and the overflow room 

 18 and people that are joining us on the Web. Thank 

 19 you, Mr. Chairman. 

 20 MR. LUKKEN: Thanks, Commissioner. With 

 21 that, I'll turn it to Under Secretary Mark Keenum 

 22 from USDA. 

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 1 MR. KEENUM: Thank you, Mr. Chairman. I 

 2 do also want to join the chorus of commending you 

 3 for conducting this very important agricultural 

 4 forum to discuss market volatility, it's vitally 

 5 important to all of our interest, and I again 

 6 commend you and the Commission. We look forward 

 7 at USDA to working with you as you address these 

 8 very important issues. 

 9 As has been stated very clearly this 

 10 morning, we are facing tremendous volatility in 

 11 our agricultural market prices, most dramatically 

 12 since the beginning of this year. Manufacturers 

 13 are driving prices, including market fundamentals, 

 14 investment, speculative market flows, and broader 

 15 economic factors such as the value of the dollar, 

 16 and even oil prices. 

 17 Also the declining global stocks have 

 18 caused major importing countries to increase 

 19 imports to -- figures of potential food shortages 

 20 in the event of production shortfalls. Also to 

 21 dampen domestic prices, some countries that 

 22 normally export products are imposing trade 

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 1 restrictions, export taxes, or outright export 

 2 bans to reduce supplies on the world market. 

 3 While these policy actions exacerbate price 

 4 run-ups, the eventual easing of these trade 

 5 restrictions could contribute to sharp price 

 6 declines. 

 7 As the department that's charged with 

 8 assisting American farmers and ranchers, USDA is 

 9 concerned about how market volatility and changes 

 10 in the relationship between futures and local 

 11 prices are effecting producers' ability to manage 

 12 their price risk, both in selling their crops and 

 13 buying feed for livestock operations. 

 14 Increased volatility in futures markets 

 15 and sharply higher prices have led to higher 

 16 margin requirements, increased cost of hedging. 

 17 It has even ended forward pricing opportunities 

 18 for some of our farmers. For example, cotton 

 19 shippers and some grain elevators are no longer 

 20 bidding for future delivery because of risk and 

 21 cost associated with maintaining hedges. 

 22 Excess volatility combined with 

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 1 increasing margin requirements based on options -- 

 2 market closing prices rather than futures closing 

 3 prices, has driven traditional market participants 

 4 away from hedging in the futures market. We have 

 5 seen baseball anility increase markedly, rendering 

 6 traditional futures based risk management 

 7 strategies less effective. This shifts risk, 

 8 which translates into higher cost back to 

 9 producers and across the food and fiber marketing 

 10 system, eventually reaching consumers. 

 11 The increasing disconnect between 

 12 traders with an interest in the physical commodity 

 13 and speculators with little or no interest beyond 

 14 speculative profit has also raised fears that cash 

 15 in futures markets will face convergence problems 

 16 if the trend intensifies. 

 17 One implication of the current market 

 18 change is that some smaller producers, whether 

 19 country elevators or small producers, will be 

 20 squeezed out, adding to the growing consolidation 

 21 in the food and agricultural system. 

 22 USDA's CCC commodity loan program has 

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 1 not experienced any negative effects as of yet. 

 2 But high and volatile market -- because high and 

 3 volatile market prices, because of those high 

 4 prices, the adjusted world price for cotton and 

 5 rice and our posted county prices for grains and 

 6 oil seeds are significantly above the loan rates. 

 7 However, if market prices collapse and 

 8 cause loan repayment rates to near or below loan 

 9 rates, there could be significant impacts on 

 10 program activity and government expenditures. So 

 11 these are some of the issues and concerns that we 

 12 have at USDA, and I personally am looking forward 

 13 to hearing your comments and input from all of the 

 14 roundtable participants. This is a vitally 

 15 important topic for the future of American 

 16 agriculture. And we at USDA stand ready to work 

 17 with this Board, this Commission, and all of you 

 18 to address these important issues. Again, Mr. 

 19 Chairman, I want to thank you for conducting this 

 20 very important roundtable. 

 21 MR. LUKKEN: Thanks for your 

 22 partnership, Doctor Keenum. With that we'll turn 

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 1 to Board Member Lee Strom. 

 2 MR. STROM: Thank you, Mr. Chairman, and 

 3 Commissioners, Secretary Keenum. It is an honor 

 4 to join you today on this very important topic. 

 5 And I think I will probably be the most brief of 

 6 the introductory comments here. 

 7 Again, the Farm Credit Administration, 

 8 there are several staff here in the room also 

 9 today, and I'd also like to make it a point to 

 10 introduce the Chairman of the Board, Nancy 

 11 Pellett. I believe, Nancy, if you'd raise your 

 12 hand or stand. She's joining us after just 

 13 returning from an international trip. And 

 14 obviously, we're here to listen from and learn 

 15 from the lending aspect on this also. Again, my 

 16 name is Lee Strom, and I'm here today representing 

 17 the Farm Credit Administration Board. I have been 

 18 a member of the FCA Board since December of 2006. 

 19 And prior to that, I served on Farm Credit 

 20 Institution boards for over 25 years. I've also 

 21 been an agricultural producer from Illinois, where 

 22 I am a third generation family farm owner that 

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 1 produces corn and soybeans. 

 2 And having been a producer, I understand 

 3 first hand the issues that the producers are 

 4 facing today in this very interesting and dynamic 

 5 agricultural market that we're living in. 

 6 I want to thank the Commissioners for 

 7 this opportunity for all of us to hear and 

 8 participate and have comments and share concerns 

 9 during this challenging time for the agricultural 

 10 industry. 

 11 I am pleased that a member of the FCA 

 12 staff, Andrew Jacob, who is in the far end of the 

 13 table there, who serves as our Director of the 

 14 Office of Regulatory Policy, is a participant on 

 15 that panel. Andrew will provide some additional 

 16 information about FCA's roles as the regulator of 

 17 the Farm Credit system. And again, I want to 

 18 thank you for the opportunity to be here, and I 

 19 look forward to hearing and participating in the 

 20 comments today. Thank you. 

 21 MR. LUKKEN: Thank you, Lee, for being 

 22 here. And thank you, Nancy. I know it's a long 

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 1 trip you've made to be here and we appreciate your 

 2 partnership, as well. 

 3 So with that, we will go around the room 

 4 and have all the participants introduce 

 5 themselves, their name and organization. 

 6 I would ask that everybody, if you 

 7 could, turn off your blackberries and cell phones 

 8 during the day, that interferes with our 

 9 equipment, and that would be useful. As well, 

 10 when you want to talk during today's discussion, 

 11 if you wouldn't mind just turn your placard on its 

 12 end so we know that you're interested and have a 

 13 comment and we'll try to do that in order as best 

 14 we can. 

 15 Oh, and lastly, for our court reporter, 

 16 if you wouldn't mind, before you talk today, to 

 17 just state your name so that we're able to 

 18 properly transcribe who is talking during today's 

 19 proceeding. So with that, I'll start with Dave 

 20 Lehman on the end and we'll go around the room. 

 21 MR. LEHMAN: Thanks, Mr. Acting 

 22 Chairman. Dave Lehman, Director, Commodity 

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 1 Research, CME Group. 

 2 MR. CAREY: Charlie Carey, Vice 

 3 Chairman, CME Group. 

 4 MR. FARLEY: Tom Farley, President, COO, 

 5 ICE Futures, U.S., formerly Nibot. 

 6 MR. TOWERY: Justin Towery representing 

 7 the USA Rice Federation and USA Rice Producers 

 8 Association. 

 9 MR. LIND: Luke Lind, member of National 

 10 Cattlemen's Beef Association. 

 11 MR. DUNAVANT: Bill Dunavant, cotton 

 12 merchant from Memphis, Tennessee, representing 

 13 Dunavant Enterprises, I am Chairman of the Board. 

 14 MR. COLEY: Chuck Coley, Chairman of 

 15 American Cotton Producers representing National 

 16 Cotton Council. 

 17 MR. GREER: My name is Bob Greer, I am a 

 18 Product Manager with PIMCO. 

 19 MR. ELLIS: My name is Rob Ellis, I'm 

 20 managing partner of Ridgefield Capital. 

 21 MR. POPP: My name is John Popp, I'm 

 22 Chairman of the Independent Bakers Association. 

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 1 MR. BROWN: Dave Brown, Sarah Lee Corp, 

 2 representing American Bakes Association. 

 3 MR. STALLMAN: Bob Stallman, President 

 4 of the American Farm Bureau Foundation, and a rice 

 5 and cattle producer. 

 6 MR. NIEMEYER: Gary Niemeyer, Director 

 7 of the National Corn Growers Association. 

 8 MR. HARRIS: I'm Jeff Harris, the Chief 

 9 Economist here at the CFTC. 

 10 MR. FENTON: I'm John Fenton, I'm the 

 11 Director of Market Surveillance at the CFTC. 

 12 MR. KASS: David Kass, I'm a Senior 

 13 Economist in the Chicago office, also in Market 

 14 Surveillance of CFTC. 

 15 MR. BANGE: I'm Jerry Bange, 

 16 Chairperson, World Agriculture Outlook Board, 

 17 USDA. 

 18 MR. KUNDA: My name is Eugene Kunda at 

 19 the University of Illinois at Urbana-Champaign. 

 20 MR. JACOB: I'm Andrew Jacob, the 

 21 Director for the Office of Regulatory Policy at 

 22 the Farm Credit Administration. 

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 1 MR. McREYNOLDS: I'm Jerry McReynolds, a 

 2 producer from Kansas and representing the National 

 3 Association of Wheat Growers. 

 4 MR. WALTER: My name is Mike Walter, I'm 

 5 President of the Commodity Markets Council. 

 6 MR. BYRUM:: Jim Byrum, President of the 

 7 Michigan Agri-business Association. 

 8 MR. HEPWORTH: I'm Doug Hepworth, I'm 

 9 Director of Research for Gresham Investment. 

 10 MR. EASTLAND: I'm Woods Eastland, I'm 

 11 the CEO of a Cotton Marketing Cooperative and I'm 

 12 representing AMCOT, which is a trade association 

 13 of cotton marketing cooperatives. 

 14 MR. MILLER: I'm Sam Miller, I'm with 

 15 M&I Bank in Wisconsin and I'm representing the 

 16 American Bankers Association. 

 17 MR. WEIL: I'm Andy Weil, I'm a cotton 

 18 merchant from Montgomery, Alabama with Little 

 19 Brothers Cotton, Incorporated, and I am President 

 20 of the American Cotton Shippers Association. 

 21 MR. BUIS: Tom Buis, President of the 

 22 National Farmers Union. 

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 1 MS. KLEMME: Diana Klemme with Grain 

 2 Service Corporation of Atlanta, Georgia; we're a 

 3 grain consulting firm. 

 4 MR. COYLE: Tom Coyle with -- Holdings 

 5 in Chicago and I represent the National Grain and 

 6 Feed Association. 

 7 MR. KOWALIK: John Kowalik, California 

 8 Public Employee Retirement System, Commodities 

 9 Portfolio Manager. 

 10 MR. CARLSON: Layne Carlson, Treasurer 

 11 with the Minneapolis Grain Exchange. 

 12 MR. LUKKEN: Well, thank you very much. 

 13 And I think we have Esther George in the back 

 14 there. Esther, can you -- Esther George with the 

 15 Kansas City Federal Reserve Bank. Thank you, 

 16 Esther, for being here. So with that, we'll turn 

 17 it over to Dave Kass from our Surveillance Team 

 18 for the CFTC's presentation. 

 19 MR. KASS: Thank you. Let me outline 

 20 how the presentation is going to go as far as I'm 

 21 concerned. I've got some charts on fundamentals, 

 22 but obviously we've got -- Doctor Bange here from 

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 1 USDA is also going to talk about fundamentals. 

 2 The folks in this room and those participating by 

 3 web cast are living the fundamentals. So it would 

 4 be presumptuous of me to say a whole lot about 

 5 fundamentals. 

 6 But let me assure you that this is 

 7 something we look at quite thoughtfully, we 

 8 collect quite a bit of data as far as our market 

 9 surveillance effort, we analyze that data. 

 10 I know I've talked to some of you in 

 11 this room personally, and I'm sure some of the 

 12 folks out there on web cast are attaching a face 

 13 to a name that they've probably talked to on the 

 14 phone, many of which over the last few months, as 

 15 you can imagine. 

 16 The main focus, though, that I want to 

 17 present is the data that those other folks aren't 

 18 going to be able to give you, and that's market 

 19 composition data. Market surveillance does have 

 20 access to daily trading data for the largest 

 21 traders in the market above reporting levels. Mr. 

 22 Fenton here is going to talk about cotton, and 

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 1 he's going to show many of the same sorts of 

 2 analysis I'm about to show you for the other 

 3 markets, he'll show you that for cotton. So I'm 

 4 going to talk a little, just slide through I guess 

 5 literally and figuratively. 

 6 MR. LUKKEN: Why don't you try it again? 

 7 There you go. 

 8 MR. KASS: All right. So I'm going to 

 9 just kind of breeze through the fundamentals, but 

 10 hopefully, like most things, and sometimes I think 

 11 they call me a senior economist because I'm 

 12 entitled to a senior moment now and again. But as 

 13 you recall history, it's nice to actually see it 

 14 in front of you. So some of the purpose of these 

 15 graphics is to be able to see where we were on 

 16 things like bases and convergence and some other 

 17 things rather than have to recall it from memory. 

 18 We're going to talk -- clearly, spend 

 19 most of my presentation on market composition, 

 20 then I'm going to talk a little bit about price 

 21 limits with an example. So let's proceed. And I 

 22 might add, these are the sorts of briefings that 

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 1 we give our Commissioners and senior staff weekly, 

 2 so I apologize. They're going to be seeing many 

 3 of the things they've seen. As you can imagine 

 4 also, grain markets have been the subject of 

 5 continuous briefings each week. One or the other 

 6 or a collection of them have been on our agenda 

 7 for quite some time, so they've seen quite a bit 

 8 of this already. 

 9 The first is a graph of some of the 

 10 major markets. And you can see -- I apologize, 

 11 cotton is not included, it was a little difficult 

 12 because of the scaling, but rest assured, when Mr. 

 13 Fenton presents cotton, it'll have its own price 

 14 chart. As you can see from the little inset box, 

 15 I guess you're not going to be able to see it. 

 16 MR. LUKKEN: Does everybody have the 

 17 actual charts around the room? Here we go, I 

 18 think we're -- here we go. 

 19 MR. KASS: All right. 

 20 MR. LUKKEN: All right, thank you. 

 21 MR. KASS: All right. So these are some 

 22 of the major markets. Unfortunately, something 

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 1 like corn, you don't get to scale when you throw 

 2 it on the same market as Minneapolis wheat and 

 3 rice, but I think you get the concept there. 

 4 We're going to show some individual price charts 

 5 later. And, of course, the little inset box shows 

 6 the dates of some of the all time record high 

 7 prices that we've experienced recently. Rice is 

 8 outdated even on that, which was through Friday, 

 9 it set a new record high a bit above that; 

 10 yesterday it closed a little lower. So this is, 

 11 obviously a very fluid situation. 

 12 In fact, I think one of the panelists 

 13 said that some of these prices are unprecedented, 

 14 perhaps not in our careers or lifetimes. 

 15 Unfortunately, some of that is not -- less true of 

 16 me probably. I remember when soybeans hit 1290 

 17 back in the summer of 1973, and only recently 

 18 eclipsed that price. So that gives you an idea of 

 19 how long it's been since some of these prices have 

 20 been around. 

 21 This is simply sort of a reference. I 

 22 think the Acting Chairman referenced some of these 

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 1 price changes year over year, and it's true in a 

 2 couple others. You can see there's a few 

 3 negatives there, lean hogs and live cattle, and 

 4 obviously we've got some producers here that 

 5 aren't too happy about the relationship of corn 

 6 being on the upper end and going very high and 

 7 some of the livestock markets going very low. 

 8 Again, these are the fundamentals, I'm 

 9 just going to quickly go through, because I know 

 10 Doctor Bange has many of these same slides. This 

 11 is corn stocks-to-use ratios and ending stocks. 

 12 Corn actually, through this year, looks less 

 13 remarkable than most of the others, except for 

 14 this aspect, and this is corn used for ethanol, 

 15 both in terms of billions of bushels, the green 

 16 line versus percent of production, and you can see 

 17 that is again, I'm preaching to the choir here, 

 18 most of you know, over 30 percent of the U.S. corn 

 19 crop this year is likely to go to ethanol. 

 20 World wheat, first looking at the world 

 21 situation, and some of these are annotated, you 

 22 can see world ending stocks are the lowest since 

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 1 1977, better than 30 years ago. World 

 2 stocks-to-use is the lowest on record, which I 

 3 believe go back into the '60's. 

 4 U.S. situation, much the same, if not 

 5 worse. You've got to go back to the mid '40's to 

 6 see similar ending stocks low, that is, and 

 7 stocks-to-use ratios when we were shipping wheat 

 8 over to the war ravaged Europe as part of the 

 9 Marshall Plan, and I wasn't around for that. 

 10 The soybean ending stocks, the 

 11 remarkable thing is how we went from a record high 

 12 ending stocks, the end of the -- '05/'06, and the 

 13 very next year, of course, because of diversion of 

 14 acres to corn, we went to one of the lowest sets 

 15 of figures as you look back historically. Rice 

 16 world ending stocks, lowest since 1983, 

 17 stocks-to-use, lowest since 1976, again, very 

 18 remarkable numbers. That was the world U.S. 

 19 Situation, ending stocks down substantially from 

 20 the last year, you see that big drop off, lowest 

 21 since 1980, stocks-to-use ratio, lowest since 

 22 1974. These are amazing numbers. When you look 

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 1 back at that price chart and that little box of 

 2 inset, it's not like we exceeded some of these 

 3 prices by a couple of pennies or a nickel, in some 

 4 cases it's literally dollars per bushel, which is 

 5 just incredible. 

 6 Diesel average price, I show diesel 

 7 price, we're all painfully aware, farm community 

 8 particularly as they fill up their diesel for farm 

 9 equipment and what not. Many of the rest of us 

 10 see it in terms of gasoline prices. 

 11 But as you can see, diesel is, of 

 12 course, vital to the agricultural community. 

 13 Virtually every way grain and produce move uses 

 14 diesel, whether you're talking truck, rail, barge, 

 15 or whatever. 

 16 So you can see clearly we're in record 

 17 territory for this time of year. And the last 

 18 report in April, we're still rising. And if gas 

 19 pumps are any indication, that's not going to 

 20 change any time soon. And, of course, one aspect 

 21 of diesel prices is clearly how it effects the 

 22 Illinois barge freight rate, and I show barge 

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 1 freight rates, but, of course, the corn and 

 2 soybean futures contracts are essentially an 

 3 Illinois Waterway System contract for export using 

 4 barge rates. And, again, you can see where we are 

 5 historically this time of year, well outside. Oh, 

 6 and let me show you the set up on these, because 

 7 you're going to see this kind of a set up on a lot 

 8 of other graphics. And I probably should have 

 9 shown it on the last one. 

 10 The vertical bars that you see there are 

 11 a measure of history, in this case 11 years, from 

 12 1994 through 2004, kind of a high/low during that 

 13 11 year period. The red line is the median over 

 14 that time period. And then we'll often show the 

 15 last few years in perspective, and then, of 

 16 course, this year. And you can see these are 

 17 monthly data and where we are. This spike here, 

 18 of course, was the Katrina and its effect on barge 

 19 rates. 

 20 And I will, by the way, just as point of 

 21 know, this is -- for cost, bushels of corn, and 

 22 I'll refer to this later, this is the March, and 

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 1 it was about 85 cents a bushel, and you're going 

 2 to actually see -- reflecting that in the very 

 3 next slide. 

 4 This is the corn basis in the fourth 

 5 week of March, so a couple of weeks ago now. 

 6 Again, the historical range of the basis in that 

 7 week of March going back, and then the red is the 

 8 median, and then the green represents this year, 

 9 the blue represents the year prior. The Gulf 

 10 basis is actually historically quite strong, and 

 11 it looks like about 55 cents over. 

 12 Upper Illinois River, however, is 

 13 outside the range, and even less than last year, 

 14 which was outside the range on the down side at 

 15 about 30 cents. 

 16 But, of course, if you take the 30 cents 

 17 versus the 55 cents, 85 cents, it's no coincidence 

 18 obviously that an 85 cent difference is going to 

 19 reflect largely that 85 cent barge rate. And then 

 20 you can see where we're at, some of the other 

 21 locations. Some are within the range, most are 

 22 weak. 

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 1 Wheat basis separated this into the 

 2 three variety -- main varieties of wheat, the 

 3 spring wheat at Minneapolis, cash prices, hard red 

 4 winter, traded on, of course, the Kansas City 

 5 Board of Trade, and the soft red winter wheat, 

 6 traded, of course, in Chicago, and you can see the 

 7 relationships there of basis historically. 

 8 Gulf, the high end of the range; 

 9 Chicago, near the low, slightly -- only slightly 

 10 better than last year. Wheat in Minneapolis, a 

 11 dollar over, cash, a dollar over, obviously very, 

 12 very strong historically. Wheat, hard red winter 

 13 wheat, again, very strong, but Chicago wheat has 

 14 been somewhat -- Toledo, of course, being the 

 15 major delivery point for this contract, and it's 

 16 pretty much right in the middle of the range. 

 17 Soybean basis, similar to the others, although 

 18 here, again, most of this is different. In this 

 19 case, it comes out to about a dollar, so it's not 

 20 entirely explained by barge rates, but, of course, 

 21 barge rates are going to be the bulk of that, but 

 22 uniformly weak, and we're going to see that in 

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 1 some of my later graphics. 

 2 We're obviously approaching the 

 3 expiration of the May corn futures contracts and 

 4 the May contracts for the other major markets 

 5 here. I certainly don't expect you to follow any 

 6 individual lines here across the page, but this is 

 7 how we end up. 

 8 This is matching the futures price to 

 9 the equivalent of putting grain, in this case 

 10 corn, on a barge on the Northern Illinois River, 

 11 in zone one of the Illinois Waterway System, the 

 12 northern most zone of the system. So a zero means 

 13 that you are indifferent between the two. If the 

 14 line here is weak, that's a weak basis, that means 

 15 that you would not be taking futures delivery, to 

 16 take delivery, because it would be far more 

 17 expensive. It would be cheaper to buy it on the 

 18 river rather than take delivery. 

 19 An interesting thing, 2000 was the first 

 20 year of this Illinois Waterway System. You can 

 21 see we had, relative to the other years, very 

 22 terrible convergence during that year. Last year 

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 1 we actually had quite good convergence, 2007. One 

 2 thing I would note, folks talk about, and I'm 

 3 going to be talking about index trader's index 

 4 funds very shortly, but we had very little index 

 5 participation back here, and we had very heavy 

 6 index participation, relatively speaking, here in 

 7 2007. 2006, another bad year for convergence, 

 8 somewhere in the middle there. 2008 sits out here 

 9 by itself, extremely weak corn basis. 

 10 This is new crop corn, that was May 

 11 corn, this would be new crop corn, and how it 

 12 looks historically. So -- and these are the 

 13 calendar weeks. So, of course, new corn will go 

 14 off in about the 50th calendar week, in mid 

 15 December. 

 16 And you can see, regardless of where it 

 17 started here, discounts of let's call it 22 to 

 18 maybe 35 cents. We typically end up, on this new 

 19 crop corn, we end up with a basis of about ten. 

 20 Now, this is north elevator -- in north 

 21 central Illinois. So you can see where we start 

 22 out, where we end up. This year it's a little 

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 1 hard to see down there, but there it is. We're 

 2 obviously starting out at a much, much lower 

 3 level, probably at least twice as weak in terms of 

 4 basis as we've seen in the past -- instead of the 

 5 normal sort of, you know, at least maintaining a 

 6 weak basis, and then finally converging to about 

 7 20 cents under, sagged quite a bit, it never did 

 8 converge as well as years before that. And again, 

 9 this is what we're looking at this year, 

 10 unprecedented, probably three times as weak as 

 11 we've seen in years past. 

 12 We've heard a lot about new crop hedging 

 13 in some of the commodities, and the fact that 

 14 there are folks out there that -- local elevators 

 15 and even some major merchants that are not writing 

 16 fixed price contracts out more than 60 days, not 

 17 against new crop positions, so we wanted to look 

 18 at that and see if we could see the impact of 

 19 that. It's clearly happening. We wanted to see 

 20 if that was impacting some of the amount of new 

 21 crop hedging in some of these markets. 

 22 We picked corn, for example. So this, 

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 1 again, the bars represent a history of how much 

 2 commercials were short in futures for, at this 

 3 time of year, from January through August, in the 

 4 December contract, and months beyond December. 

 5 So it would be even including perhaps 

 6 another crop year further out. How much 

 7 commercial short positions we saw, we could see, 

 8 not surprising with corn, since it was a huge 

 9 record crop last year, 13 billion in 2007, we had 

 10 a lot of short hedging, way beyond what we'd seen 

 11 in past years. This year, 2008, we're actually 

 12 exceeding that. I think that's about 15 percent 

 13 or so. Yeah, we're about 15 percent above. 

 14 So in terms of large trader data, we're 

 15 still seeing -- now, whether, of course, a lot of 

 16 this hedging came on earlier in the year, but we 

 17 are seeing substantial short hedging, even though 

 18 certainly some of it has been curtailed because of 

 19 some dampening of fixed price purchases. 

 20 New crop wheat, again, a similar set up 

 21 in terms of the graphic. Again, we're seeing in 

 22 wheat substantially more than last year, which was 

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 1 more historically, at least up through this point 

 2 in early April. 

 3 So we're not seeing a lack of short 

 4 hedging in this market, even though we know some 

 5 of that's being curtailed. Of course, we're 

 6 talking futures July and beyond to be 

 7 representative of new crop. This is Chicago Board 

 8 of Trade, so we're about a third greater than we 

 9 were last year. 

 10 Oh, I'm sorry. This is soybeans, which, 

 11 of course, would be the November future, and 

 12 again, similar to what we saw in the past. This 

 13 one is actually up about 60 percent from last 

 14 year, the amount of short hedging. So at least in 

 15 terms of large traders and amount of short hedging 

 16 in the market in new crop futures and beyond, 

 17 we're not seeing -- we're seeing an increase over 

 18 last year. Now, this is where we get into -- a 

 19 little bit of that was market composition talking 

 20 about short hedging, but this is where we're 

 21 really going to get into the stuff that's our shop 

 22 and market surveillance, and I think this is what 

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 1 -- add in a little transparency to this 

 2 discussion. 

 3 This graphic shows how this thing that 

 4 we've all talked about and we've heard a lot 

 5 about, index traders, who they are and how they 

 6 find their ways into the market. This is a class 

 7 of folks that want exposure to commodities 

 8 essentially as a security, as another asset class, 

 9 like real estate, stocks, bonds, precious metals, 

 10 all these various things that they invest in. 

 11 Commodities as part of an index are part 

 12 of this, and, of course, it attracts a lot of 

 13 institutional investors. 

 14 I think the actual European investors 

 15 and pension funds got into this bigger, earlier 

 16 than the U.S., but the U.S. is certainly catching 

 17 up. And, of course, you have some individual 

 18 investors now that are seeing this. We've heard 

 19 an anecdotal story. I know Dan Brophy of -- when 

 20 he was representing Commodity Markets Council, was 

 21 talking about a broker and settling the estate, I 

 22 believe it was of his mother, talked about 

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 1 investment, put five percent or something into 

 2 commodity, so it's prevalent. How do they find 

 3 their way into the markets? And you can go 

 4 through financial services firms, the Wallstreet 

 5 type firms, the swaps dealers, banks, all these 

 6 sorts of things, where they may give you a swap 

 7 agreement, they will give you the return on an 

 8 index, for example. 

 9 You might find its way to a hedge fund, 

 10 a mutual fund, there's a number of them out there 

 11 now, there's some ETF's out there available to 

 12 anyone who wants to participate. 

 13 Certain wealth, financed folks may want 

 14 to do it themselves and go in a replicated index. 

 15 Most of the major -- how they work is not 

 16 proprietary and you can replicate them if you want 

 17 to go through that effort. 

 18 So where do they find themselves, where 

 19 do they land in the markets? There's designated 

 20 contract markets, the ones represented here today, 

 21 CME Group, ICE Futures U.S., NYMEX, that sort of 

 22 thing. There's over-the-counter trades, there's 

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 1 other exchanges that might be available. 

 2 For the ags and the softs, they 

 3 primarily focus on designated contract markets. 

 4 There's less developed here, but they are 

 5 increasing all the time, so there seems some 

 6 diffusion there, even over the last year or two 

 7 we're seeing some more diffusion. Energies and 

 8 metals, of course, have very highly developed 

 9 over-the-counter and other exchanges available to 

 10 them. One of the differences here is how you 

 11 might be treated. 

 12 If a firm has done a swap, that's 

 13 considered commercial activity in a policy 

 14 decision made in the early 1990's, and that does 

 15 gain an exemption, we require that it be done on 

 16 application, it's not automatic, that it be non- 

 17 leveraged, that it be passively managed, that it 

 18 not be actively managed with a view toward price, 

 19 and that it stay out of the spot month. 

 20 If you've come this way, these are 

 21 considered non- commercial, either directly -- 

 22 because you're looking for market exposure, you're 

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 1 not trying to cover an exposure, you're looking to 

 2 gain an exposure. 

 3 Now, of course, is these folks run up 

 4 against position limits or for some other reason, 

 5 they could do a swap here, and then the swap 

 6 dealer could hedge it. So there are various 

 7 methods to get the money into the market. But 

 8 it's certainly a lot of money, and I think we'll 

 9 hear from some representatives of some of that 

 10 money and talk about that. With the Commission, 

 11 in response to hearing from a number of 

 12 agricultural groups, they wanted more transparency 

 13 in the market, so beginning January of a year ago, 

 14 about 16 months ago, we began publishing more data 

 15 for 12 particular markets in the agricultural 

 16 sector, where we thought our data was quite good 

 17 relative to some of the other markets, and where 

 18 this type of trading was significant. 

 19 This is the way it looked before and it 

 20 still looks. We still publish their traditions. 

 21 This is the way the new report looks, and you can 

 22 see this new column has been added showing index 

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 1 money. 

 2 For example, most of these are long 

 3 only, so you can see all of a sudden we've got 

 4 215,000 contracts. Where does that come from? 

 5 You can see it came out of in this particular 

 6 week, which was April 8th, 184,000 of that came 

 7 out of the commercial category, 30,000 contracts 

 8 came out of the non-commercial category, so 

 9 roughly a six to one ratio in terms of where those 

 10 positions were in the traditional report and where 

 11 they came from to find their way into this index 

 12 trading report. 

 13 This little graphic shows the numbers of 

 14 contracts. The blue line represents the numbers 

 15 of contracts devoted to index trading on a net 

 16 basis, it's the net long, and of course, it's 

 17 almost all long anyway. And the red box represent 

 18 percent of open interest. So you see, for 

 19 example, corn, which is the largest has nearly 

 20 450,000 contracts net long on this particular date 

 21 devoted to index trading, and that percentage 

 22 which we read on the right scale was about 20 

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 1 percent of the market. 

 2 So even some of these are very small 

 3 markets, feeder cattle, Kansas City Wheat, but 

 4 their percentages are comparable. Interesting to 

 5 note, the markets right now are recently with the 

 6 highest percentages, at what, just under 45 

 7 percent. If you'll remember back in those price 

 8 charts, those were a couple of the weakest 

 9 markets, in fact, had year over year negative 

 10 changes. So, clearly, it doesn't seem to be 

 11 related to percent of index trading in the market. 

 12 Now, I have heard the argument, well, 

 13 these are not storage markets, and if you look at 

 14 only storage markets you see a better pattern. 

 15 But, of course, you've got things like rice which 

 16 had more than doubled in price, you saw something 

 17 like 120 percent increase, and the amount of index 

 18 trading in rice is very, very small, it's not 

 19 published by CFTC. And, of course, it you look at 

 20 that volatility graphic, if you remember, I think 

 21 my first data slide that showed Minneapolis Wheat 

 22 going sharply higher and sharply lower, there's 

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 1 virtually no index trading in Minneapolis Wheat. 

 2 So we find it hard to find a direct relationship 

 3 between the amount of index trading by percent or 

 4 otherwise versus some of the volatility and some 

 5 of the price rises we've seen of late. At least 

 6 there's no simple analysis. 

 7 This graphic simply adds all the numbers 

 8 of contracts devoted to index trading in these 12 

 9 markets, and you can see them layered here and 

 10 referenced over here, sugar, and cotton, and 

 11 cocoa, et cetera. And if you add them all up, 

 12 there's so many contracts of corn, so many 

 13 contracts of cocoa, obviously we know we're adding 

 14 very similar things. But I've seen this analysis 

 15 done by others, as well. 

 16 You can see there's about a 38 percent 

 17 rise, it's not really, it just happens that it 

 18 seems to match this scale, but there's about a 38 

 19 percent rise from about January of last year 

 20 through current. 

 21 Meanwhile, what is that percentage at 

 22 least on an average basis, percentage of their 

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 1 respective markets, and you can see that's not 

 2 nearly rising so much, it's been kind of in a 

 3 range here and gotten up to about 30 percent. 

 4 Again, no real simple solutions to some of this. 

 5 This is part of the extra transparency. You're 

 6 actually -- those in the room and able to see 

 7 these or access these graphics later are actually 

 8 going to get a little dose of additional 

 9 transparency, one is this. When we publish the 

 10 data, we publish it all futures and options 

 11 combined. This is actually futures only. And as 

 12 most know, most of the index trading is 

 13 concentrated in futures, they do some options, 

 14 it's not a great amount. 

 15 So here's the wheat futures position as 

 16 actual numbers of contracts, very, very flat. In 

 17 fact, it has been rising through it looks like 

 18 about March or so of '06, and since '06 has 

 19 actually declined in terms of numbers of 

 20 positions. 

 21 Similarly, percent of open interest 

 22 reached a peak. Again, this is different than 

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 1 what we publish, it's more transparent, at about 

 2 65 percent, but lately it's been channeled in this 

 3 area at around 40 to 45 percent. 

 4 So the actual amount of index trading in 

 5 wheat futures has flattened out and maybe even 

 6 declined a bit over the last quite a few months, 

 7 and the open interest is -- did I miss one? Okay. 

 8 So this is another graphics, similar sort of data, 

 9 and again, this is a little bit more than what we 

 10 give to the public normally. This is daily data, 

 11 and it shows the blue line is CIT, Commodity Index 

 12 Type Traders, again, that type we've looked at. 

 13 The green line represents managed money. This is 

 14 actually a bit of a subset of the non-commercial 

 15 speculative trading that we do publish. This is 

 16 -- it's probably a little hard to read, but it's 

 17 essentially commodity pools, which are like the 

 18 mutual funds of the commodity industry, trading 

 19 advisor, hedge funds, things where they're 

 20 managing lots of accounts, not individual 

 21 speculative type activity, it's group activity 

 22 coming into the market, and you can see what 

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 1 they've done over this period of time. 

 2 The red line represents the price scaled 

 3 on this side, and then the blue line represents 

 4 commercials in the market. And you can see 

 5 actually managed money has declined a bit. It's 

 6 been fairly flat. Typically you'll see these 

 7 sorts of things, where price does this, managed 

 8 money does that, because they tend to be trend 

 9 followers. 

 10 But we have noticed that even times when 

 11 prices are rising quite sharply, as you see here, 

 12 often times managed money has potentially reached 

 13 its tolerance for risk in that particular market 

 14 or exposure, and we often see it flatten out even 

 15 though prices continue to rise. 

 16 Here's the similar data per week, again, 

 17 commodity index type money as it should have been 

 18 evident from that earlier chart I showed, very, 

 19 very flat during all these volatile price 

 20 movements, managed money, very relatively small, 

 21 and again, relative flat, and then here's the 

 22 commercial. And finally the soybean market, and 

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 1 again, I want to go through these fairly quickly. 

 2 But you're not seeing the sorts of 

 3 things where you see this -- of a mirror image 

 4 here to the price down here during that period of 

 5 time, they look very, very similar, but as prices 

 6 as soybeans sky rocketed to reach over $15, 

 7 managed money did very, very little during that 

 8 period of time. 

 9 Finally, this is my last slide, I wanted 

 10 to point out one thing of a market that attracted 

 11 literally I think the world's attention in the 

 12 January, February, and at least a part of March, 

 13 and that was the Minneapolis grain exchange wheat 

 14 futures contract. I don't care where you were in 

 15 the world, I think you heard about what was going 

 16 on here. 

 17 Let me set up the graphic. The red line 

 18 represents the March Minneapolis grain exchange 

 19 wheat price. 

 20 The blue line represents a synthetic 

 21 March futures price based on options. You can 

 22 create, I'm not going to go into the details, but 

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 1 you can create an equivalent futures price by the 

 2 appropriate use of options. The green price 

 3 represents Minneapolis cash prices. And I've 

 4 annotated here a couple of things. Don't normally 

 5 see futures price behave this way, a very, very 

 6 flat, straight line, but that was because they 

 7 were literally locked limit up day after day after 

 8 day, even though I think around this point, as you 

 9 looked at the market about February 8th, there was 

 10 about a $3 to $4 difference that futures price was 

 11 under the cash price. 

 12 The synthetic futures price was right on 

 13 top of it, as you can see. So it was providing 

 14 some price discovery that the futures was not 

 15 allowed to provide because of this artificial 

 16 lock. And you can see, even though it may have 

 17 traded on some of these days, it essentially 

 18 closed at limit bid each day. 

 19 Then all of a sudden you see a different 

 20 slope to the line. Beginning on February 11th, of 

 21 course, new daily price limits took effect, what 

 22 would rachet them up by 50 percent, and then again 

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 1 and again by 50 percent until they reached, I 

 2 believe 202 1/2 at one point for the Minneapolis 

 3 that was not -- the same sort of pattern of the 

 4 other two wheat exchanges. So all of a sudden you 

 5 see the market again move to a higher plane until 

 6 finally, in about this area, we reached some 

 7 convergence, where all three, the synthetic price, 

 8 the cash price, and the futures price were finally 

 9 free to trade due to these freeing of the limits, 

 10 raising of the limits. And then here the options 

 11 finally go off, so you don't have the options line 

 12 past that date. And then finally, as you got into 

 13 the -- very close to expiration here, we had very 

 14 good convergence. And by that time, in the 

 15 Minneapolis contract, there were just a handful of 

 16 futures contracts left. 

 17 So that's a little bit about how we're 

 18 reviewing that market and this a wide difference 

 19 between cash and futures and how the futures 

 20 market really wasn't providing its price discovery 

 21 function at that point in time. Let me turn it 

 22 over to Mr. Fenton and he'll talk about cotton. 

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 1 MR. FENTON: Do you want me to switch? 

 2 MR. LUKKEN: While we do that, I just 

 3 want to make a couple notes. We're trying to get 

 4 everybody's slides, and I apologize we didn't get 

 5 these beforehand, but we'll soon have all slides 

 6 before all the participants so they can see them 

 7 before them, as well as on the screens. Also, for 

 8 the people at home that are watching, we're not 

 9 able to put the slides up and broadcast the 

 10 participants, but the slides are available to 

 11 print out at home in case you want to follow 

 12 along. So I just wanted to let people know. And 

 13 also for the folks in the atrium, there are cards 

 14 on your chairs to ask questions. Please fill 

 15 those out and pass them to CFTC employees and 

 16 we'll be sure to try to pepper questions 

 17 throughout this morning's proceedings. So with 

 18 that, back to Doctor Fenton. 

 19 MR. FENTON: Okay. Thanks, Mr. 

 20 Chairman. The story of cotton has similarities to 

 21 what Dave has talked about, the grain markets, 

 22 similarities really in the problems or the 

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 1 symptoms of problems in the market, but it has a 

 2 significant difference, as well. 

 3 Whereas the grain markets are 

 4 fundamentally tight, there is low stocks and 

 5 strong demand, cotton, there is plenty of cotton 

 6 around, and so we've had a discreet episode during 

 7 the last couple of months in cotton that doesn't 

 8 seem to be explained by the current fundamentals. 

 9 If you look at this graph, until mid 

 10 February, cotton seemed to be going along without 

 11 a problem, it was rising fairly gently. In mid 

 12 February, the market seemed to notice that cotton 

 13 prices had risen less than other agricultural 

 14 prices, competing crops. And the expectation that 

 15 acreage would be down for a second year caused 

 16 prices to start to rise. And so we saw a pretty 

 17 sharp rise, a very sharp rise in prices from mid 

 18 February to the end of February. And then 

 19 beginning in March, we had some really strong 

 20 price moves and very volatile trading, in fact, 

 21 fairly chaotic trading conditions. The thing that 

 22 ties cotton to the other agricultural markets, of 

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 1 course, is the competition for acreage. As corn 

 2 acreage has gone up because of ethanol production, 

 3 and acreage has shifted from other crops, they've 

 4 certainly shifted from cotton. 

 5 So last year, cotton acreage was down 

 6 from -- to 10.8 million acres from 15.3 the year 

 7 before, that was a decline of around 29 percent. 

 8 But there was exceptional yields for acreage, so 

 9 we actually had a fairly large crop, 19.4 million 

 10 bales of cotton. This current year, the current 

 11 estimate is that the crop will be 9.4 million 

 12 planted acres, and that would be another 13 

 13 percent decline in planted acreage. 

 14 Cotton's usage, there's been a long term 

 15 decline in domestic use of cotton. The current 

 16 USDA estimate is that for the current crop, 4.7 

 17 million bales will go to domestic use, and 14.5 

 18 million bales will go to export, so that's a total 

 19 use of 19.2 million bales, and remember, the 

 20 production was 19.4, so we've pretty much consumed 

 21 what we produced, so ending stocks have stayed 

 22 mostly unchanged, they were up slightly from 9.5 

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 1 to 9.7 million bales. That's 50 percent or 

 2 slightly more than annual use. So there's a lot 

 3 of cotton around, and a lot of it has now moved 

 4 into certificated stock, which I'll talk about in 

 5 a few minutes. This looks at the futures price, 

 6 which is the red line, and the green line is the 

 7 synthetic options price, and then we have some 

 8 cash prices to see how the futures were moving in 

 9 relation to the cash. 

 10 The light blue line is the North Delta 

 11 spot quotation by the USDA. The dark blue line is 

 12 the East Texas price quoted by USDA. And then the 

 13 orange line is the seam spot price, which is an 

 14 average price. And some of our -- the members 

 15 from the cotton trade here can talk more expertly 

 16 about these prices. 

 17 But the point I think here is that as 

 18 the prices were rising, especially starting in 

 19 March, there was a significant disconnect between 

 20 futures prices and cash prices. And this is 

 21 looking at the basis relationship between some of 

 22 these prices. 

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 1 So the basis versus the North Delta 

 2 price is the light blue line, that changed, it 

 3 didn't change as much as some of the other prices, 

 4 and I guess it's a question of how accurate this 

 5 quote is of really the value of cotton in the 

 6 North Delta. The East Texas price, obviously the 

 7 differential between that and futures went to a 

 8 significant discount, peaked at a negative 18 

 9 cents, and the seam price went to a negative 25 

 10 percent, 25 cents rather. Now, how accurate these 

 11 prices are I guess, you know, one can question, 

 12 but the fact that so much cotton has moved into 

 13 certificated stock seems to be strong evidence 

 14 that the best place to market cotton is to move it 

 15 into delivery location, that's so that indication 

 16 of weak cash prices. 

 17 This Dave showed you for some of the 

 18 other markets, it's the positions of index traders 

 19 in the cotton market. The absolute positions are 

 20 the blue line, and you can see that they've been 

 21 going up since the beginning of the period, which 

 22 we started in January of '04, so there's obviously 

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 1 a long term trend that index trading positions 

 2 have been increasing. 

 3 Their share of the market has stabilized 

 4 and, in fact, has come down a little bit. They 

 5 were as high as 50 percent of the market in late 

 6 '05, and they're currently at just under 40 

 7 percent of the futures open interest. 

 8 Again, Dave showed you this chart for 

 9 the grain markets, so the lines all mean the same 

 10 thing. The light blue line is commodity index 

 11 trading. The green line is managed money trading. 

 12 The dark blue line is the commercial traders in 

 13 the market, it says commercial merchants, but it's 

 14 really all commercials, so it would include coops. 

 15 And I'm going to show you a more detailed picture 

 16 of the most recent two months. But you can see 

 17 that index trading has risen gently, and certainly 

 18 not dramatically over the past few years. Managed 

 19 money trading can be much more in and out of the 

 20 market, and sometimes they're short, and currently 

 21 they're long, although off from their peak long 

 22 position. 

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 1 Looking at the period from February, 

 2 beginning of February through the beginning of 

 3 April, so it's during the period when the market 

 4 was most volatile, you can see that around 

 5 February 13th, prices started to rise. And during 

 6 that period, the managed money traders positions 

 7 also started to rise, from around a net position 

 8 of 50,000 contracts long to as much as about 

 9 75,000 contracts long. 

 10 The index traders positions also started 

 11 to rise. They went up from about 105,000 to 

 12 123,000. So the combination of these two 

 13 financial type traders, the positions of them went 

 14 from 155,000 contracts to around 200,000 

 15 contracts, so that's an increase of 45,000 

 16 contracts during a little bit more than a week. 

 17 But they -- the positions peaked, and then for a 

 18 number of days before the most chaotic trading 

 19 conditions, they actually were not in that virus, 

 20 they flattened out and were in the, in the days 

 21 before the March 3rd limit up day, and then March 

 22 4th was also limit up. During these days, they 

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 1 were not buyers, and hadn't been buyers for 

 2 several days. And, in fact, during the days of 

 3 high prices, both groups were sellers in the 

 4 market. 

 5 And the merchants or the commercial 

 6 trade as a whole, during the period of the buying 

 7 by the financial traders, they were sellers of 

 8 futures, and during the period of the most rapidly 

 9 rising prices, it was actually commercial firms 

 10 that were buying back positions. 

 11 Now, I know that this may well have been 

 12 in -- it was not voluntary in the sense that it 

 13 was a result of having margin calls that couldn't 

 14 be met and having to cover positions. But the 

 15 point I guess I'm trying to make here is that 

 16 during these days, the financial traders were not 

 17 big buyers in the market. 

 18 I mentioned that certificated stock has 

 19 gone way up, I don't think it's ever been this 

 20 high. Over a million bales have moved into 

 21 certificated stock. That's ten percent, more than 

 22 ten percent of the carry over of cotton. And the 

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 1 spread relationship, which is the green line, the 

 2 May/July spread, has weakened from 175 point 

 3 discount made July to -- I think as of the close 

 4 yesterday, it was 393 points. I think the Cottons 

 5 Shippers Association, in their submission to the 

 6 Commission, estimated the cost to carry it round 

 7 290 points, so we're 100 points beyond the 

 8 calculated cost of carry. 

 9 And just one final slide, Dave showed 

 10 you this for the grain markets. There's a lot of 

 11 commentary, I presume it's correct, that the 

 12 problems of putting on hedges in the futures 

 13 markets has caused commercial firms both in grain 

 14 markets and the cotton market to limit the amount, 

 15 or in fact, halt forward hedging of positions. 

 16 And so we looked at our data to see 

 17 whether we'd see in the data that there was less 

 18 hedging in forward months than in the past, and as 

 19 Dave showed you, in the grain markets, cotton is 

 20 similar, that there is, in fact, more short 

 21 positions in forward months than there had been in 

 22 previous years, considerably more. 

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 1 But in the past five weeks, there has 

 2 been basically no additional short positions. So 

 3 it certainly consisted with the story that people 

 4 have stopped forward hedging, at least 

 5 temporarily. So that's some of the background 

 6 data that we've been looking at, and I hope it's 

 7 helpful to the discussion here today. 

 8 MR. LUKKEN: Well, thank you, John. 

 9 Before we turn it over to our discussion today 

 10 around the roundtable, we've asked USDA to give a 

 11 brief overview of some of the fundamentals that 

 12 they're seeing in the agricultural markets. So 

 13 with that, I'll turn it over to USDA, and I 

 14 appreciate their participation. 

 15 We are running just a little bit late, 

 16 but we will adjust the schedule to accommodate 

 17 everybody -- there's time for everybody to speak. 

 18 Thank you. I guess we need to get tech support to 

 19 change the Powerpoint. 

 20 DR. BANGE: Good morning. Again, my 

 21 name is Jerry Bange with the USDA. I want to sort 

 22 of cover some of the same territory that Dave and 

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 1 John have covered. They focused more on prices, 

 2 we were going to look a little bit more at some of 

 3 the fundamental underlying factors. 

 4 As Dave said, many of you are living 

 5 these numbers, and who am I to give you more 

 6 details about what you're already living. But I 

 7 do think we can add a little bit to the 

 8 conversation here, and I'll try not to cover the 

 9 same ground that Dave and John have covered. 

 10 Under Secretary Keenum laid out some of 

 11 the big picture in his opening remarks. What I'd 

 12 like to do is talk a little bit more about the 

 13 market fundamentals and some of the uncertainties 

 14 facing the market that we think are contributing 

 15 to the -- not only to the volatility, but to the 

 16 very strong prices that we've seen of late. I'm 

 17 going to go through a series of slides here. Some 

 18 of them you'll probably barely get a look at 

 19 before they're gone. But I understand that 

 20 there's going to be copies available, and we at 

 21 USDA certainly will put them on our web site so 

 22 you can look at them later. 

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 1 What I'd like to do is just focus on 

 2 about six or seven points here that we think are 

 3 really underlying the commodity situation. Again, 

 4 I'm not going to go into the detail. Each one of 

 5 these probably could have a discussion of its own 

 6 for an extended period of time, we don't have time 

 7 to do that. I'll try to keep my remarks, by the 

 8 way, to less than about 20 minutes. So don't get 

 9 worried if it seems like it's getting a little 

 10 long here. 

 11 There's some factors -- the underlying 

 12 factors that I would cite would be this very 

 13 strong demand that we're seeing world wide for ag 

 14 commodities right now. I think everybody would be 

 15 in concurrence with that. Obviously, the rising 

 16 petroleum prices and increased production of 

 17 renewable fuels is adding to the situation. Along 

 18 with that we have tight grain and soybean stocks, 

 19 as been mentioned. I want to say a little bit 

 20 more about world wheat when we get to that, 

 21 because that did draw a lot of attention recently 

 22 with the huge price run ups we saw, particularly 

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 1 on HRS. We've got -- world wheat consumption has 

 2 exceeded production in six of the eight -- six of 

 3 the last eight years, you may or may not know. 

 4 And then Under Secretary Keenum 

 5 mentioned something about the restrictions on 

 6 world exports of grains, I'll say a little bit 

 7 more detail on that. And then John just talked 

 8 about the U.S. cotton situation with regard to the 

 9 lower area, so I won't say a whole lot about that 

 10 other than to show it to you when we get there in 

 11 graphic or tabular form, and then say a few words 

 12 about the rising input costs. 

 13 As I said, we've seen strong demand for 

 14 world ag -- world wide for ag commodities. We've 

 15 seen very strong income growth in the developing 

 16 countries, India and China, in particular. And 

 17 it's also noteworthy again, as Under Secretary 

 18 Keenum mentioned in his opening remarks, that some 

 19 countries are buying very, very strong, despite 

 20 the very high prices that we've seen, Japan, of 

 21 course, being a case in point particularly with 

 22 regard to wheat. And then underlying this whole 

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 1 discussion I think we're having this morning 

 2 probably is rising petroleum prices as much as 

 3 anything and the increased production of renewable 

 4 fuels, notably using corn for ethanol in the 

 5 United States and oil seeds for biodiesel in the 

 6 EU. 

 7 The tight grain and soybean stocks again 

 8 have been mentioned. U.S. wheat stocks are at a 

 9 60 year low. I was not at USDA when that 

 10 happened, but I was at USDA when the 30 year low 

 11 happened for the world wheat stocks, and so we're 

 12 seeing remarkably low numbers. 

 13 Corn stocks are down sharply, likely to 

 14 decline further in 2008 and '09, as most of you 

 15 probably know. Soybean acres were down sharply in 

 16 2007 and '08, but fortunately at the beginning of 

 17 2007 and '08, we had very, very high soybean 

 18 stocks which cushioned some of that 400 million 

 19 bushel shortfall with regard to production. 

 20 On the South American situation, we kind 

 21 of expected more soybean acres to appear in Brazil 

 22 in 2007 and '08, it didn't happen. There's a 

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 1 variety of reasons for that which we could 

 2 discuss. But be that as it may, the Brazilians 

 3 did not increase acreage as much as we thought. 

 4 Nevertheless, they are going to produce a record 

 5 crop which is playing into the market now. And 

 6 China's imports of forecast seem like they just go 

 7 on ad infinitum, it seems like to be no end to it 

 8 with regard to what they can import, and their 

 9 imports are growing to record levels. The world 

 10 wheat consumption, as I mentioned, has exceeded 

 11 production for six of the eight last -- six of the 

 12 last eight years. Yields have been below trend in 

 13 the major exporting countries, you may or may not 

 14 be aware of that, for the past two years. 

 15 Everyone is aware that Australia 

 16 recorded two back to back crop failures, just a 

 17 bismal of crops. Essentially they lost one full 

 18 year's output and the two last -- in the two past 

 19 years, just huge losses there due to drought. 

 20 Hopefully the situation there will improve this 

 21 year. 

 22 EU crops have been below par, U.S. 

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 1 yields have been below trend, and Canadian crops 

 2 have been below average. 

 3 So all of this has contributed to the -- 

 4 certainly contributed to the wheat situation. 

 5 On the restrictions on world exports, 

 6 specially Ukraine, Russia, Kazakhstan, have all 

 7 curtailed grain exports in some manner. Argentine 

 8 has shut off export registrations on corn and 

 9 wheat and raised taxes on soybean exports. 

 10 Vietnam, India, Egypt, Cambodia, and China have 

 11 imposed various restraints on rice exports. The 

 12 exporters are having difficulty securing supplies 

 13 to meet their contracts. And again, Australia 

 14 exportable supplies have been down sharply due to 

 15 drought. The cotton situation was discussed in 

 16 some detail by John Fenton, I won't go into a lot 

 17 on that other than to say the cotton acreage lost 

 18 to competing crops, as you well know. The 2007 

 19 export forecast has reduced; we have come down on 

 20 that as the seasons have progressed due to 

 21 diminished China purchases. And increased 

 22 competition from India, you may or may not be 

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 1 aware, but India is coming on very, very strong in 

 2 terms of cotton production. 

 3 The U.S. areas forecast to decline again 

 4 in 2008 and '09. Projected net returns are 

 5 expected to favor grains and oil seeds over 

 6 cotton, so we would expect to see less cotton 

 7 acres. Again, cotton -- competitor production has 

 8 been growing very sharply, notably in India, it 

 9 recorded a very, very large crop this year. 

 10 There's other countries we could talk about also, 

 11 but there is a lot of cotton coming from elsewhere 

 12 in the world. 

 13 China has produced a series of excellent 

 14 crops. We think that plantings in China this year 

 15 will, at best, be the same as -- will, at best, be 

 16 flat in 2008 and '09. The Australian crop has 

 17 been reduced by drought. Hopefully that situation 

 18 there will improve. This year Pakistan has had a 

 19 number of insect infestation problems which have 

 20 lowered the crop there. On the issue of rising 

 21 import cost, again, we come back to the idea that 

 22 rising fuel prices, fuel prices are up sharply, 

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 1 and again, underlying much of what we're talking 

 2 about here today. 

 3 One thing that's not been talked about 

 4 is, fertilizer prices are at record highs. What 

 5 we're looking at now is very strong global demand, 

 6 higher incomes, improved cultural practices, more 

 7 cultivated area amid these rising prices for ag 

 8 commodities, so you would expect to see more 

 9 fertilizer usage. 

 10 At the same time, the U.S. dependency on 

 11 imports is growing. Domestic production accounts 

 12 for less than half of nitrogen needs in the U.S. 

 13 right now. And, of course, the disproportion of 

 14 that impact will be on corn, which is a more 

 15 intensive crop. 

 16 Just a word about the balance sheets 

 17 here. Balance sheets, of course, are sort of our 

 18 life and blood at the World Agricultural Outlook 

 19 Board. It's been mentioned a few times, the 

 20 situation with regard to stocks on wheat, we see 

 21 they're very, very low for that 2007/2008 column, 

 22 very, very low ending stocks, 242 million bushels, 

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 1 again, a low by many, many years. Also along with 

 2 that, we're seeing an average market price of 665 

 3 for the year, which would be far and away a 

 4 record, nothing even close to that. You'll notice 

 5 on that 2008/2009 column, you may say, where did 

 6 that come from, that came from our outlook forum. 

 7 And it so happens that at the outlook forum, the 

 8 analysts at USDA did a pretty good job of guessing 

 9 what the wheat area would be this year for the 

 10 2008/2009 crop at 64 million acres. If that comes 

 11 to pass, and we have the S&D numbers correct, 

 12 we're probably looking at another record price in 

 13 2008/2009. 

 14 I would hasten to add there, though, if 

 15 you look at these numbers, you'll notice that the 

 16 export number for 2007/'08, the 1275, was a high 

 17 number by recent standards. Our exports have 

 18 tended to wind down in recent years, but they came 

 19 back very sharply this past year for the factors 

 20 that I mentioned earlier. 

 21 However, we do think that there's going 

 22 to be a significant increase in world wheat 

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 1 production in 2008/'09, leading to lower U.S. 

 2 exports in 2008/'09. However, we still see a very 

 3 strong price outlook, primarily because we expect 

 4 strong prices in the first part of the year. I 

 5 just wanted to mention here that one of the 

 6 reasons that people sometimes do not understand 

 7 our price forecast is, we look at the prices 

 8 received by farmers, and what this graph or what 

 9 this chart is saying here, by the way, there is an 

 10 error here, this 81 percent marketed is not 

 11 September/January, it should be for the June to 

 12 January period. 

 13 My point here in this chart is simply to 

 14 say that wheat marketings and most other ag 

 15 commodities, as a matter of fact, are sort of 

 16 front loaded, they occur very early in the year. 

 17 That's one of the reasons that we see the kind of 

 18 prices we see now. I'm sure that many of these 

 19 people who sold early in the year, regardless of 

 20 which commodity you're talking about, probably 

 21 have regrets this year for having done so. It 

 22 probably led to a few interesting discussions 

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 1 around the dinner table about why did we market 

 2 the way we did given the prices that we're seeing 

 3 now. 

 4 On the U.S. corn S&D, the 13 billion 

 5 bushel crop has been mentioned. 2007/'08, again 

 6 we see a record price there of $4.30. Now, this 

 7 one for the 2008/'09 column, I must do some 

 8 explaining here. On 2008/'09, we're showing a 

 9 planted area of 90 million acres, that was what 

 10 the analysts at USDA thought the acreage report 

 11 would show. As you well know, the perspective 

 12 plannings report, many of you well know, showed 

 13 only 86. Just let me say that the year is not 

 14 over yet, we'll see what the acres turn out to be. 

 15 There's been a lot of discussion of what the corn 

 16 acres are going to be versus what the soybean 

 17 acres are going to be. I think that most USDA 

 18 analysts, if they were left on their own, they'd 

 19 say we think that maybe those acres, corn acres, 

 20 may be a little higher than our perspective 

 21 plannings report showed, but that's the official 

 22 number, the department at 86, however, using 90, 

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 1 we still get a record price for 2008/'09. 

 2 Going through the balance sheet once 

 3 again, we see this very large use for ethanol, 3.1 

 4 billion bushels in 2007/'08, 4.1 projected for 

 5 2008/'09, again, that's based upon an acreage, 

 6 which is higher than what we're showing in the 

 7 perspective plannings report, and still showing a 

 8 record price again of 460. One can only imagine 

 9 what the price would be if we were looking at an 

 10 acreage of 86, so that remains to be seen. 

 11 Again, corn marketings, front loaded, 56 

 12 percent, so front loaded for corn, as well. I 

 13 just would mention, in looking at the corn 

 14 production in total use numbers here, while we had 

 15 that record crop, that's that sort of brown color 

 16 column there in 2007/'08, our consumption actually 

 17 exceeded that number, that huge record number 

 18 based upon that very large area. We still managed 

 19 to consume more of that, again, largely because of 

 20 the corn use, and also because of the very, very 

 21 exports and domestic use. The soybean S&D I 

 22 mentioned earlier, about the 2007/'08 year. I 

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 1 apologize, you'll be able to look at these in a 

 2 little bit more leisure at some later time. 

 3 But anyway, 2007/'08 did show, we 

 4 started the year with a beginning level of stocks 

 5 at 574 million bushels, which really was helpful, 

 6 because as already been mentioned here, the 

 7 planted area decreased very, very sharply, looking 

 8 at a very huge drop, between 67 and 78 in terms of 

 9 the acres because of the shift to corn. 

 10 However, when we got to the bottom line 

 11 here, we had the 160 ending stocks left over, 

 12 primarily because -- which is a low number, but 

 13 primarily because we started with a beginning 

 14 level, which was so strong. 

 15 Now, on this one, we have the opposite 

 16 situation, what we had on corn with regard to 2008 

 17 and '09. The perspective plannings report showed 

 18 74.8 million acres. Our analysts at USDA had been 

 19 working with 71. That would yield a price at 

 20 about 11.50 for the 2008/'09 year. Again, prices 

 21 would increase, however, at 74.8, one would expect 

 22 to see a lower price for soybeans in 2008/'09. 

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 1 Again, soybeans are marketing a front load at 60 

 2 percent through January. The reason we use 

 3 January here as sort of the point to take a look 

 4 at how much of the crop was marketed. Much of the 

 5 price volatility we're talking about here occurred 

 6 in the February/March period. That's when the 

 7 markets really seemed to, for whatever reason, get 

 8 very, very volatile and take off in many 

 9 instances. We'll talk a little bit more about 

 10 that in a moment. 

 11 Soybean oil is another one of those 

 12 crops. It's got involved, of course, in the 

 13 biodiesel industry. The biodiesel usage here at 

 14 -- for methyl ester, which is sort of synonymous 

 15 with biodiesel, 2.95 billion pounds in 2007/'08, 

 16 projected to rise to 3.5 in 2008/'09. 

 17 I'll just say parenthetically here that 

 18 the 2.95 billion pounds is not as high as what we 

 19 had thought about earlier. We had seen -- we had 

 20 had some higher numbers when we projected this. 

 21 The reason we came in somewhat lower is because of 

 22 the -- the usage has been lower, we'll see here in 

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 1 a moment, has been because of the very sharp run 

 2 up in the soybean oil prices that basically made 

 3 it inefficient or economically infeasible to use 

 4 it to produce biodiesel. We'll talk a little bit 

 5 more about that in a second. We have seen a huge 

 6 run up, a very sharp run up in soybean oil prices, 

 7 at 52 cents for 2007/'08. Meal, I only mentioned 

 8 here, primarily because, like other ag commodities 

 9 this year, we've seen a sharp run up in that -- 

 10 those prices. That's not of great consequence. 

 11 It might be good for a soybean producer to see 

 12 that, but it's not so good for a livestock 

 13 producer to see that. So we get a lot of 

 14 discussion on the other side of the ledger here 

 15 with regard to the negatives associated with these 

 16 sharp rising prices, that the livestock producers 

 17 are feeling the brunt of that, and we do, of 

 18 course, hear that at USDA and we understand their 

 19 concerns. 

 20 Just a little bit about the 2007 Energy 

 21 Act, again, just as a reminder here, everyone 

 22 knows about the 15 billion gallon corn based 

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 1 ethanol starting in 2015, we're well on our way to 

 2 that. The mandate calls for an ambitious start of 

 3 nine billion gallons in 2008. We say ambitious 

 4 here, but I can tell you that our capacity to 

 5 reach that will far exceed that in 2008, so we're 

 6 doing very, very well. 

 7 By 2016, all of the RFS increase must be 

 8 met with cellulosic ethanol or some other foreign 

 9 state -- non-foreign start biofuels, which really 

 10 I haven't seen what that's going to be yet. A lot 

 11 of research done in that area, but right now, corn 

 12 looks like it's the only game in town with regard 

 13 to ethanol production that makes economically any 

 14 sense. The ethanol production capacity in this 

 15 country has grown very rapidly. This chart simply 

 16 shows what the capacity will be at the end of this 

 17 September. We're looking at a capacity of about 

 18 11 billion gallons, a very, very sharp increase 

 19 over time, and we're well on our way to reaching 

 20 the mandated number. 

 21 Look at it in terms of corn usage, our 

 22 projection for 2008/'09 suggests that more than 30 

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 1 percent of the corn crop will be used for ethanol, 

 2 once again getting up pretty high numbers. That 

 3 number, as you can see, that percentage is growing 

 4 every year. 

 5 You may be curious as to what the 

 6 mandate suggests for 2015/'16. If you work 

 7 through the arithmetic and using the present 

 8 conversation factors, it would look like about 

 9 between five and six billion bushels of corn would 

 10 be used to produce ethanol in 2015/'16 to reach 

 11 that mandate. 

 12 I will mention that the exports, even 

 13 with one of the concerns we heard earlier on, with 

 14 the growing use of ethanol would be, could we 

 15 still maintain our exports. We did, in fact, or 

 16 we will, in fact, in this year, 2007/'08, export a 

 17 record corn crop. So even with the -- what we've 

 18 done with regard to ethanol, we're still managing 

 19 to export a record corn crop. Much of the 

 20 discussion here has been around prices, I won't 

 21 belabor that or talk about that anymore. 

 22 Everybody knows the sharp run up in prices here. 

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 1 I will just mention, though, look at how these 

 2 prices have run up since September, September, $3, 

 3 now we're looking at corn prices well over 5, well 

 4 on their way to 6, in some cases even over 6, 

 5 we've seen prices, so it's been just a sharp run 

 6 up in prices. 

 7 On the biodiesel mandate, that one is 

 8 written in a little bit different terms, that's 

 9 written in terms of consumption. That one has 

 10 been struggling a little bit for reasons I'll talk 

 11 about in a moment. It says that we will consume a 

 12 billion gallons of biodiesel within the next few 

 13 years. And we're having some difficulty reaching 

 14 that for a number of reasons, not the least of 

 15 which is price. 

 16 One of the heavy consumers of biodiesel, 

 17 more so than the U.S. really, in relative terms, 

 18 of course, would be the EU. So much of the growth 

 19 in EU, in biodiesel consumption world wide, much 

 20 of it is right in the EU. 

 21 One of the reasons that soybean oil 

 22 prices have not been a very -- soybean oil has not 

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 1 been -- we've not been using the capacity, the 

 2 production capacity we have on biodiesel in the 

 3 U.S., which far exceeds what we're actually 

 4 producing, is because we've seen this very sharp 

 5 run up in soybean oil prices. It appears that the 

 6 vegetable oil or food use people can outbid really 

 7 the people that are attempting to use soybean oil 

 8 to make a methyl ester or biodiesel, and as a 

 9 result of that, we've actually seen some negative 

 10 margins here, and when the price gets up to 55 or 

 11 60 cents for soybean oil, you're basically looking 

 12 at a $4 commodity that they're trying to make a $3 

 13 commodity out if, and that doesn't work too well. 

 14 So the bottom line here is that we've seen some 

 15 fits and starts in the biodiesel business. 

 16 On the soybean prices, again, like corn, 

 17 we've seen a very, very sharp run up. Note the 

 18 sharp run up in prices since September. The 

 19 cotton S&D, I'm not going to talk about that very 

 20 much. John has already mentioned the sharp drop 

 21 in area that we've seen in 2007 and '08, owing to 

 22 the fact that they're switching from -- to a more 

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 1 favorable profit. We expect to see that again. 

 2 When USDA analysts looked at this back 

 3 in February, they were thinking in terms of 9.5 

 4 million acres planted; it turned out to be 9.4 in 

 5 the perspective plannings report. I won't say 

 6 more about that at the moment. Again, marketings 

 7 are front loaded, 62 percent marketed here by 

 8 January. Again, on this one, if January -- it was 

 9 after January that we saw a very -- the very 

 10 volatile market, and so much of the crop had 

 11 marketed by the time that that happened. 

 12 Again, this is a graph that John has 

 13 shown in another form with a very, very sharp run 

 14 up in cotton prices, not for -- we don't 

 15 understand the connection there, or there appeared 

 16 to be a disconnect, should we say, between the 

 17 market fundamentals and what actually happened. 

 18 And then another way of looking at that 

 19 is this volatility. You can see that, it's just 

 20 huge, it just shows up very well here, how 

 21 volatile the market became. Now, let me say a 

 22 little bit more about this area situation. These 

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 1 are the numbers I put in here, you can look at at 

 2 your leisure, these are the planted areas -- 

 3 numbers that came out of the perspective plannings 

 4 report. 

 5 One of the things I would point to here 

 6 is that the overall increase in acreage for the 

 7 commodities I've listed here is between five and 

 8 six million acres for 2008/ '09. Again, it shows 

 9 the corn acres of 86, and it shows the soybean 

 10 acres of 74.8, and there's that 9.4 million acres 

 11 that John has talked about with regard to cotton. 

 12 Just focus a second on the corn and soybeans 

 13 acreage and some of the factors, we were looking 

 14 at USDA. Even with the fertilizer costs being 

 15 what they are, we see that the net returns outlook 

 16 for the field props are very good. You'll notice 

 17 the only one on here where it doesn't look great 

 18 right now, of course, is cotton. 

 19 On corn and soybeans, we're seeing a 

 20 continued increase in the net returns prospect for 

 21 2008. There's been, relatively speaking, a large 

 22 increase in net returns for soybeans. However, if 

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 1 you look at the returns in total for corn, it's 

 2 still favorable for corn, is one of the reasons 

 3 why the USDA analysts think that maybe we'll see 

 4 more corn than the perspective plannings report 

 5 showed. 

 6 If you go to the next chart, it's a 

 7 very, very interesting chart, because what this 

 8 chart shows is, if you look at that red line, that 

 9 red line is what -- is the ratio between soybean 

 10 and corn prices. When you have a ratio that's in 

 11 the realm of 2.5 to one, meaning soybean prices 

 12 are two and a half times what corn prices are, 

 13 generally that means you get more soybean acres. 

 14 Farmers would prefer to go in that direction. 

 15 At the time the survey was taken on the 

 16 perspective plannings report, and at the time, 

 17 we're looking at the -- the farmers are looking at 

 18 the perspective plannings report or deciding how 

 19 to respond to that, the price ratio looked very 

 20 good. Since that time, the price ratio has turned 

 21 much in favor of corn. And what we've seen in the 

 22 past when that has happened, and the reason that 

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 1 it did that is, when the ratio was in the realm of 

 2 two and a half or 2.4 to one, it looked like 

 3 farmers were so called buying soybean acres. 

 4 Then it became clear that we had the -- 

 5 that the soybeans acres were coming, and the 

 6 perspective plannings report confirmed that, we 

 7 saw that price drop on soybeans relative to corn, 

 8 and we saw that ratio drop sharply. 

 9 So this is what farmers are looking at 

 10 now, and they're still in the -- still working on 

 11 what crops they're going to plant. So they'll be 

 12 looking at this over the next few weeks as they go 

 13 out to the fields and plant whatever they decide 

 14 to plant. 

 15 Now, in the past, the reason I mention 

 16 that, we've seen a sharp change between the March 

 17 perspective plannings report and June. If you 

 18 look at the numbers at what happened last year, 

 19 the outlook conference started back in February of 

 20 last year, the USDA thought, well, 87 would be 

 21 probably the corn acres, and then by the time the 

 22 perspective plannings report came along, the 

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 1 report showed 90.5, and then when we saw the June 

 2 acreage report, which is a key report to look at, 

 3 that number had increased to 92.9, and what 

 4 actually happened was 93.6. My only point here 

 5 is, between March and June, farmers can make -- or 

 6 March and June, or March and what they actually 

 7 plant, they can make very large changes in 

 8 numbers. 

 9 This year, I guess we're looking to the 

 10 fact that maybe we'll see somewhat more corn acres 

 11 than the perspective plannings report indicated. 

 12 However, the big question there will be whether or 

 13 not weather will cooperate. 

 14 So far weather has not cooperated, it 

 15 has been too wet in the midwest, it is drying out 

 16 a little bit now, hopefully it'll dry out enough 

 17 for that to -- for the farmers to get in and plant 

 18 corn. If they don't, then the soybean acres 

 19 probably will be very large, as the perspective 

 20 plannings report showed. So we'll just have to 

 21 wait and see how that comes out. Okay, thank you. 

 22 MR. LUKKEN: Thank you very much, Jerry. 

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 1 Before we turn to our roundtable, I quickly wanted 

 2 to welcome and recognize former Commissioner Fred 

 3 Hatfield who's here today, and we miss you, Fred, 

 4 but we're glad you're back in this capacity. And 

 5 also welcome to some Congressional staff that we 

 6 work quite closely with, so thank you for coming 

 7 down here today. With that, before we open it up 

 8 for questions, I know people have a lot of 

 9 questions based on those broad presentations, but 

 10 I've asked the CME Group to lead off the 

 11 discussion, to give us their views of what they're 

 12 seeing in the markets, and then I encourage you to 

 13 start asking questions by, again, raising your 

 14 placard, and we'll try to call on you and start 

 15 the roundtable discussion. So with that, I'll 

 16 turn it over to the CME. 

 17 MR. LEHMAN: Thanks very much, Acting 

 18 Commissioner. And again, thank you to the 

 19 Commission for holding the Ag roundtable, the Ag 

 20 Forum. I'd also like to thank many of our 

 21 customer associations that are in the room for 

 22 engaging in dialogue with us. 

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 1 We've had a very constructive dialogue 

 2 with National Grain and Feed, in particular on how 

 3 our contracts are working. We've had a number of 

 4 producer groups and other organizations come into 

 5 the Commodity Markets Council meetings that were 

 6 held in Chicago two weeks ago. It's a very 

 7 complicated situation. We agree certainly with 

 8 many of the comments on the fundamental factors 

 9 that are effecting the markets today. And one 

 10 that wasn't mentioned, I was a little surprised, 

 11 and USDA may have some data on this, but the 

 12 exchange rate volatility or the depreciation of 

 13 the dollar I think is a major factor that we see 

 14 in the higher level of commodity prices. 

 15 What we're doing in addition to this 

 16 forum, the outreach that we did to Commodity 

 17 Markets Council, we are implementing some changes 

 18 in our contract specifications that will come into 

 19 effect in July of this year for the wheat 

 20 contract. We'll be changing the delivery 

 21 instrument to a shipping certificate, which 

 22 increases the capacity for deliveries on the wheat 

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 1 contract. 

 2 We're increasing storage rates in the 

 3 wheat contract, as well as in the corn and soybean 

 4 contracts in November and December of this year by 

 5 about ten percent. So we think these changes will 

 6 improve the performance of our contracts. 

 7 We've also looked at just how the 

 8 contracts are performing and recent expirations. 

 9 And we've run charts that I know CFTC is very 

 10 familiar with, I think we have some copies here of 

 11 the last nine expirations in corn, beans, and 

 12 wheat. So starting with March of this year 

 13 working back, the January soybean, December -- in 

 14 September of '07 expirations. 

 15 And out of those nine expirations, we 

 16 see good convergence to, in some cases, excellent 

 17 convergence in seven of those. We see a couple of 

 18 expirations where we didn't see as good a 

 19 convergence as we normally would. And when we're 

 20 speaking about convergence, we're really looking 

 21 for an appreciation in basis or a strengthening in 

 22 basis as we move toward expiration. 

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 1 I don't think we ever see an exact -- I 

 2 mean we do at times see futures and cash come 

 3 right together at expiration, but that's probably 

 4 the exception rather than the rules, and studies 

 5 going back into the '80's that were conducted look 

 6 at convergence as a band around the futures price, 

 7 plus or minus. 

 8 In the '80's, it was six cents or eight 

 9 cents per bushel, plus or minus, it's what the 

 10 academics felt represented convergence. I think 

 11 with the higher price levels, certainly you could 

 12 argue that that band is likely wider. 

 13 So those are things that the CME Group 

 14 is doing. We are making changes, as I said, to 

 15 our corn, soybean, and wheat contracts that we 

 16 think we'll improve their performance. We're very 

 17 interested in the feedback from all of our 

 18 customer groups, everyone here today, and I think 

 19 Commodity Markets Council will be coming out with 

 20 a summary report of the feedback gained in those 

 21 meetings. And, again, we thank everyone for their 

 22 participation, and certainly be happy to go 

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 1 through some of our convergence slides or pass 

 2 those around if you thought it would be helpful. 

 3 MR. LUKKEN: Any comments from the 

 4 group? 

 5 MR. CAREY: I'd just like to say that -- 

 6 first, I'd like to thank you for the 

 7 presentations, the opportunity today. I think 

 8 it's important to have dialogues like these. 

 9 I think that -- the one thing we are 

 10 unanimous on here in this room, and there's 

 11 probably nothing other than this, is that it's a 

 12 very challenging environment to manage risk. 

 13 And I think the historical perspective 

 14 that was communicated to this group through the 

 15 charts, when you look at low stocks, high 

 16 volatility, and the challenges to the risk 

 17 management function, you see people trying to 

 18 downstream the risk management function. 

 19 You know, I'm here to say that when we 

 20 became aware of this as an exchange, as the former 

 21 Chairman of the Chicago Board of Trade and now 

 22 Vice Chairman of the CME Group, we basically took 

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 1 it very seriously, we do, we conduct the meetings, 

 2 we participated in the CMC meetings that were held 

 3 at Chicago Board of Trade. A couple of things 

 4 we've done, we requested the Commission to defer 

 5 consideration of increases in federal speculative 

 6 limits until we see really what shakes out here, 

 7 because while we still support those increases, we 

 8 understand the environment, and we don't want to 

 9 be accused of making a situation worse, whether it 

 10 is or whether it's perception. 

 11 We understand that the market place is 

 12 at a tough spot, particularly the traditional risk 

 13 managers, the elevators, the processors, those 

 14 people that take on the inventory and are the 

 15 short hedgers. 

 16 We also recommended that new risk 

 17 management exemptions be delayed. And really, for 

 18 our part, as a solution, and Dave highlighted some 

 19 of the changes to the markets, but you know, we 

 20 proposed that -- prohibition on the clearing of 

 21 agricultural swaps products, training the OTC 

 22 market, because we really think that one of the 

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 1 things that we're going to have to discuss and put 

 2 on the table is innovation, because the markets, 

 3 because of whether it be a shifting paradigm, 

 4 whether it be a one time admiration, the fact of 

 5 the matter is, we're going to require more 

 6 products, better products, to really meet the 

 7 needs of the market place, because grain flows are 

 8 no longer just the Mississippi River, they're east 

 9 and west, there's ethanol included, there's 

 10 feeders included, and to address all those things, 

 11 a one size fits all, may not help, but if we 

 12 continue to innovate in that area, we think we'll 

 13 go a long way to meeting the needs of the market 

 14 place. 

 15 And when I looked at those charts, I 

 16 remember my father -- I've been a member of the 

 17 Board of Trade 30 years as of last week, and I 

 18 remember my father told me that President Harry 

 19 Truman blamed the Chicago Board of Trade and a 

 20 bunch of speculators for the high prices during 

 21 the marshall plan. 

 22 So this is not unique, it's a 

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 1 challenging environment, it's important that we 

 2 all get in this room and talk about potential 

 3 solutions that will work for everybody. 

 4 Thank you. 

 5 MR. LUKKEN: Thank you, Charlie. Yes, 

 6 John. 

 7 MR. POPP: I'd like to echo or at least 

 8 -- 

 9 MR. LUKKEN: I'll remind the group to 

 10 introduce yourself and organization for our 

 11 transcript. 

 12 MR. POPP: Oh, yes, okay. I'm John Popp 

 13 with the Independent Bakers Association, also CEO 

 14 of a bakery in the midwest, Aunt Millie's Bakery. 

 15 We are about $150 million regional bakery. But 

 16 I'm glad to hear that there seems to be some 

 17 hesitation to increase the speculative limits. 

 18 The current limit of 5,000, 11,000, the magnitude 

 19 of those -- that much is -- I don't know if many 

 20 people really understand, but our business, we're 

 21 the third largest private bakery in the country, 

 22 and we only use 780 contracts a year. 

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 1 My friend, Sara Lee, who is a $3.4 

 2 billion company, only uses probably 10,000 

 3 contracts. So to increase those limits I think 

 4 puts so much power and dominance in the hands of 

 5 speculative traders. And we like to see all of 

 6 the funds be under the same restrictions of those 

 7 speculative limits. Thanks. 

 8 MR. LUKKEN: Doug Hepworth. 

 9 MR. HEPWORTH: Hi, Doug Hepworth from 

 10 Gresham. I actually saw a few people smile when 

 11 Mr. Kass mentioned commodities as an investment, 

 12 but they do serve a very valuable role. We offer 

 13 our clients long exposure to commodities through 

 14 diversified baskets of fully collateralized 

 15 commodity futures. 

 16 And there have been 196 rolling five 

 17 year periods since we started doing this in 1987. 

 18 And the addition of a five percent allocation to 

 19 commodities to a portfolio that's composed 60 

 20 percent equities and 40 percent bonds would have 

 21 reduced the volatility of the total portfolio in 

 22 each of those 196 periods. And the average 

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 1 reduction in volatility would have exceeded five 

 2 percent. This volatility reduction makes this 

 3 kind of investment very attractive to pension 

 4 funds, who are trying to protect their retirement 

 5 incomes of their beneficiaries. 

 6 Our representative client is not a 

 7 speculator, he's not a hedge fund owner making a 

 8 billion dollars to build a new mansion in front of 

 9 his mansion in Greenwich, Connecticut. A 

 10 representative client for us is a school teacher, 

 11 age 42, making about $60,000 per year, and I just 

 12 want to make sure that they're represented, as 

 13 well. 

 14 MR. LUKKEN: John with Calpers. I know 

 15 that you're a large organization pension that may 

 16 use our markets; can you give us a little overview 

 17 of how pensions typically get involved in our 

 18 markets? 

 19 MR. KOWALIK: Sure; John Kowalik from 

 20 Calpers. Similar to what Doug mentioned is that 

 21 we are slowly increasing our allocation to 

 22 inflation linked assets, which for us includes 

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 1 commodities, in effect, to one of the major 

 2 industries, and we expect to increase it from a 

 3 small amount to a, you know, still a very small 

 4 amount compared to our overall portfolio. The 

 5 reason we're doing so is because it provides a 

 6 great benefit for diversification. We're 

 7 generally getting our exposure passively. We do 

 8 not participate in the front end of the market or 

 9 have anything to do with physical commodities in 

 10 terms of our investments. 

 11 So in terms of asset allocation, from a 

 12 big portfolio perspective, it is a great 

 13 performing asset. And, in fact, it's the 

 14 diversification benefits that make it attractive 

 15 as opposed to, of course, we'd all like higher 

 16 prices and gains, but the diversification aspect 

 17 is really the most important part of it from our 

 18 big picture portfolio perspective. 

 19 MR. LUKKEN: Thank you. Garry. 

 20 MR. NIEMEYER: Garry Niemeyer with the 

 21 National Corn Growers. We would kind of like to 

 22 have a reexamination of how you define hedgers. 

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 1 It's NCGA's opinion that large hedge funds have an 

 2 overwhelming influence on the markets and they 

 3 really are non-commercial traders. 

 4 Frequently we see dramatic shifts in 

 5 futures markets that have really no substantial 

 6 fundamental drivers. 

 7 While we do not want to drive the index 

 8 or the hedge funds from the market, they should be 

 9 treated as they are, speculators. NCGA realizes 

 10 that large index funds are selling a commodity 

 11 index and then going long in each of their market 

 12 basket commodities, which could be construed as a 

 13 hedge. But they are selling a market basket of 

 14 futures prices, not a market basket of physical 

 15 commodities. NCGA proposes that the index funds 

 16 no longer be afforded the same margin requirements 

 17 as traditional commercial hedgers. Specifically 

 18 to be classified as a hedger, the entity must have 

 19 a cash position. 

 20 We're not suggesting that they have an 

 21 equal or proportional cash position, but somewhere 

 22 within the company they must be buying or selling 

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 1 cash grain to retain the hedger classification. 

 2 We believe this will have a very limited 

 3 impact on the market liquidity. The large funds 

 4 are still welcome to take their net long positions 

 5 in each commodity market, but they will have a 

 6 margin requirement just the same as any other 

 7 speculator. 

 8 MR. LUKKEN: Thank you. David. 

 9 MR. BROWN: Just to -- Dave Brown with 

 10 -- representing American Bakers Association. Just 

 11 to jump on top of Garry's comments here a little 

 12 bit around the definition of a hedger, actually I 

 13 have that prepared and written down here today, 

 14 and the definition of a hedger is, "an entity with 

 15 a position in a futures market opposite to a 

 16 position held in the cash market to minimize the 

 17 risk of financial loss from an adverse price 

 18 change, or a purchaser's sale of futures as a 

 19 temporary substitute for a cash transaction that 

 20 will later occur." And I think it comes down to 

 21 really defining the definition of what a hedger is 

 22 versus a speculator as we dig into this. 

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 1 MR. LUKKEN: Andy. 

 2 MR. WEIL: Thank you, Mr. Chairman. In 

 3 the cotton industry, we have similar concerns as 

 4 the two previous gentlemen pointed out for their 

 5 recommendations. We've never seen a market like 

 6 this, not in Weil Brother's history of 130 years. 

 7 And we -- as you saw in the 

 8 presentations today, cotton is a bit different in 

 9 the way that our stocks to use ratio is much, much 

 10 higher than the grains, and cotton, the divergence 

 11 came from I guess what speculators look at on 

 12 charts and perceive value there, where as the 

 13 fundamentals, of course, is supply and demand. 

 14 We, you know, would like -- to require 

 15 that an index fund with a hedge exemption restrict 

 16 this position and a commodity to the dollar 

 17 allocation or the percentage of funds allocated to 

 18 that commodity as defined in the funds -- and 

 19 recorded with the CFTC. Further, any variation 

 20 should be subject to speculative position limits, 

 21 and such funds should report the cash positions on 

 22 a weekly basis. We'd like a requirement that the 

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 1 reporting of all swap and OTC contracts by market 

 2 participants and that the CFTC determine the 

 3 aggregation position from all sources, including 

 4 the exchanges, ETF's, swaps, OTC, and all other 

 5 trading entities, require that all non-traditional 

 6 hedge accounts, those not involved in the 

 7 commercial enterprise of physically trading bales 

 8 of cotton be reported as a separate individual 

 9 category, require that the ICE and its clearing 

 10 members adhere to the practice of margining 

 11 futures to futures settlements and options to 

 12 options settlements, and that only those involved 

 13 in the physical handling of cotton be eligible for 

 14 hedge margin levels. Thank you. 

 15 MR. LUKKEN: Thank you, Andy. Mr. 

 16 Dunavant. 

 17 MR. DUNAVANT: Well, I'm in full support 

 18 of Andy's and American Cotton Shippers' position. 

 19 We have serious problems in the cotton futures 

 20 market, in the ICE exchange. I go back to March 

 21 4th, and cotton traded from 84.95 to synthetically 

 22 to $1.09. That makes no sense. The market is 

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 1 broken, it's out of whack, and somebody has got to 

 2 step in and give some relief. The cotton producer 

 3 is being penalized, the cotton cooperative is 

 4 being penalized, the cotton merchant is being 

 5 penalized, the textile industry; we need to get 

 6 back to trying to function as a futures market 

 7 that has some stability, and we certainly don't 

 8 have it now, and I think the traders, the 

 9 commercial hedgers need to be treated on a totally 

 10 different basis than speculators and commodity 

 11 funds. 

 12 We need to be margined completely 

 13 different, because we are physical users of the 

 14 market, and we would ask you to review our 

 15 feelings very carefully. Thank you. 

 16 MR. LUKKEN: Thank you. Woods. 

 17 MR. EASTLAND: I agree with what both 

 18 Billy and Andy have said, and I might elaborate 

 19 just a little bit. The purpose of these markets I 

 20 think is to find very well in the act. And the 

 21 strongest evidence as to whether or not the 

 22 self-regulation scheme of the board and management 

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 1 of ICE and the regulation duty of the CFTC is 

 2 being met, of course, is in the basis, not only 

 3 convergence with the cash during delivery, but the 

 4 relationship between cash and futures between 

 5 delivery periods, trading in a historical, normal 

 6 range. 

 7 And, of course, as we saw from the other 

 8 end of the table, in cotton, it did not. And that 

 9 by definition is a broken market, but probably 

 10 more importantly by definition of the act, those 

 11 sort of unwarranted price changes are defined in 

 12 the act as an undue burden on interstate commerce, 

 13 which puts it on your shoulders to make sure, and 

 14 ICE's shoulders, to make sure it doesn't happen 

 15 again. So I've got a series of suggestions, too, 

 16 that I'll be filing with my statements with the 

 17 CFTC all along these lines. 

 18 I would say one thing, I think a market 

 19 the size of the cotton market, I think you need 

 20 this one size fits all idea is incorrect, and a 

 21 market -- the worse thing that could happen for 

 22 cotton right now would be to increase the 

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 1 speculative limits. In fact, I think in a market 

 2 our size, speculative limits should be decreased 

 3 for cotton. Thank you. 

 4 MR. LUKKEN: Joe. 

 5 MR. NICOSIA: I am Joe Nicosia, CEO of 

 6 -- Cotton Company, Executive Vice President of -- 

 7 MR. LUKKEN: If you could try to get to 

 8 a mike for our transcribers, it's helpful. And 

 9 I'll remind everybody, even though I call on you, 

 10 state your full name and organization. It's very 

 11 helpful. Thank you. 

 12 MR. NICOSIA: My name is Joe Nicosia, I 

 13 am a CEO of Allenburg Cotton Company and Executive 

 14 Vice President with Louis Dreyfus, and I'm here 

 15 today in my capacity as incoming President with 

 16 the American Cotton Shippers. As opposed to 

 17 regoing over what several of my colleagues have 

 18 just said, I would like to touch a little bit on 

 19 what we view as some of the problems that were 

 20 caused in cotton, and maybe some of the solutions, 

 21 as well. 

 22 I found it very interesting in the 

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 1 opening comments that I didn't hear anything or 

 2 any studies about the OTC market place, aggregate 

 3 of positions, swap market, or any of those 

 4 problems that exist. And it's no secret that it 

 5 is a fully developed market place, one that is 

 6 used to totally circumvent position limits. 

 7 Commissioner Chilton, you asked earlier 

 8 today was there something that was out there that 

 9 maybe you were not watching or something that you 

 10 could more monitor to try to get a better handle 

 11 on the situation. I would suggest that the 

 12 inclusion of your monitoring and/or requiring 

 13 reporting of swap and OTC positions would be a 

 14 great place to start. 

 15 Today you may have an entity which may 

 16 have five to ten times the spec limit, and yet you 

 17 have no idea that that is even out there and 

 18 existing. And they use these forms to totally 

 19 influence price and change what is happening out 

 20 in the market place without any recourse 

 21 whatsoever. Also, I know that there is the idea 

 22 that there's possible, passive investment word has 

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 1 been used several times, especially in conjunction 

 2 with index funds. I would offer that that is -- 

 3 passive is absolutely the improper word to use. 

 4 When we look at the weeks that happened in cotton, 

 5 the week before, the giant run up of index funds 

 6 strangely added almost 13,000 contracts. And the 

 7 week where we went up the equivalent of 25 percent 

 8 in 90 minutes, they strangely exited 12,000 

 9 contracts. I would offer that's anything but 

 10 passive. 

 11 Also one of the problems that we have, I 

 12 noticed we had the report that came through that 

 13 showed forward hedging, and it showed that because 

 14 open interest was up, that the relationship to 

 15 that was that there was not a lack of forward 

 16 hedging that was taking place. 

 17 Because if we had moved away from the 

 18 whole loan economics that existed, the entire crop 

 19 must be hedged. Therefore, the open interest 

 20 demands for increased hedging is substantial, 

 21 probably 300 to 500 times what you have seen. So 

 22 a small increase in the open interest of the 

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 1 hedger is totally non-representative of the amount 

 2 of demand for forward hedging that's necessary. 

 3 So when we see a percentage increase in 

 4 the open interest from the commercial, it really 

 5 needs to be three to five times that amount as 

 6 being totally restricted. I have several other 

 7 remarks, but I'll hold them until the other 

 8 sections that you have. Thank you. 

 9 MR. LUKKEN: Thank you, Joe. Any other 

 10 comments? Tom? 

 11 MR. COYLE: Thank you, Chairman. First, 

 12 before I make a couple of comments on both the 

 13 participation in this new capital in the 

 14 agricultural markets, and also on the terms of the 

 15 CME, I want to thank the Commissioner and -- 

 16 Commissioner Dunn for all the time you've spent 

 17 with the National Grain and Feed this year. It's 

 18 really been quite impressive, the time you've 

 19 spent with our association to understand the 

 20 issues. 

 21 I also want to compliment Mr. Kass on 

 22 your charts; again, you've outdone yourself. So 

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 1 later, when we talk about convergence, that will 

 2 be quite helpful. Going back to some of the 

 3 comments I heard from Dave Lehman and Charlie 

 4 Carey, you know, our association has done a lot of 

 5 work on contract terms. 

 6 We had a task force last summer to talk 

 7 about contract terms, what could we do to respond 

 8 to the imbalance that we're seeing in the market. 

 9 We had a lot of participation from a broad group 

 10 of participants, from funds, to professional 

 11 traders, to mills, to grain elevator operators, to 

 12 country elevators. In the end, we didn't come up 

 13 with a silver bullet, which we were hoping for, 

 14 but we did come up with some recommendations for 

 15 the Board of Trade, which were intended to 

 16 increase the utility of the current delivery 

 17 system, and the Board of Trade did listen to those 

 18 recommendations, had an industry forum, made the 

 19 recommendations to the Commission, and so I 

 20 understand they'll be adjusted in the fall; we 

 21 really do appreciate that. 

 22 So we certainly can say that the CME has 

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 1 been responsive. We spent a lot of time with you 

 2 on this, as well. As it relates to this new 

 3 capital that's participating in our market, the 

 4 National Grain and Feed feels pretty strongly that 

 5 despite the charts that right now show that 

 6 there's actually maybe some reduction in the share 

 7 of these passive participants in the market, if 

 8 you dig in the -- well, first I'll say that we do 

 9 believe that it's having an impact on the market, 

 10 it is creating an imbalance, and while there are 

 11 more contracts that are being traded, it's not 

 12 increasing liquidity, it's actually reducing 

 13 liquidity, because if you have in the case of 

 14 wheat, if you look at the long open interest, take 

 15 out the spread trade and just look at the longs 

 16 and shorts, 60 percent of the current market is 

 17 owned by an index fund. If you look at the net 

 18 positions, it's 50 percent, the longs and shorts. 

 19 Clearly, that's having an impact on the market. 

 20 Our view, again, like Mr. Popp said 

 21 earlier, that we're -- we weren't in favor of an 

 22 increase in spec limits at this time. Today we'll 

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 1 talk more about convergence and forward 

 2 contracting issues later. 

 3 But as it relates to the new capital in 

 4 the market, we believe, as I've heard a number of 

 5 the previous speakers say, that the margin issues 

 6 for these new participants should be changed, that 

 7 we would recommend 100 percent margining. 

 8 If, in fact, as I heard clearly, there's 

 9 going to be more money coming into our markets, 

 10 that's not a bad thing. However, if it's supposed 

 11 to be a notional value and it's a long term 

 12 passive investment, then it should be margin 

 13 dollar for dollar, as opposed to -- which may 

 14 happen today with a couple of the approved hedged 

 15 exemptions, but if you're coming through a swaps 

 16 dealer, well then you don't have one for one 

 17 margining. We think that might actually create 

 18 some balance in the market. 

 19 The other thing we think is, something 

 20 that should be considered, is a moratorium, much 

 21 like the CME said on the hedge -- the speculative 

 22 limits. The idea of a moratorium on hedge 

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 1 exemptions for this new capital is something that 

 2 ought to be considered, because for right now, the 

 3 market is out of balance. I'll talk a bit more 

 4 later about convergence and forward contracting, 

 5 but that's our position. 

 6 MR. LUKKEN: John. 

 7 MR. KOWALIK: I'd just like to point out 

 8 that -- 

 9 MR. LUKKEN: Again, state your name, if 

 10 possible. 

 11 MR. KOWALIK: Oh, sure, John Kowalik. 

 12 I'd like to point out for Calpers, and probably 

 13 most likely for other pension fund investors, that 

 14 all of our dollar amount of commodities exposure 

 15 is, in fact, back to 100 percent by collateral, so 

 16 there's no -- we're specifically, by policy, 

 17 prohibited from having any leverage in our 

 18 commodities position. 

 19 So for every dollar of commodity price 

 20 exposure we have, we have 100 percent collateral 

 21 behind that. And I -- I want to emphasize, it's 

 22 probably the case for a lot of the pension fund 

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 1 asset money coming into these markets. 

 2 MR. LUKKEN: Bob Greer, we haven't heard 

 3 from PIMCO. 

 4 MR. GREER: Thank you. My name is Bob 

 5 Greer, I'm with PIMCO, a couple of comments. 

 6 First, as I listened very closely to a lot of the 

 7 economic data that was presented, I did not see a 

 8 convincing case, a systematic case that index 

 9 money has significantly changed the major 

 10 objectives that were stated of these markets, and 

 11 that is price discovery and risk mitigation. 

 12 Second, I would suggest that as we 

 13 consider the volatility as opposed to price 

 14 levels, as we consider volatility in these 

 15 markets, we make a clear distinction between an 

 16 index investor versus a hedge fund investor, 

 17 because, indeed, their activities are different in 

 18 these markets. 

 19 The third point I would like to make is 

 20 that I can remember reading textbooks before there 

 21 ever were commodity indexes that indicated a long 

 22 only investor is assuming some price risk that 

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 1 producers and others in the commercial interest, 

 2 in the commodity business, would like to shed 

 3 themselves of. 

 4 There are now over 200,000 individual 

 5 investors in this country that are offering to do 

 6 exactly that, and I would think, though we can 

 7 probably not measure it, that they have reduced by 

 8 their collective efforts the amount of risk 

 9 premium that a commodity producer must pay as they 

 10 mitigate their risk in these markets. Thank you. 

 11 MR. LUKKEN: Thank you. Down on the 

 12 end, John Popp. 

 13 MR. POPP: Yes, John Popp with the 

 14 Independent Bakers Association. I think we have a 

 15 new situation that has not existed until now. I 

 16 think I heard in the presentation the concept that 

 17 the index funds and these large funds are not 

 18 effecting the volatility. But I think what we've 

 19 done is, under today's conditions, we have a much 

 20 different supply situation. 

 21 We've taken 22 million acres out of the 

 22 food supply and put it in the fuel supply. And so 

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 1 now suddenly we have -- we're not faced with the 

 2 surplus problems that we have been for 50 years, 

 3 we have now a limited supply, and we've got a lot 

 4 of dollars chasing a tight supply, and I think 

 5 it's time to take some of that CRP land that we -- 

 6 conservation reserve land and put it back into 

 7 production, because we need -- we're going to need 

 8 more supply of tillable land. 

 9 So I think that it's related, and that's 

 10 not the main purpose, but as we talk about 

 11 supplies, I think that tight supply has made these 

 12 huge investments by these funds have a much 

 13 different effect than it used to when we had 

 14 surpluses. Thank you. 

 15 MR. LUKKEN: Tom. 

 16 MR. COYLE: Again, Tom Coyle, Chairman 

 17 of the National Grain and Feed. A couple of 

 18 observations, one, so as not to be one sided, I 

 19 would say that we have noticed, because we got 

 20 your report that has a breakdown in the 

 21 participants in the market, as I analyze it for 

 22 this meeting, the one thing that is interesting to 

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 1 note, that in the two years since we -- the two 

 2 years of data that we have, from the breakdown in 

 3 the report today, the commitment of trader's 

 4 report, it does show that there's ten times more 

 5 index fund shorts today than there was two years 

 6 ago, and that's still not significant. 

 7 But I think in the wheat contract, that 

 8 might be 30,000 contracts, and it was 3,000 

 9 contracts or something like that two years ago. 

 10 So what that does say is that the market is 

 11 adapting, and we would assume that over time, 

 12 people would participate. 

 13 And I think I heard the Deutsche Bank 

 14 was coming up with a short only fund, so that you 

 15 would like to think that other participants would 

 16 help provide some balance, as well. The other 

 17 comment I would make is, the association feels 

 18 pretty strongly about the importance of this new 

 19 commitment of trader's report, but we think it's 

 20 important to make sure that the numbers are 

 21 accurate. And I say that in that there may be 

 22 some confusion in terms of where participation 

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 1 shows. If you are commercial, but you also happen 

 2 to have accounts that are actually index, you're 

 3 providing some kind of a role there, I think what 

 4 would happen is, in your reporting, it would show 

 5 up as a commercial trade. 

 6 On the other hand, if you're a hedge 

 7 fund that also has a portion of your equity that 

 8 is actually a long only fund, where does that show 

 9 up? Would that actually be in the non-commercial, 

 10 which would be where a hedge fund would show up, 

 11 or would it show up in an index fund? How does 

 12 that really get broken up? 

 13 I'm not sure that when you fill out the 

 14 form, right, you get put where your primary 

 15 business is. It may make some sense to make sure 

 16 that there's an adjustment in that, so you 

 17 actually do know which contracts are going where. 

 18 The numbers are quite big. 

 19 MR. LUKKEN: Okay. I know Andy had a 

 20 question, and then I'm going to turn to Jerry, and 

 21 then I'm going to ask my colleagues on the dais 

 22 whether they have any questions for the group. So 

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 1 Andy. 

 2 MR. WEIL: Thank you, Mr. Chairman. In 

 3 terms of the requirement for margining futures to 

 4 futures settlements and options to options 

 5 settlements, this is really necessary in terms of 

 6 valuing our collateral at the banks, the banks to 

 7 market every day, and when the market did what it 

 8 did, the banks -- not only did we lose confidence 

 9 in the market, but our banks certainly lost 

 10 confidence in the market and didn't understand 

 11 what was going on. And as you well know, the 

 12 banks are our life blood in this industry. 

 13 Thanks. 

 14 MR. LUKKEN: Jerry, did you have a 

 15 question on the end? 

 16 MR. MCREYNOLDS: Yes, I did. Thank you 

 17 for this briefing and this opportunity to share 

 18 some of our comments. 

 19 I'm a producer. Speculators are 

 20 extremely important in this market system, they're 

 21 important to each of us producers, but we all come 

 22 in with a little different -- from a little 

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 1 different background, a little different 

 2 perspective. 

 3 One of the concerns that we may need to 

 4 look at is to examine some of the index funds, the 

 5 position limits. There could be some tweaking 

 6 done that would I think help the situation, but we 

 7 want to keep in mind that speculators are 

 8 extremely important. We have to have a way to lay 

 9 off risk to someone that's willing to accept that 

 10 risk. Concerning the CRP ground, of course, that 

 11 gets my attention, because you don't want my CRP 

 12 ground to go into production, it needs to be in 

 13 graphs, so I'm not sure that's where we want to 

 14 go. 

 15 I think there's an opportunity here in 

 16 the way of crops, some genetic improvements that 

 17 can continually improve, they are continually 

 18 improving the production, and that's a direction 

 19 that we need to continue to develop. 

 20 It's extremely important that we allow 

 21 these markets to function with as many players in 

 22 a very controlled, but yet not overly regulated 

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 1 environment, because I'm very sensitive to those 

 2 excessive regulations, because as a producer, I 

 3 know we don't have a way to pass it on. Somehow 

 4 that risk gets kind of put down the line, and 

 5 we're at the bottom of the heap, and so we don't 

 6 have a way to pass that on. So I'm very sensitive 

 7 to excessive regulation that's going to cost 

 8 producers dollars. Thank you. 

 9 MR. LUKKEN: Thank you, Jerry. I'll ask 

 10 any of my colleagues on the dais whether they have 

 11 questions for the group before we -- 

 12 MR. CHILTON: Mr. Chairman, I have just 

 13 one quick one. I was interested, Mr. Coyle, in 

 14 your analysis of our charts, and I want to make 

 15 sure that we get this right. So I thought maybe 

 16 Mr. Kass could comment on your comments and we 

 17 could sort of figure out where we are here. 

 18 David, would you mind? 

 19 MR. KASS: Well, I think, and as many 

 20 have said, clearly, index trading is a very 

 21 substantial part of these markets now, not only 

 22 the ones we publish data for, but other ones, as 

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 1 well. I think I showed in that one graphic that 

 2 showed total number of open contracts for each and 

 3 their percentage. 

 4 We don't see a clear relationship 

 5 between the holdings, either in terms of absolute 

 6 number of contracts or percentage in some 

 7 relationship either to volatility or to, for 

 8 example, year over year price move, or even price 

 9 moves over small time frames. 

 10 But this is an area, clearly, that's 

 11 right for research. One of the motivating factors 

 12 for us to put out these data was to engender the 

 13 sort of research that might result from people now 

 14 having these data, and we put out a year's worth 

 15 of history, because we're still studying the 

 16 situation. It's new to everyone, and now at least 

 17 there's some data out there. In terms of 

 18 classifying traders, we do obviously have to 

 19 classify traders one way or another. You can't 

 20 split hairs day to day to day on which part of 

 21 which position is this. So we have to look at 

 22 where the preponderance of their trading. So 

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 1 there is some slippage in either direction, but 

 2 it's not just all in one direction that all the 

 3 slippage goes from non-commercial to commercial or 

 4 vice versa. There's clearly slippage. 

 5 They're better than anybody else has, 

 6 it's where we feel very confident in the data, we 

 7 spent a lot of time doing it, and we're reviewing 

 8 it constantly. Thank you. 

 9 MR. FENTON: I think -- just to follow 

 10 up on that. Tom, in answer to your question, I 

 11 think if a hedge fund is doing index trading, 

 12 they'll end up as an index trader in our 

 13 supplemental report. And I think we're confident 

 14 that we're getting that portion pretty close to 

 15 right, because they leave a pretty distinction 

 16 footprint in the type of position they have. 

 17 So I think they are being moved from, on 

 18 the traditional report, they're in the 

 19 non-commercial category, they're being moved into 

 20 the index trader category in the supplemental 

 21 report. For the other and the more -- the larger 

 22 portion of the index trading community, it's the 

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 1 swap dealers who are being moved -- on the 

 2 traditional report they're being shown as 

 3 commercials, they're being moved into the index 

 4 trader category. Now, the swap dealers may be 

 5 doing things other than index trading. One of the 

 6 reasons why we felt like we could publish accurate 

 7 data for ag markets is because, in the ag markets, 

 8 they weren't, and I think still aren't doing much 

 9 other than index trading. 

 10 They certainly -- we interviewed them a 

 11 year and a half ago when we were working on this 

 12 project, and they were -- pretty much their 

 13 futures position matched up with their index 

 14 trading book. The short side positions that 

 15 you've noted that have grown over the past year 

 16 and a half may be an indication that other things 

 17 besides index trading is coming into the market. 

 18 Now, you thought that it might represent 

 19 short side index trading, and that's possible, but 

 20 I think it's probably more likely that those are 

 21 outright swap positions that are being held in the 

 22 book of swap dealers. 

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 1 MR. LUKKEN: Tom, did you have a follow 

 2 up? 

 3 MR. COYLE: Well, yes; I would say, 

 4 first, I wouldn't want to give anyone the wrong 

 5 impression. We think the report is spectacular. 

 6 We just want -- I mean we use it. 

 7 And I was really quite intrigued when I 

 8 spent time over the weekend checking it out to see 

 9 what does it really tell me to make sure I wasn't 

 10 off base. And what I noticed was that there were 

 11 3,800 contracts in January of '06 that was shown 

 12 as the CIT short, and today it shows 31,600. I 

 13 thought that was a nice change to see. It gives 

 14 you some hope that the market is evolving. 

 15 Also, as I kept hearing comments about 

 16 the fact that the index funds really weren't 

 17 growing, I wanted to see, well, what is growing, 

 18 because the open interest is going up. 

 19 And as I looked at it, it showed that, 

 20 in the case of wheat, for instance, in the two 

 21 year period, the index length, net index position 

 22 is long, 16,000 more contracts, but the non- 

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 1 commercial, so either a hedge fund or a 

 2 speculative interest are up 33,000 contracts. 

 3 Now, that's offset by, I presume, our 

 4 members being short, because there 41,000 contract 

 5 increase in the short side. So it gave me a sense 

 6 of who was doing what. But, no, I think the 

 7 report is great. I just -- we're pretty 

 8 passionate on using it. 

 9 MR. LUKKEN: Anymore comments from the 

 10 dais, or questions? Under Secretary Keenum. 

 11 MR. KEENUM: Thank you, Mr. Chairman. I 

 12 want to follow up on a couple of points that were 

 13 made. 

 14 Mr. Weil mentioned, when he was making 

 15 his comments, talking about the index fund should 

 16 be restricted to speculative position limits, and 

 17 then we heard Mr. Dunavant, and also Mr. Woods, 

 18 to an extent, talk about how the cotton market is 

 19 broken, and we talked about the 84 cent run up to 

 20 $1.09 cents, and the synthetic options price. 

 21 Mr. Woods talked about the negative 

 22 effects this is having on interstate commerce and 

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 1 that we should consider speculative limits, it 

 2 should actually be reduced. Mr. Nicosia talked 

 3 about how the open interest of a hedger must be 

 4 considered. 

 5 I guess my question is, from a USDA 

 6 perspective, when we were looking at the 

 7 tremendous run up in prices that we saw occur from 

 8 mid February into early March, about a 25 percent 

 9 increase in cotton prices, and we really saw no 

 10 fundamental bullish news, at least from a USDA 

 11 perspective, as Doctor Bange described when he was 

 12 making his presentation. 

 13 In fact, during that time period, we saw 

 14 our export sales decline tremendously from 484,000 

 15 bales in the end of February to only 66,000 bales 

 16 by mid March. So we saw declining exports. And 

 17 then also, according to USDA, we estimated that 

 18 our ending stocks were going to raise from 8.2 

 19 million bales in February to 9.7 million bales, 

 20 the highest ending stocks for cotton in 40 years. 

 21 So during this time period, when we saw a very 

 22 sharp increase in prices, contrary to anything 

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 1 bullish in the market, it was very barish. And 

 2 you all made some very revealing comments, and I'm 

 3 just curious if anyone of you who were involved in 

 4 this -- would like to comment on what you're 

 5 seeing in the market and what we saw during that 

 6 time period. 

 7 MR. LUKKEN: Tom with ICE futures, I 

 8 don't know if you have comments about what ICE was 

 9 seeing at the time and describe some of the things 

 10 that you're trying to do in this area. 

 11 MR. FARLEY: Sure, thanks, Chairman 

 12 Lukken, thanks -- pardon me. Thanks, Chairman 

 13 Lukken, thanks, Commissioners Sommers, Dunn, and 

 14 Chilton, for having us today. Thanks also to the 

 15 members of our cotton contract committee who are 

 16 here today, who have worked very closely with us 

 17 over the last month or month and a half as we've 

 18 looked at this issue. 

 19 I just want to say, it's somewhat 

 20 intimidating to address your question directly and 

 21 talk about cotton fundamentals with four leaders, 

 22 global leaders of the cotton industry sitting 

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 1 about five feet from me here. We have taken a 

 2 look at cotton fundamentals and didn't find any 

 3 secret answer as to exactly why we saw the 

 4 activity on March 3rd and March 4th that Mr. 

 5 Dunavant described as out of whack, which is a 

 6 characterization with which I agree. We did, 

 7 however, take a look at our market overall and 

 8 look at the composition of index funds and look at 

 9 the composition of speculative traders and the 

 10 composition of the merchants over a short time 

 11 period, I'll call it a month, three months, six 

 12 months, even two years, and what we've seen is 

 13 that, on balance, the contribution of those 

 14 various asset classes has remained fairly 

 15 constant. 

 16 So, again, no answer really jumped out 

 17 at us. And so we're left as an exchange, looking 

 18 at some more global macro factors. And we went 

 19 and we looked at the volatility of markets, not 

 20 just the domestic ags markets, which are the 

 21 subject of this conversation today, but, in 

 22 general, specific assets or asset classes, whether 

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 1 it be oil or large cap stocks, small cap stocks, 

 2 the euro dollar, and what we found is that the 12 

 3 assets and asset classes we selected, ten had 

 4 higher historic, excuse me, ten had 60 percent 

 5 higher historic volatility on March 31st than they 

 6 did on September 30th. All 12 had much higher 

 7 volatility. So what jumped out at us was, wow, 

 8 there's a global volatility phenomenon that also 

 9 happens to be specific to our market, which is 

 10 cotton. And then second, we looked very specific 

 11 to cotton, at the cash markets, and we spoke to 

 12 some of the gentlemen who are around the table 

 13 today, and what we heard was that the cash market 

 14 effectively shut down. It wasn't just really a 

 15 basis differential, which is what Mr. Kass and Mr. 

 16 Fenton discussed, but it was really a shut down of 

 17 the cash market. 

 18 And then third, another global macro 

 19 factor was, as we all know, we're in the middle of 

 20 a liquidity crunch, and so what happened is, the 

 21 price of cotton was rising over a several month 

 22 period, over a several week period it was rising 

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 1 very, very quickly. 

 2 The lines of credit that many of these 

 3 cotton farmers and coops and merchant firms had in 

 4 place expired, and when they went to say, hey, 

 5 it's a very volatile environment in cotton 

 6 globally, the futures price is rising, we need to 

 7 get some additional capital to be able to make 

 8 these margin payments, the answer was, no, or the 

 9 answer was, give us time and let us research that 

 10 from the lending community. 

 11 So as an exchange, that's kind of our 

 12 view as to what drove some of the out of whack 

 13 fundamentals -- Mr. Dunavant characterized it as, 

 14 and I'll have some more comments later on about 

 15 margining in the third section. 

 16 MR. LUKKEN: I know Commissioner Dunn 

 17 has a comment. 

 18 MR. DUNN: Well, just a comment on Mr. 

 19 Lehman's comment about the weak dollar. 

 20 I was at a meeting a couple of weeks 

 21 back with the Farm Bureau, and Jeff Hanniman from 

 22 Advanced Trading was there and presented a chart 

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 1 to us, in which he compared the U.S. dollar to a 

 2 basket of foreign currencies, and he said the 

 3 dollar is about 68 percent of its 2002 level, and 

 4 he translated that into corn, saying $6 corn then 

 5 to the foreign currency would be $4.08, and for 

 6 $12 beans, would be $8.16. 

 7 So that is, to me, explains a lot of the 

 8 volatility there, even with the demand. As that 

 9 dollar gets stronger, I expect to see some 

 10 movement in that direction. Let me ask a specific 

 11 question on the cotton, because that's the one I 

 12 am having the most difficulty understanding what 

 13 went on there. And I've heard this explained, 

 14 it's like being in a card game, where you've got 

 15 $100, and the other guy has $100,000, when he goes 

 16 all in, you're in a lot of trouble. And this is 

 17 what I've heard, that it got to the point where 

 18 those folks that had the shorts had to begin 

 19 selling just to make margin calls. Is that what 

 20 happened out there; 

 21 And did it become a self-generating 

 22 thing? 

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 1 MR. NICOSIA: I think -- 

 2 MR. LUKKEN: Behind you. 

 3 MR. NICOSIA: Thank you. In response to 

 4 that, about what happened in the cotton market, a 

 5 couple of things. 

 6 I found it interesting in the discussion 

 7 we just had a minute ago about the percentage of 

 8 open interest that was showing that the index 

 9 funds are relatively on a slow increase, but that 

 10 somewhat self-perpetuates itself. As they get 

 11 bigger, open interest increased. Try looking at a 

 12 percentage of open interest as a percentage of the 

 13 crop and you'll get a very different view of what 

 14 it is that's taking place. 

 15 Mr. Fenton mentioned that the open 

 16 interest was 200,000 contracts of spec longs going 

 17 into that week, which is roughly -- it doesn't 

 18 take a rocket scientist to do the -- it's larger 

 19 than the entire United States crop. I think 

 20 there's a word for that, when someone buys more 

 21 than everything that exists, and that's what 

 22 happened in our market place. So, yes, you can 

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 1 call it a poker game, but fundamentally what took 

 2 place is, there was a systematic approach to push 

 3 prices higher. At night sessions, you saw a 

 4 larger volume than ever existed, you saw larger 

 5 price moves while the industry slept, so that you 

 6 came in the market with extreme pressure. 

 7 As the pressure rose for more margin, 

 8 you saw that continuously happen, and you saw it 

 9 on an accelerated level. 

 10 The problem is that the tools to look at 

 11 what went wrong and who did it, you don't even 

 12 have, and you don't ask for them, and you don't 

 13 look at them, because so much is taking place off 

 14 the exchange that you're not able to look at it. 

 15 So as we try to even reconstruct to say 

 16 certain entities had multiple times their spec 

 17 limits and continue to push, you don't even have 

 18 the idea to look at it, because you don't even 

 19 require it. 

 20 Yet as a real hedger, as the hedger in 

 21 the cash business, you require us to give you 

 22 massive amounts of information, what are our cash 

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 1 sales, we report them all the time, how many bales 

 2 do you have, what are your limits to do that, and 

 3 yet you give freedom to all these other people 

 4 with no requirements to you. You should at least 

 5 ask for all those people to put forth their swap 

 6 and/or cash activity so that you can see if 

 7 there's any offset, if there is any reasonable 

 8 reason they have those size of positions, and they 

 9 don't have to do that. So what took place was 

 10 exactly that. 

 11 Mr. Fenton mentioned that, on the day of 

 12 the huge spike, where we went up, you know, prices 

 13 moved ten limits in 90 minutes, that the trade was 

 14 a buyer on March 3rd and 4th, which was absolutely 

 15 true because they had been run out of the market 

 16 place. They weren't systematically buying on the 

 17 way up, they were forced out at the top. 

 18 Witness what happened three to four days 

 19 later, the prices ended below where all of this 

 20 started. And so, obviously, something was broken 

 21 in what happened, and the shame of it is that we 

 22 don't even -- you can't even construct it because 

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 1 you don't even have the information to look at it 

 2 to see how it took place. 

 3 MR. DUNN: It reminds me of some of the 

 4 testimony we heard during the various energy 

 5 hearings. Let me end here by asking the two 

 6 Presidents of the General Purpose Farm 

 7 organizations, Bob Stallman and Tom Buis, what 

 8 your members are telling you, because we saw on 

 9 the charts that there is a lot of folks, more than 

 10 usual, in open interest positions, but how does 

 11 that translate to the farmer and rancher out 

 12 there? 

 13 MR. STALLMAN: Bob Stallman, American 

 14 Farm Bureau Federation -- it gets back to using 

 15 the futures market as a risk management tool, as 

 16 having the price discovery and using it as a risk 

 17 management tool. And what is happening as we've 

 18 diverged from a market that was fundamentally 

 19 based on supply and demand fundamentals over the 

 20 years, and now being used as an investment 

 21 vehicle, that the dynamics of that market have 

 22 changed to the point that the tool is 

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 1 fundamentally no longer there for the average 

 2 producer. 

 3 You know, producers still haven't had as 

 4 much direct involvement in the market as many of 

 5 us in agricultural have said they needed to in 

 6 terms of direct involvement in the futures market 

 7 for risk management, you know, they've done it 

 8 through their elevators, they've, you know, done 

 9 it through other mechanisms with those parties 

 10 relying on the futures market. 

 11 And as, you know, pricing has been 

 12 removed as an option basically for producers 

 13 because of what's happening with the volatility in 

 14 the futures market, they find themselves trying to 

 15 struggle to deal with price risk management at the 

 16 same time that their input costs are, you know, 

 17 rising rather rapidly. And all that is creating a 

 18 problem in terms of the utility of the futures 

 19 market as a mechanism for price risk management. 

 20 MR. LUKKEN: I know Lee has a question, 

 21 but then I'm going to get to -- 

 22 MR. DUNN: Let Tom Buis -- 

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 1 MR. LUKKEN: Oh, I'm sorry, Tom. 

 2 MR. BUIS: That's okay. Thank you for 

 3 the opportunity and, Commissioner Dunn, for the 

 4 question. We started raising these concerns in 

 5 March, after hearing from a number of producers 

 6 who have been shut out of being able to forward 

 7 contract their grain by local elevators and coops 

 8 because they were exceeding their credit limits to 

 9 meet the margin calls. 

 10 And I think, as Mr. Stallman just 

 11 mentioned, this is really critical, because we all 

 12 know that gravity works in markets, and what goes 

 13 up can come down and come down with a thud. And 

 14 if a farmer cannot forward price these commodities 

 15 at higher prices, they're at greater risk today 

 16 than they've ever been. 

 17 As input costs have tripled over the 

 18 past two years, they've got more money invested, 

 19 they have a safety net and a farm bill that's the 

 20 lowest percentage it's been since the mid '90's, 

 21 and if they can't market that crop at these high 

 22 commodity prices, we've got a train wreck coming 

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 1 that's going to be greater than any we've ever 

 2 seen in agriculture. For those who say that 

 3 everything is working right, I'm sorry, maybe I'm 

 4 wasting my time here, but there's problems out 

 5 there, and I think it is incumbent upon us all to 

 6 address these problems sooner rather than later. 

 7 MR. LUKKEN: We're going to break here 

 8 shortly, but I wanted to give Lee Strom an 

 9 opportunity, and Diana, and then Doug, who's been 

 10 waiting patiently, too. We're going to take a 

 11 short break and let everybody get some coffee and 

 12 use the restrooms, and then we'll come back and do 

 13 our presentations on convergence. But these are 

 14 all related subjects, so don't -- hold your 

 15 questions, we'll get to them in the second panel, 

 16 as well. But with that, I'll turn it over to Lee. 

 17 MR. STROM: Thank you, Mr. Chairman. I 

 18 just had a quick question. I mean there's been 

 19 some reference already at this point to the credit 

 20 and lending industry. I know we're planning this 

 21 afternoon to get into this more thoroughly, but I 

 22 had a question of Mr. Farley. 

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 1 You referenced the cotton exchange and 

 2 the very volatile time, you said when I think -- 

 3 your constituents that were using the market place 

 4 went to their lenders, and there was an answer of 

 5 no or we'll get back to you. Did producers, do you 

 6 know, did producers, were they forced from the 

 7 market, from existing hedges, because they -- of 

 8 their margin issues? 

 9 MR. FARLEY: It is my understanding, 

 10 yes, the answer to that question is yes. However, 

 11 I think that Woods might be a more appropriate 

 12 person to answer that, because that's Woods' 

 13 constituency, is the producer community. 

 14 MR. EASTLAND: Since we are -- we're 

 15 hedging for producers because they are a marketing 

 16 coop, in our case the answer was yes. 

 17 MR. LUKKEN: Diana? 

 18 MS. KLEMME: Diana Klemme; I'd like to 

 19 step back for just a moment and look at the bigger 

 20 picture, if I could. 

 21 The new issue of the economist magazine 

 22 has, on the cover, about the tsunami, the global 

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 1 food crisis, which is what we're in. 

 2 Whether you look at it from the fact of 

 3 souring food prices, rice at $1,000 a ton, which 

 4 unless my math is off, that's somewhere around $45 

 5 a 100 weight, which we're not even close to that 

 6 in the futures price, and we have declining, 

 7 plummeting global stock, so we need more 

 8 production, we need more acres, farmers need to 

 9 benefit from these higher prices, investment 

 10 capital is going to flow into the market one way 

 11 or another, and I don't mean to -- I'm not 

 12 speaking for Calpers or PIMCO, but I'm guessing if 

 13 you want commodity exposure, you'll find it. 

 14 Maybe you'll find it in London, maybe you'll find 

 15 it somewhere else in Europe, maybe in Asia, but 

 16 you'll find it. And we don't want to see a market 

 17 that we're so hand strung because of liquidity and 

 18 financing issues that the farmers can't benefit 

 19 from the higher prices because it's going into 

 20 other markets out there. 

 21 Your land costs are up, your input costs 

 22 have soared. We need high prices right now. And 

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 1 I don't know that that's $15 beans or $8 beans, 

 2 I'm not going to say what that is, but we need 

 3 prices that will generate the acres here and 

 4 abroad to address the global food crisis, the 

 5 problems we see everywhere out here, and I think 

 6 if we distill everything out to just one issue, it 

 7 has to do with the ability to finance these 

 8 markets. 

 9 There would be new crop bids, there 

 10 would be 2009 crop bids a plenty in about every 

 11 commodity we can think of if the elevators, grain 

 12 companies, and everyone else up and down the chain 

 13 could feel confident that they could meet the 

 14 margin costs. Basis would widen because of 

 15 increased risk, especially on forward crops, but 

 16 they would be there, up to a risk comfort level. 

 17 But if you don't have the financing, credit lines, 

 18 or you're afraid the credit line won't be there, 

 19 they don't dare go down that road, and then the 

 20 bids disappear, the farmer is in disadvantage 

 21 because your input costs and land costs go up, and 

 22 you can't market the cash grain, which was just 

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 1 addressed. 

 2 Maybe it's a little bit less than 

 3 cotton, I'm not an expert in cotton, I can't speak 

 4 to that one at all, but I think we're about two 

 5 rainy weeks away from a potential crisis right 

 6 here in this country in corn if we can't get the 

 7 corn acres in. 

 8 People are scared to death to hedge 

 9 right now, to short hedge, because they have no 

 10 idea where we could be in two weeks, four weeks. 

 11 Maybe God will be burstful on us and we'll have 

 12 perfect weather from here out. But as a risk 

 13 manager, I can't advise my clients to bet on that. 

 14 MR. LUKKEN: Do you have solutions? I 

 15 mean financing is clearly outside of -- financing 

 16 is clearly outside the CFTC's purview, but we do 

 17 have the USDA, which has some financing elements, 

 18 we have bank regulators in the room, and bankers; 

 19 are there thoughts on what might help the 

 20 situation? 

 21 MS. KLEMME: Commissioner, you're 

 22 absolutely right. You know, the CFTC does not 

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 1 have a solution, and they wouldn't, and my letter 

 2 to you hit on that is, right here at this table, 

 3 and in this room, we have some of the best 

 4 resources that we could bring to bear. It's the 

 5 money sector, it's the exchanges, it's the 

 6 producer groups all together, we can't put that 

 7 burden on CFTC to solve an issue. 

 8 But I do ultimately think, at least in 

 9 the short term, convergence is an important issue, 

 10 basis levels, forward contracting tools, but the 

 11 root of it all right now is liquidity, the ability 

 12 to finance these kinds of new markets that we're 

 13 in, and I don't think they're going to go away in 

 14 the short term. 

 15 So somehow if the financial resources 

 16 are out there, or at the very least, if we know 

 17 what the limits of those financial resources are, 

 18 then perhaps we can make some different decisions, 

 19 or hopefully better decisions out there. 

 20 MR. LUKKEN: We're going to end with 

 21 Doug Hepworth, I think he's our last question 

 22 before we break. But, Doug, I'm curious, too, 

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 1 there's talk of limiting exposure to index traders 

 2 in our markets; where would that go? I think 

 3 there's thoughts we're limiting demand, but where 

 4 would that go potentially if you were limited in 

 5 your ability to give it exposure in the commodity 

 6 markets? 

 7 MR. HEPWORTH: Thank you, Chairman. 

 8 Well, actually, I'll make a couple points and then 

 9 come to yours, if I can. The first is that we run 

 10 fully collateralized portfolios that are subject 

 11 to position limits, so we get a dog in this fight. 

 12 And we're never in spot months. I think our 

 13 compatriots are never in spot months, as well. 

 14 And I have never yet understood the mechanism, how 

 15 people who are out of a market a month before 

 16 trading ends could be impacting a convergence. 

 17 There was a comment that now we've seen 

 18 this world where the commercials make up a 

 19 preponderance of the short open interest, I think 

 20 that describes the futures markets since their 

 21 dawn. 

 22 And also, I want to point out, just in 

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 1 terms of the -- reiterate, just in terms of the 

 2 food inflationary component, that the biggest move 

 3 in grains was in rice, which is not a liquid 

 4 future, and it's not in any passive strategy. 

 5 The biggest movement in protein was 

 6 eggs, which also, not a liquid future and not in 

 7 any index strategy. In fact, when I listened to 

 8 the discussions around this table, the one thing 

 9 that's clear to me is that even people who are 

 10 saying that position limits shouldn't be raised 

 11 should be arguing that speculative position limits 

 12 should be raised, because, in fact, what that will 

 13 do is no longer force investment dollars into the 

 14 unregulated swaps world and keep them in the well 

 15 regulated CFTC futures world, I think that's a 

 16 positive. 

 17 I do not think anybody in this room 

 18 would like to see all of the long investment 

 19 interest suddenly force to dump $40 billion worth 

 20 of agricultural futures onto the market, I do not 

 21 think that's in anybody's interest. 

 22 What would happen is, there probably 

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 1 would be a dislocation, and ultimately the 

 2 solution would probably involve non-U.S. exchanges 

 3 that would have contracts that would be 

 4 benchmarked to U.S. agricultural products. We're 

 5 a very significant player in the agricultural 

 6 world. 

 7 But I do not think it's in anybody in 

 8 this room's interest to have these markets become 

 9 less regulated either by trying to end this long 

 10 investment or by allowing it to move even more so 

 11 into the non-regulated space. 

 12 MR. LUKKEN: Thank you. We're going to 

 13 take a short break here of about 10 minutes, if we 

 14 can, and meet back here, and we'll take up our 

 15 University of Illinois study. Thank you. 

 16 (Recess) 

 17 MR. LUKKEN: Thank you. While everybody 

 18 is grabbing their seats, we're going to turn to 

 19 our presenters. 

 20 I know there's a coin flip. Are you 

 21 going first, Jeff, or -- okay. Jeff Harris, the 

 22 CFTC's Chief Economist, will give first on some of 

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 1 their analysis on convergence, and then we'll turn 

 2 it over to the University of Illinois, where I 

 3 know they've done a lot of good work. Eugene 

 4 Kunda has done a lot of good work in this area, as 

 5 well, so we welcome your presentations, and we'll 

 6 turn it over to you. Thank you so much. 

 7 MR. HARRIS: Thank you, Mr. Chairman. I 

 8 am Jeff Harris, the Chief Economist here at the 

 9 CFTC. I'm here with Doctor Kunda from the 

 10 University of Illinois to discuss and focus more 

 11 closely on issues related to hedging and 

 12 agriculture of future markets. 

 13 The Office of the Chief Economist, of 

 14 course, works closely with our colleagues in the 

 15 Division of Market Oversight, who just presented 

 16 this morning, and we provide analysis and advice 

 17 to managers to the oversight of these markets. 

 18 And we have seen from John Fenton and Dave Kass' 

 19 presentation this morning, the CFTC is actually 

 20 keeping close contact with agricultural futures 

 21 markets on a daily basis during these 

 22 unprecedented times. My role here today is 

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 1 basically to introduce the topic of convergence in 

 2 futures markets. Along the way I will focus a 

 3 short discussion on the convergence between spot 

 4 in futures prices and how forward contracting in 

 5 agricultural markets allows this. 

 6 Although I could surely talk for at 

 7 length on each one of these subjects, I will keep 

 8 us closer to schedule, not quite on schedule 

 9 perhaps, by relating the futures convergence to 

 10 price discovery in these markets. 

 11 While functioning markets serve that 

 12 price discovery role, and because futures markets 

 13 are publicly available, private agents can make 

 14 decisions by observing futures prices in our 

 15 markets, incorporating any information in the 

 16 insights from a great number of experts who trade 

 17 in these futures markets. 

 18 The textbook example of this convergence 

 19 perhaps is the farmer who makes his or her 

 20 planting decisions at the beginning of each crop 

 21 year. In those instances, the price signal that's 

 22 conveyed from futures markets is useful in 

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 1 allotting the acreage to that crop, and we've seen 

 2 some of that information on planned and responsive 

 3 to acreage planning this morning. Similarly, 

 4 cooperatives can use these price signals to 

 5 committing purchases from producers, or from the 

 6 produce of their members. Such forward 

 7 contracting alleviates the price risk, of course, 

 8 that individual farmers would otherwise bear. 

 9 Likewise, futures markets enable dealers 

 10 to offer swap contracts for risk management needs 

 11 of large scale commercial operations. Each one of 

 12 these very valuable services depends on an 

 13 efficient price discovery in our markets. 

 14 Convergence between spot in futures 

 15 markets is an issue, because many believe the lack 

 16 of convergence is symptomatic of a poorly 

 17 functioning market. A quote from one of the many 

 18 members or letters that the Commission has 

 19 received on this topic, this comes from Advanced 

 20 Training in Bloomington, Illinois, which stated, 

 21 "The less that futures serve as an accurate proxy 

 22 for cash, the greater risk for elevators and 

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 1 others involved in the grain business." 

 2 I agree that incomplete convergence of 

 3 the futures and cash markets as expiration 

 4 approaches can indicate a poorly functioning 

 5 market. But an apparent lack of convergence can 

 6 also indicate other issues, as well. After all, 

 7 convergence is really a matter of the law of one 

 8 price. 

 9 That is to say for identical items at 

 10 the same place, at the same time, the price must 

 11 agree with each other. That law is fully 

 12 operative in our futures markets, and, in fact, at 

 13 the moment of contract expiration. The contract 

 14 delivered according to a futures -- the commodity 

 15 delivered according to a futures contract can 

 16 commend no more or no less than the current spot 

 17 price at expiration. 

 18 Prior to expiration, however, 

 19 convergence is a matter of four variables and 

 20 actually one activity. The four variables are the 

 21 spot market of the commodity at that instant, the 

 22 cost of storage of that commodity at that instant, 

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 1 the value of having immediate access to that 

 2 commodity perhaps, and the cost of delivering the 

 3 commodity according to the contract 

 4 specifications. 

 5 The activity involved is actually 

 6 arbitrage. All of these are crucial to obtaining 

 7 convergence in these markets. I'll admit the 

 8 discussion perhaps of immediate access to the 

 9 commodities, because most of our letters to the 

 10 Commission actually indicate that convergence on 

 11 the positive side is really not a problem. But 

 12 the DMO charts that we actually saw this morning 

 13 do highlight that there is a positive basis at 

 14 many of our Gulf Coast delivery points. So 

 15 locations -- highlighting sort of the fact that 

 16 location is important when we look at -- discuss 

 17 the issues of convergence. High storage costs 

 18 such as that can be expected when the storage 

 19 facilities are scarce actually widen the cost, or 

 20 the gap between futures and cash prices, as well. 

 21 Likewise, what we saw this morning, the high cost 

 22 of delivery can create an apparent convergence 

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 1 issue. And I say apparent because delivery in the 

 2 contract incurs the cost both of storaging the 

 3 commodity and delivering it to the future delivery 

 4 point. 

 5 As noted by my colleagues, Dave and 

 6 John, this morning, diesel costs and Illinois 

 7 freight costs are at historical highs for this 

 8 time of the year, in fact, greatly exceeding what 

 9 the historical prices have been in these markets. 

 10 The futures prices, because they reflect 

 11 these costs, will appear to converge less strongly 

 12 as a result if these costs remain high. Despite 

 13 that, appearance to -- still does apply. The all 

 14 end cost of the futures contracts should converge 

 15 to the cash price at expiration. And I emphasis 

 16 storage and deliver costs because our reports 

 17 indicate that both of these costs may be 

 18 contributing to the weaker convergence in these 

 19 markets. Lastly, but also crucial to the 

 20 convergence, is arbitrage activity. Arbitrage 

 21 consists of examining the four variables I 

 22 mentioned for the profit potential. If the 

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 1 futures price lags above the spot price, then 

 2 shorting the futures contract and delivering on 

 3 that contract is an arbitrage activity that would 

 4 alleviate the differential in the spread and the 

 5 basis. 

 6 I have a -- if we could put up my figure 

 7 here, just demonstrating an example from the 

 8 soybean market -- just similar to what we had seen 

 9 this morning, this is a soybean basis plotted over 

 10 time for the most recent -- I guess last year's 

 11 2007 contracts, and point out that the basis, as 

 12 you see, is not converging to zero in the soybean 

 13 market last year. 

 14 And I just point out the differential 

 15 there, if there is a cost to actually storing and 

 16 transporting the beans from the point of the cash 

 17 market to the future deliver point, that could 

 18 reflect the costs of arbitrage or the arbitrage 

 19 activity in the markets, people that recognize 

 20 that this is an apparent mispricing. 

 21 The negative basis results for the 

 22 futures prices that exceed spot prices in this 

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 1 particular market, and if this represents true 

 2 mispricing, arbitragers would short the futures, 

 3 like I said, and deliver by buying in the spot 

 4 market and deliver that product. Any costs of 

 5 buying the spot market deliver against the futures 

 6 position, however, will impede the arbitrage in 

 7 this market, and may result in a relatively weak 

 8 basis. Increases of freight and storage costs, 

 9 like I mentioned, and those that are at historic 

 10 highs, like we've seen this morning, exacerbate 

 11 the situation. 

 12 Of course, the prospects that arbitrage 

 13 is impeded by some other factor is a concern to 

 14 our market participants and to the CFTC in 

 15 general. And the CFTC has been closely monitoring 

 16 new entrance into these commodity markets, like 

 17 index traders, hedge funds, and other managed 

 18 money traders in the agricultural markets. 

 19 As highlighted by our presentations 

 20 earlier today from the CFTC participants, the 2007 

 21 and '08 price increases in ag commodities have 

 22 occurred largely under relatively stable 

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 1 participation by managed money traders, and we've 

 2 had a number of opinions on that subject this 

 3 morning. 

 4 As noted earlier, we do witness an 

 5 increase in net long positions by index traders. 

 6 This index trading entries has only marginally 

 7 occurred over the last few months. And since 

 8 overall open interest has been growing 

 9 concurrently, their market share has remained 

 10 relatively stable. Profit opportunities, of 

 11 course, result from the buy and sell pressures in 

 12 our markets that bring about convergence. 

 13 Increased cost of executing arbitrage trades 

 14 inhibit arbitrage activities. Absent evidence 

 15 that any particular traders might artificially or 

 16 intentionally impede arbitrage in agricultural 

 17 markets, the Office of the Chief Economist would 

 18 simply caution against policy decisions that might 

 19 further sort of exacerbate or raise the cost of 

 20 conducting that arbitrage. 

 21 Such policies could have negative 

 22 consequences for convergence. And among the more 

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 1 crucial policy choices are regulations to raise 

 2 trading costs are those that may limit the extent 

 3 of arbitrage that could be conducted. And since 

 4 we have an expert here who studied this 

 5 convergence for the last couple of years, I will 

 6 turn it over to my colleague from Illinois, Doctor 

 7 Kunda. 

 8 DOCTOR KUNDA: Thank you, Jeff. Mr. 

 9 Chairman, my name is Eugene Kunda and I am here 

 10 today to provide a statement based on research 

 11 conducted at the University of Illinois regarding 

 12 the recent convergence behavior of CBOT, the CME 

 13 Group, corn, soybean, and wheat futures contracts. 

 14 In this testimony, we focus on the nature and 

 15 consequences of recent convergence problems. We 

 16 also briefly comment on proposals for changing the 

 17 contracts to address the problems that have 

 18 surfaced recently. Please note that a 

 19 comprehensive set of charts related to convergence 

 20 performance is provided in the appendix, but in 

 21 the interest of brevity, we'll only refer to a few 

 22 of the charts in the statement today. 

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 1 To begin, it is important to note a few 

 2 basic points about the delivery process. It is 

 3 the essential component of futures contracts with 

 4 physical delivery, as it ties the futures price to 

 5 the cash price at different locations. 

 6 In a perfect market, with costless 

 7 delivery, at one location and on one date, 

 8 arbitrage should force the futures prices at 

 9 expiration to equal the cash price. Otherwise, a 

 10 violation of the law of one price that Jeff 

 11 mentioned would exist. 

 12 In reality, delivery on futures 

 13 contracts is not costless and is complicated by 

 14 the existence of grade, location, and timing of 

 15 delivery options that have demonstrated value to 

 16 sellers of the contracts. So a more realistic 

 17 approach is to think of a zone of convergence 

 18 between cash and futures prices during delivery 

 19 periods with the bounds of convergence determined 

 20 by the cost of participating in the delivery 

 21 process. The following charts show the difference 

 22 between cash and futures prices, the basis, on the 

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 1 first and last day of the delivery period for corn 

 2 and wheat futures contracts expiring between 

 3 December, '01 and March, '08, and for soybeans 

 4 contracts expiring between November, '01 and 

 5 March, '08. 

 6 Note that with a negative basis means 

 7 that the cash price is less than the futures 

 8 price, and the positive basis means that the cash 

 9 price is more than the futures price. 

 10 For these calculations, grade and 

 11 location adjustments are made to cash prices where 

 12 they're appropriate. The convergence patterns in 

 13 the presented location are representative of the 

 14 convergence patterns at the other locations. 

 15 For each of the three commodities, 

 16 convergence generally is within reasonable bounds 

 17 through 2005, ignoring the problems created by 

 18 Hurricane Katrina in September, 2005 expiration. 

 19 The convergence weakness first surfaced in July, 

 20 2006, in the wheat contract. Non-convergence was 

 21 extremely large by historic standards, reaching a 

 22 low in September, 2006, when the Toledo cash price 

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 1 ended up 90 cents below futures on the last day of 

 2 the delivery period. This weakness in wheat 

 3 persisted through the July, '07 contract. 

 4 Convergence was relatively good for the September, 

 5 '07, the December, '07, and March, '08 contracts 

 6 at Toledo and at Chicago in December, '07, but was 

 7 poor in March, '08 at Chicago. Convergence in 

 8 soybeans was poor beginning with the March, '07 

 9 contract, especially for -- in the September, '07 

 10 contract, improved to almost acceptable in 

 11 November, '07, but returned to a very poor 

 12 performance in January and March, '08. 

 13 In general, convergence performance 

 14 since July, '06 was much better for corn than for 

 15 wheat or soybeans. Convergence performance was 

 16 weakest for corn in September, '07 and March, '08. 

 17 While the recent convergence failures 

 18 are dramatic, in isolation, each episode is not 

 19 necessarily damaging to the overall economic 

 20 functioning of markets. Real economic damage is 

 21 associated with increased uncertainty in basis 

 22 behavior, as markets bounce unpredictably between 

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 1 converging and not converging. 

 2 And as first noted by Holbrook working 

 3 many years ago, this is damaging because basis in 

 4 storable commodity futures markets should provide 

 5 a rational storage signal to commodity inventory 

 6 holders. A wheat basis should be a signal to 

 7 store, and vice versa. However, this depends on 

 8 the predictability of the subsequent change in 

 9 basis over the time, thereby earning the carry for 

 10 someone holding stocks of the commodity and 

 11 simultaneously selling the futures. The 

 12 reliability of basis signals can be quantified by 

 13 measuring the level of basis at some point before 

 14 the delivery period and comparing this initial 

 15 basis to the change in basis from that point 

 16 forward through the delivery period. 

 17 Perfect delivery location predictability 

 18 is illustrated in the chart. Note that when 

 19 delivery location basis is perfectly predictable, 

 20 the relationship between the initial basis and the 

 21 change in basis has a slope of negative one and 

 22 runs through the origin. 

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 1 In other words, if the basis is 50 cents 

 2 per bushel two months before expiration, the 

 3 change in the basis over the subsequent two months 

 4 should be a positive 50 cents per bushel as it 

 5 raises to convergence. 

 6 Additionally, all points lie directly on 

 7 the line, which indicates that the hedges over the 

 8 interval are perfectly effective in eliminating 

 9 price risk. The next three charts will show the 

 10 predictability of delivery location basis for 

 11 CBOT, corn, soybeans, and wheat, before and after 

 12 2006. Each horizontal access in the chart 

 13 measures the level of the delivery location basis 

 14 on the day after the preceding contract expires. 

 15 The vertical access measures the change in the 

 16 delivery location basis from the day after the 

 17 preceding contract expires on the first day of 

 18 delivery. 

 19 Note that all the observations for all 

 20 delivery locations and expiration months for a 

 21 given commodity are pulled together in the 

 22 analysis. And the observance of new crop, 

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 1 December and November contracts for corn and 

 2 beans, start on the first trading day of October, 

 3 so as not to be influenced by the transition 

 4 months of September. 

 5 The chart before you is the 

 6 predictability of the CBOT contract and the basis 

 7 for corn. The charts indicate a sharp decline in 

 8 basis predictability for all three markets since 

 9 2006. In corn, the upper right regression line 

 10 indicates the futures market, performs reasonably 

 11 well in terms of basis predictability before 2006, 

 12 as the slope and the intercept are near the 

 13 negative one values and zero. 

 14 And the hedging effectiveness is 

 15 measured by the R square is a respectable.87. The 

 16 lower left regression line shows the precipitous 

 17 drop in basis predictability over the last two 

 18 years in corn. While the decline in the slope is 

 19 not large, the intercept increases considerably, 

 20 and the hedging effectiveness drops to 37 percent. 

 21 Basis predictability results for soybeans are even 

 22 more dramatic. The lower left equation line 

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 1 indicates delivery location basis since 2006 

 2 changes are far less than the initial basis, as 

 3 indicated by the slope of a negative.36, and the 

 4 hedging effectiveness drops to only 19 percent. 

 5 The results for wheat are different from 

 6 corn and beans in that the basis predictability 

 7 was unimpressive before 2006. Nonetheless, the 

 8 predictability since 2006 has followed the pattern 

 9 of corn and soybeans and deteriorated 

 10 substantially relative to the earlier period. 

 11 The bottom line from the predictability 

 12 analysis is that location basis in corn, soybeans, 

 13 and wheat generally is weaker and far less 

 14 predictable post 2006 compared to pre 2006. This 

 15 has far reaching implications for hedging use of 

 16 these futures markets if the situation is not 

 17 corrected. 

 18 An obviously important question is what 

 19 caused the convergence problems observed over the 

 20 past couple of years. 

 21 A relevant observation in this regard is 

 22 that the nature of convergence problems was 

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 1 inconsistent through time and across markets. For 

 2 example, convergence in wheat was weakest during 

 3 2006, but recovered somewhat in late 2007 and 

 4 early 2008, while the convergence in soybeans was 

 5 weakest in the second half of 2007 and early 2008. 

 6 So this makes it difficult to identify a single 

 7 cause and difficult to accept a one solution 

 8 remedy. 

 9 Solutions to convergence issues 

 10 suggested to date have tended to be one 

 11 dimensional and focus on, one, encouraging longs 

 12 to liquidate before first notice date by changing 

 13 delivery rules to force takers to load out, this 

 14 sometimes is called the demand certificate, or by 

 15 increasing the maximum storage charges to make 

 16 owning delivery instruments less attractive, the 

 17 assumption being that forcing the longs out before 

 18 delivery would drive down the nearby contract and 

 19 improve convergence. 

 20 A second proposed solution is to change 

 21 the terms of the futures contract to a cash index 

 22 rather than the certificate market that currently 

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 1 exists, thereby forcing convergence to a cash 

 2 index by definition. 

 3 Thirdly, to manage the influence of 

 4 passive longs and perhaps other groups by limiting 

 5 hedge exemptions, thereby forcing these groups to 

 6 trade with spec margins and spec limits. This 

 7 solution follows from the assumption that these 

 8 traders are artificially and permanently forcing 

 9 futures prices above the fundamental value of the 

 10 commodities in the cash market. Fourth and lastly 

 11 here is the proposal to expand delivery capacity 

 12 in order to accommodate more arbitrage of cash and 

 13 futures prices during the delivery period and 

 14 thereby force convergence. 

 15 Without a consensus to the cause or 

 16 causes for poor convergence performance, it may 

 17 not be advisable to make substantial changes in 

 18 contract specifications at the present time. The 

 19 unintended consequences could be worse than the 

 20 poorly designed remedy, particularly if market 

 21 conditions change in the near future. 

 22 The tweaking of some of the contract 

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 1 specifications like storage rates and delivery 

 2 capacity and monitoring performance make sense, 

 3 but may not be palatable to market participants 

 4 who would like an immediate fix. 

 5 As a final point, it is important to 

 6 note that convergence problems at delivery 

 7 locations are not necessarily identical to 

 8 non-delivery basis performance issues. Basis in 

 9 some non-delivery markets may be influenced by 

 10 lack of convergence, but it is not uniformly the 

 11 case. Corn basis at interior processing markets, 

 12 for example, is less influenced by the Illinois 

 13 River basis than corn markets tributary to the 

 14 river. Basis at non-delivery locations is 

 15 influenced by transportations costs, storage and 

 16 ownership costs, the supply of and demand for 

 17 storage in the local market, and the merchandising 

 18 risk or the margin risk that's been alluded to, as 

 19 well. All of these factors have likely 

 20 contributed to the weaker basis at many of the 

 21 non-delivery markets. Thank you for considering 

 22 this statement, Mr. Chairman. 

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 1 MR. LUKKEN: Thank you very much. I'd 

 2 now like to turn it over to Tom Coyle to kick off 

 3 the discussion on convergence. I know he's done a 

 4 lot of thinking in this area. I would note, one 

 5 of our atrium participants, Michael Brown, has 

 6 asked about this idea of cash settlement of 

 7 contracts, so as you go through this, if you 

 8 wouldn't mind addressing some of these ideas that 

 9 were brought up in Professor Kunda's presentation. 

 10 Thank you. 

 11 MR. COYLE: Thank you, Chairman Lukken, 

 12 and I'll be happy to touch those. What I'll do is 

 13 go through each of the key questions for the 

 14 segment of the discussion. Have had a lot of data 

 15 presented earlier, and charts, in the current 

 16 presentations. 

 17 I'm going to walk through this a bit 

 18 more like a commercial operator. I represent the 

 19 National Grain and Feed, but I manage a business 

 20 that's entire role is delivery convergence, it's 

 21 all we do, 24/7, every day of the week. It's in 

 22 Chicago, so it should be.0, so we have some 

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 1 perspective. First, what is convergence? We've 

 2 heard a couple of comments. From our perspective, 

 3 convergence is at point when cash equals futures. 

 4 Essentially, if you want a perfect convergence, 

 5 you would get to a point in time where there would 

 6 be no incentive for the maker to make delivery or 

 7 for the taker to take delivery. 

 8 Someone suggested that we should have 

 9 convergence every day. But the fact is, we have a 

 10 system that allows us to do that during the 

 11 delivery expiration process, and there are a lot 

 12 of things that can impact the convergence. But 

 13 you're counting on it during the expiration of a 

 14 contract. 

 15 Traditionally, we've had reasonable 

 16 convergence. Today, as Mr. Kass' charts show, we 

 17 don't have that. We do get convergence at times. 

 18 Even this year, with the very wide basis levels in 

 19 wheat, we did get the convergence in Toledo in the 

 20 fall. 

 21 At the same time, of course, we could 

 22 not sell bushels in Chicago for 50 cents a bushel 

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 1 cheaper than Toledo. 

 2 But then in February, we actually got to 

 3 convergence. Of course, it only lasted for about 

 4 two weeks, and now we're -- three million bushels 

 5 of wheat, we're going to carry in a new crop. So 

 6 it isn't as dependable as it was before. So the 

 7 question is, what happened? First, the 

 8 calculation for convergence has changed. There 

 9 really was a point in time, and it wasn't so long 

 10 ago, that you could calculate within a half a cent 

 11 a bushel what is convergence. And I can recall 

 12 many discussions with the investigative arm of the 

 13 CME or calls to the CFTC that, you know, someone 

 14 is doing something that's uneconomic, for half a 

 15 cent a bushel. In hindsight, it almost seems kind 

 16 of silly to have those discussions. 

 17 But the fact is, as I've heard someone 

 18 mention earlier, there is -- I think Dave Lehman 

 19 made the comment, convergence is a band, all 

 20 right, yeah, you can calculate, and since we do it 

 21 all day, we really know what is the cost of 

 22 loading it, what are the assumptions in terms of 

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 1 how much storage you're going to have to pay, and 

 2 what is the real shrink, and what are your 

 3 inspection costs. 

 4 But the fact is, there's a band, there's 

 5 a bid and offer in the barge market, there's a bid 

 6 and offer in the barge freight market, there is -- 

 7 and guess in terms of how long you're going to 

 8 have to pay storage. So you really want to figure 

 9 out your costs. Those numbers have changed 

 10 dramatically in the last ten years, most of it I 

 11 would say in the last four or five years. Today, 

 12 you might have a five cent spread between the bid 

 13 and offer in the barge market for a loaded barge. 

 14 It used to be a quarter or a half a cent. In the 

 15 barge market, it used to be easily a five percent 

 16 spread between bid and offer in a barge freight 

 17 market. In fact, often times you would trade two 

 18 and a half percent of tariff, that would be what 

 19 you'd be negotiating. Today you wouldn't even get 

 20 a counter. The spread might be 25 to 50 percent 

 21 of the tariff in the bid spread. What does that 

 22 mean? That's nine cents a bushel out of Chicago. 

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 1 So what happens is, now you have this 

 2 huge band of what convergence is, and that's 

 3 without any influence from an index fund or this 

 4 new capital. The fact is today, with wider 

 5 transportation -- higher transportation costs, 

 6 much more volatile transportation costs, this 

 7 convergence is harder to calculate. 

 8 Now you throw in the influence of new 

 9 capital that's entering the market. A question 

 10 was asked earlier, how is it that an index fund 

 11 that doesn't even participate in the delivery 

 12 cycle, the expiration, how could that impact 

 13 convergence? Well, in the case of wheat, if you 

 14 look at the net open interest in wheat, excluding 

 15 spread trade, 50 percent of the open interest is 

 16 actually held by a passive long that isn't going 

 17 to sell it at any price. Well, that, by its own 

 18 nature, elevates the price of grain. There's no 

 19 doubt that prices would be higher today because of 

 20 all the global comments we heard, the real supply 

 21 and demand issues we heard earlier. We do have 

 22 biofuels, we do have growing population, we do 

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 1 have inflation, so there's no surprise by that. 

 2 But if you've got a percentage of the 

 3 market that is not for sale at any price, that 

 4 accentuates the problem. And if you look at the 

 5 other charts that were shown earlier about the 

 6 farmer's tendency to sell, when he sells, a 

 7 greater percentage early in the crop year, well, 

 8 what happens as the crop year progresses, and that 

 9 grain has already hedged, and now you've got new 

 10 participants buying it? 

 11 Well, what happens is, you end up having 

 12 more speculators on the other side of that. And 

 13 at this point, the numbers show that you've got 

 14 more speculators actually buying the market, as 

 15 well. So there is an impact, but it is clearly 

 16 not the only reason why we have a convergence 

 17 issue. 

 18 We spent a lot of time in the last year 

 19 in the National Grain and Feed analyzing the 

 20 issue, trying to get ideas. Each time, in fact, 

 21 it's gone beyond the last year, we've made 

 22 recommendations to the CME, they have implemented 

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 1 the changes, the shipping certificates in July for 

 2 the week -- is going to increase utility of that 

 3 market, because an elevator doesn't have to move 

 4 grain backwards or pay transportation costs, so 

 5 they shouldn't pay at the wrong time, because they 

 6 can buy grain in the country knowing that they can 

 7 tender a shift certificate. It's a powerful tool. 

 8 We have some track record here in 

 9 Chicago to be able to see what happened in corn 

 10 and beans. We also asked for an increase in 

 11 storage rates, partly because the costs of storage 

 12 have gone up. The costs include your shrink as 

 13 the prices go up, all right. It's no one's fault, 

 14 but the fact is, you having a shrink running your 

 15 grain over, so now your cost of storage goes up. 

 16 Your aeration as you're maintaining the crop, the 

 17 quality of deterioration, there's a cost of that, 

 18 as well. If you store grain for a long period of 

 19 time, there's a cost of that, as well. 

 20 The insurance on the grain that you're 

 21 storing, all of these factors add to the real 

 22 cost. So aside from that, you actually have the 

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 1 value of storage which varies at the time of the 

 2 year. We've made a recommendation to the CME 

 3 after our task force to increase the storage 

 4 charges and load out fees, which increases the 

 5 utility of the current elevators, and it better 

 6 reflects the storage. The current recommendation 

 7 you're going to see from us, despite the fact that 

 8 the Commission has just approved those increases, 

 9 is we think that you ought to take another look at 

 10 them immediately. A lot has changed. 

 11 So you've done your poll before, repoll 

 12 the industry and find out what the storage rates 

 13 are, because they should reflect the cost and 

 14 value of storage, and today they clearly don't. 

 15 If we built a lot more storage, 

 16 convergence would not be a problem. We'd store 

 17 the grain longer, as long as we had the money to 

 18 do that. If people could make a lot of money 

 19 storing grain, they wouldn't ship the grain, and 

 20 you'd get the basis to recover. 

 21 The recommendations that we have related 

 22 to this issue, we'll talk about the funding in a 

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 1 second, one is the storage review. It's not going 

 2 to be a major thing. I think if you survey, you 

 3 may find that they're a little bit higher, we 

 4 think that would help the situation. But it's not 

 5 -- you're not going to find major differences from 

 6 the changes that you've already made. Second is 

 7 the idea of agriculture swaps that opens the door 

 8 to new innovation. We think that that's something 

 9 that does make sense. How exactly? Well, the 

 10 Board of Trade -- the CME is already working on, 

 11 you know, basis swaps that could -- that they 

 12 could clear, that provides an opportunity. We 

 13 talk about the liquidity issues, if somebody can 

 14 clear a swap that actually has financing embedded 

 15 in there, and that can go through the CME, that's 

 16 a benefit. 

 17 We understand that the Commission staff 

 18 may be considering adjusting the ATO rules, again, 

 19 another tool that we can engage and try to provide 

 20 better balance in the market. 

 21 We considered, as you mentioned, we 

 22 considered a number of things during our task 

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 1 force, some of which you've already heard, and so 

 2 I'll address some of those issues. One of the -- 

 3 I would say the most widely supported alternative 

 4 would be a dramatic increase in storage charges. 

 5 Instead of making five or six cents a bushel, why 

 6 not make them nine or ten cents a bushel? 

 7 If that happens, you know, sometimes the 

 8 market will get to fully carry, like during 

 9 harvest, but other times it won't. So the market 

 10 won't get to full carry, so you'll get 

 11 convergence. And there is a contingent of our 

 12 association, we'd love to see that. And as an 

 13 elevator operator, that's a good thing. The 

 14 problem is, I like it, but if you look in the 

 15 market, the problem is that it becomes imbalanced. 

 16 Now you have a situation where, if you have high 

 17 storage rates, and then later in the year, when 

 18 storage is not quite as valuable, well, I'm a 

 19 delivery elevator with a -- certificate, and if 

 20 the market -- if someone is going to pay me too 

 21 much and give them shipping certificates, I'm 

 22 going to give it to them. 

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 1 So what happens then is, the market 

 2 doesn't respond the other way, so that the long, 

 3 the other side of the hedger, the miller that's 

 4 counting on the market to respond when they can't 

 5 buy grain, all right, they don't want the basis to 

 6 have to go to 100 over either, they want to get to 

 7 that point where the market gets imbalanced, the 

 8 futures market responds. 

 9 If you have storage rates that are too 

 10 high, then the futures market can't respond there 

 11 either. So it's been an ongoing, I would say 

 12 debate within our association, but our task force 

 13 concluded it just wasn't balanced. 

 14 Another thing that was considered was 

 15 alternative delivery points. We used to have 

 16 Toledo deliverable for corn, beans, and wheat; 

 17 today they're not deliverable. We've gone through 

 18 that, and, in fact, you could add Toledo again, 

 19 and maybe you add delivery elevator in Lincoln, 

 20 Nebraska, where they have lots of storage, as 

 21 well. What that would do would provide better 

 22 basis convergence in those local markets, because 

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 1 those -- there would be guaranteed sales in those 

 2 markets. 

 3 But the problem, again, is that you have 

 4 a disadvantage to the long. If there's really 

 5 tightness in Toledo, you're not going to get any 

 6 corn in Toledo. If there's a tightness in 

 7 Nebraska and you really want it, you're not going 

 8 to get anything there. 

 9 The way the system is designed today, 

 10 grain kind of flows in and out. It's almost like 

 11 the export market is the buffer. If there's too 

 12 much ethanol demand, grain will not get to the 

 13 Illinois River, and if it doesn't get to the 

 14 Illinois River, the market will do its job. 

 15 So the idea was that while it may 

 16 provide some better basis management in the areas 

 17 which you put a delivery -- you actually would not 

 18 get convergence because you would be harming 

 19 consumers that were counting on getting Nebraska. 

 20 The fact is, if there's grain in -- if 

 21 they see it in Nebraska, you'll probably get it in 

 22 Toledo. But it is something that can be 

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 1 considered. The second -- the other issue that 

 2 got a lot of the debate in our association was 

 3 compelled load out, where the maker of delivery 

 4 can actually -- I can make a decision to deliver 

 5 grain and then force the taker, the long, to load 

 6 it out, and when space is tight, that's a really 

 7 good thing. You know, we have a guaranteed bid on 

 8 our Chicago elevator for 11.3 million bushels. 

 9 But the minute we are full at 11.3 million 

 10 bushels, we've got, like every other elevator, 

 11 we've got to find something else to do. 

 12 If we're in a situation where we could 

 13 compel load out, well, clearly the basis loaders 

 14 are going to go up, because we could force some 

 15 long to load the grain out, and that would get 

 16 convergence, at least from our perspective. The 

 17 problem with that is, it imbalances the market. 

 18 Who wants to be long in a market where they could 

 19 be forced to take the transportation risk when 

 20 it's the maker of delivery that already has the 

 21 luxury of making delivery? 

 22 So I have one benefit, and now I can 

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 1 force them to load it out; all of a sudden I've 

 2 really imbalanced the market. So we debated and 

 3 decided that it really didn't provide the balance 

 4 that is required. 

 5 We did talk about the idea of an index 

 6 contract. It was a recommendation we made to 

 7 maybe look at the idea of an index. The problem 

 8 is that there is no -- while it sounds like an 

 9 interesting theory, and we brought it up, and we 

 10 thought, well, maybe -- we had a lot of interest 

 11 in the room. 

 12 I mean literally there were hedge funds, 

 13 and there were professional traders, and millers, 

 14 and county elevators, and terminal elevators, and 

 15 delivery elevators. It sounded like a neat idea. 

 16 The problem is that if you do that, 

 17 that's no guarantee that you're going to get a 

 18 convergence anyway, and now you've created a new 

 19 problem. You're somebody in Iowa today that at 

 20 least knows that there is a price at which you can 

 21 put a real -- sent it to Chicago to a delivery 

 22 market, or if, worse case, you put it in a truck 

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 1 and take it to the Illinois River. 

 2 You can figure those values. But what 

 3 happens if you change that, so now it's a basket? 

 4 Well, there is, first of all, there is now, from a 

 5 country elevator perspective, how do they now 

 6 figure out what their basis risk is? How is my 

 7 basis relative to a basket? You basically have 

 8 the same problem, but in a more complicated way. 

 9 And you give the one thing that you have 

 10 today in the market, you have a guaranteed place 

 11 to go with grain. There is -- there's a -- where 

 12 the -- I would say your worse sale should be to a 

 13 delivery elevator, all right, because if you can't 

 14 sell it to anyone around you, a consumer, and you 

 15 have to direct it against flow to a delivery 

 16 elevator, we can get a bid, but -- because there 

 17 is a bid that we can buy it and deliver it to the 

 18 market. 

 19 On the other hand, if you're a long, 

 20 right, there is a price at which you'll get it. 

 21 You may not be on the river, you may be in a place 

 22 that's a -- but you sure can take a barge, take it 

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 1 some place, unload it, and bring it to you. There 

 2 is at least today some place you can get grain if 

 3 you must have it. 

 4 That goes away if you have an index 

 5 contract. The futures market in the system was 

 6 never designed so that the delivery market would 

 7 be the easiest source of cash. It's not really 

 8 supposed to be your easiest source of cash. 

 9 So we looked at a number of different 

 10 issues in terms of convergence, we've made some 

 11 minor recommendations, we'll make -- and you'll 

 12 see the letter that we -- our recommendation today 

 13 is that you'll quickly take a quick look at your 

 14 storage rates to make sure the ones you're 

 15 implementing are appropriate. 

 16 We don't anticipate there will be a 

 17 major swing, but you have the opportunity to do it 

 18 now, it's a good time to do it. And again, we're 

 19 supportive of the ag swaps and the trade options, 

 20 as well. The next item on here was the forward 

 21 contracting of elevators, and that's the one that 

 22 probably has been the scariest for our association 

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 1 and our members. I recall being in an Executive 

 2 Committee meeting in January, and I saw 

 3 blackberries going off. Normally they're not even 

 4 on in an Executive Committee meeting. But people 

 5 turn white as a ghost. You could tell that they 

 6 had their customers calling them saying they're 

 7 running out of money. 

 8 Our little company in Chicago bought 

 9 grain from one elevator in store because they just 

 10 had to have a bid. They needed to sell 300,000 

 11 beans, which was $4 million. So I visited them, 

 12 and they said, well -- I said, what do you need, 

 13 well, they needed a total of $11 million to get 

 14 them through January. So we found a way to get 

 15 our bank to approve them, and we got in the middle 

 16 between them, and by the way, the consumer, and 

 17 funded their inventories. 

 18 Before the month of January was over, 

 19 that was up to $70 million. We're fortunate the 

 20 way it actually had access to that capital. I can 

 21 only imagine people that hadn't thought ahead. 

 22 And then the phone is ringing off the hook, people 

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 1 saying they're going to get out of their futures 

 2 contracts because they can't afford the margins. 

 3 They just don't have the liquidity. So what do 

 4 they do? So if you've got inventories, I mean 

 5 what caused the problem? Well, first of all, you 

 6 have greater inventories, you produced a lot more 

 7 corn last year. 

 8 Secondly, you have a lot more -- you 

 9 have higher prices. So that's for your inventory. 

 10 Your need for capital has gone up. For the most 

 11 case, you're able to get that, the banks will give 

 12 you the money for your inventories, you have 

 13 collateral, as long as you're able to manage your 

 14 inventories, that's probably not a problem. And 

 15 the banking industry, frankly, has done a great 

 16 job of servicing our industry. 

 17 But when you get into deferred 

 18 contracts, that becomes a different issue. 

 19 They're willing to give a certain amount of 

 20 dollars, but not dollar for dollar. And what's 

 21 happened with the high price of commodities, and 

 22 we've seen it from the charts that Mr. Kass had 

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 1 put up, there is a lot more forward hedging. 

 2 And now you have this tremendous need 

 3 for capital to fund your margin calls. And the 

 4 result, well, interesting, is that this is 

 5 typically the most attractive bushels for a grain 

 6 elevator. If you buy deferred bushels, first of 

 7 all, you can manage your business better. Now I 

 8 know I've got the origination, I can manage my 

 9 transportation, and in this environment, that's 

 10 something you'd like to do. If you need to buy 

 11 storage capacity or build storage capacity or find 

 12 some creative storage like grain on the ground or, 

 13 in our case, a storage boat, you'll do that if 

 14 you've got that time. 

 15 So traditionally, you've always had this 

 16 margin risk, but you didn't think of it. If it's 

 17 going to cost you one or two cents a bushel to do 

 18 that, fine, it's more than offset by the benefit 

 19 of managed logistics and running your business. 

 20 But what's happened is, the money has 

 21 gotten so significant that two things happen. 

 22 First of all, you are literally getting -- the 

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 1 bank says, I don't have it anymore, they're 

 2 getting more selective, there is a liquidity 

 3 issue. 

 4 As the prices went up, you first could 

 5 say, well, my costs are going up. So I used to 

 6 give it away, I wasn't even including that as a 

 7 cost of business, that was offset by my logistic 

 8 benefit. So now what you do is, you widen your 

 9 basis levels, you widen your basis levels to cover 

 10 your cost. 

 11 All that makes sense. But at some point 

 12 you get to a time and you say, it isn't a function 

 13 of cost, it's a function of availability, and 

 14 there is no price at which a grain elevator 

 15 operator can run out of money, all right, they 

 16 can't run out of money in the fall when the farmer 

 17 says, I want to deliver the bushels and I want to 

 18 get paid. The farmer wants to walk out the door 

 19 with a check in their hand, if necessary. If you 

 20 ever get in a situation where you can't do that, 

 21 the farmer goes away. 

 22 On the other hand, you can't be in a 

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 1 situation where the CME calls and says, you know, 

 2 or your FCM calls and says, I need to get -- I 

 3 need the margin money, then you can't make it. So 

 4 if you get to the point where you're not certain 

 5 that you're going to be able to make that margin 

 6 call, you have no choice but not to bid. 

 7 So it's a giant step backwards. I mean 

 8 the Commodities Exchange Act and the exclusion for 

 9 forward cash contracts were specifically designed 

 10 so that our industry could literally buy grain for 

 11 farmers, that was the whole point. 

 12 And now we're in a situation where we 

 13 are concerned, and some people just said I can't 

 14 do it, I cannot estimate the cost because I don't 

 15 know it, the futures market may go up $10 a bushel 

 16 a corn, who says we can't be $15 in corn. There 

 17 are some compelling issues. Maybe that does 

 18 happen. And secondly, I can't determine whether 

 19 or not I actually could be in a situation where I 

 20 cannot come up with the money, and a very 

 21 profitable organization is gone overnight. And I 

 22 can tell you that our association was genuinely 

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 1 concerned that we'd come in some Monday morning, 

 2 after Friday, when a number of our members were 

 3 unable to make a margin call, the next thing you 

 4 know is, they're all blown out of their positions, 

 5 and then, of course, the market would turn and go 

 6 down, and then we'd have a serious problem. 

 7 So it's clearly not a situation where 

 8 elevator operators don't want to buy deferred 

 9 grain, they really, really want to buy grain. But 

 10 I mean that's our primary role for servicing our 

 11 farm customers. But it was a risk that was not 

 12 manageable. 

 13 So how do you deal with that? As an 

 14 association, we had a conference call with our 

 15 banking members. I think there were 14 members, 

 16 including presidents of banks, I think the 

 17 President of -- bank may have been on there. It 

 18 was amazingly well attended, to find out, how are 

 19 we doing. They've done a great job of servicing 

 20 -- do they have the money. And what they said 

 21 was, you know, we're -- they have the money today, 

 22 and they're, frankly, trying to take money from 

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 1 other parts of their balance sheet so they can 

 2 service the industry, but even they're starting to 

 3 get some heartburn, because what happens if 

 4 there's nothing else on the balance sheet that 

 5 they can steal from Peter to give it to the grain 

 6 industry? Well, then you have the problem. So 

 7 they clearly were putting the yellow flag up and 

 8 saying they were going to be more selective with 

 9 their customers. 

 10 The next call we had was with either 

 11 members that are funds or funds that we are aware 

 12 of to say, is there a way your money can get 

 13 deployed in the market different. I mean, think 

 14 about it, we have people chasing the agriculture, 

 15 and we're saying stay away, that just doesn't seem 

 16 right. 

 17 I mean think of how good it is for 

 18 implement dealers, for seed dealers, for farmers, 

 19 I mean -- but at this point, they're creating an 

 20 imbalance, because what they chase now are futures 

 21 contracts and not real bushels. So we ask the 

 22 question, is there a way that you would be willing 

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 1 to deploy your money by buying deferred contracts. 

 2 Think of a fund that bought deferred 

 3 bushels from country elevators, and if -- right 

 4 before delivery, the day before the shipment 

 5 period were to start, the contract either gets 

 6 converted to physical inventories, now the fund 

 7 that wants money in the ag space gets it, or it 

 8 gets converted to Chicago futures and everyone is 

 9 fine. The answer we got, and it was unilateral, 

 10 is they simply don't want the counter party 

 11 exposure. And they're not structured to be able 

 12 to handle 500 customers. They're very happy to go 

 13 to the CME and to trade futures, it's quite easy, 

 14 it's low cost, they don't have the counter party 

 15 risk. So they made it clear they were unwilling 

 16 to do that. 

 17 So the next question is, how do we do 

 18 that? I think it was Commissioner Dunn that 

 19 suggested, well, is there something in the USA, is 

 20 there some tool that's available. Well, there may 

 21 not be today. But who's to say that the CRC 

 22 insurance coverage couldn't be changed so that 

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 1 there's actually an extra premium if the farmer 

 2 wants the fall protection, and if that happened, 

 3 then you would be able to securitize those forward 

 4 contracts, because there is no risk, because it's 

 5 backed by the U.S. government, and someone is 

 6 paying a fee for the insurance anyway, and now you 

 7 find another way to get all these billions of 

 8 dollars of capital -- industry. 

 9 We just haven't got there yet, which is 

 10 one of the reasons why we suggested a moratorium 

 11 on the new participation from these long onlys. 

 12 It's not saying that they're going to go away, 

 13 because they're not, they want to get in our 

 14 space, and we want to find a way to get them 

 15 there. We're just not ready today, and we can't 

 16 afford that, before we're ready, that we have 

 17 grain elevators that go bankrupt. 

 18 Good, you know, conservative grain 

 19 elevators go bankrupt because they didn't -- they 

 20 couldn't manage the capital. So that kind of 

 21 answers the question in terms of the last question 

 22 for the second one is, what do we see for swaps. 

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 1 We don't really know. But if you open the door so 

 2 that you can clear an ag swap, then what happens 

 3 is, the industry, instead of the Board of Trade 

 4 coming out with new products, the industry brings 

 5 products to the Board of Trade, things that they 

 6 can clear. 

 7 Maybe some of those products actually 

 8 have financing embedded in there. We won't know 

 9 like it started, but it seemed like it is a 

 10 possible solution. That's it. 

 11 MR. LUKKEN: Thank you very much, that 

 12 was great. Are there any comments to Tom's -- 

 13 Mike Walter from the CMC. 

 14 MR. WALTER: I'm Mike Walter from the 

 15 Commodity Markets Council. And as was mentioned 

 16 earlier, we did hold a session a couple weeks ago 

 17 where we invited people from all aspects of the 

 18 user side of the commodity exchanges to come in 

 19 and talk to us about a variety of issues, and one 

 20 was convergence. Clearly, they told us that they 

 21 didn't want to see any radical changes to the way 

 22 business was being done. 

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 1 And to echo what Tom was talking about, 

 2 they were very amenable to raising storage rates, 

 3 they understood what that would mean and what that 

 4 could do, also expanding daily capacity through 

 5 shipping certificates or maybe some in line 

 6 delivery areas that currently are not available 

 7 for delivery now would help with the convergence 

 8 issues. 

 9 We did see a variety of them that came 

 10 up with ideas, like the cash settled way of 

 11 handling this. It really didn't get traction, 

 12 nobody wanted to see that. Shipping certificates 

 13 were very unpopular. I used to trade when we did 

 14 have shipping certificates, and it is very unfair 

 15 to the taker, so I think that was out. 

 16 But ag swaps, certainly they're very 

 17 interested in, and thought that that would be very 

 18 helpful. So just to give you a proxy of what the 

 19 users of the exchange would like to see happen 

 20 with respect to convergence, again, they don't 

 21 want to see any radical changes, but they would 

 22 like to see some tweaks in there. And with 

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 1 respect to the funds, they just really did not 

 2 understand the funds impact, you know, in terms of 

 3 delivery and convergence, because as Doug 

 4 mentioned, you know, they're out of the markets 

 5 through that period of time, but they certainly 

 6 think that that warrants more study on the 

 7 convergence side. 

 8 And with respect to what we're hearing 

 9 on the finances, certainly there's a lot of stress 

 10 and strain out there on the farm community, as 

 11 well as the elevators, and what's really happened 

 12 is, you know, the major, or not the major, but 

 13 just grain companies in general, and the big grain 

 14 processors used to absorb all that risk. Two or 

 15 three years ago they took it all on, and it didn't 

 16 bother them. 

 17 And to Tom's point, buying deferred 

 18 grain or making deferred sales to food 

 19 manufacturers, those kind of things were -- that's 

 20 where a lot of money was. And there was never an 

 21 issue with respect to counter party risk. 

 22 Now the counter party risk is enormous, 

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 1 and the amount of money that these larger concerns 

 2 have to put up with respect to large and daily 

 3 maintenance, it's becoming very onerous for them, 

 4 I think particularly the publicly traded ones, 

 5 because it shows up as debt on their books, and 

 6 they're just -- they're just backing away from it. 

 7 They're saying, okay, we're not going to take that 

 8 risk anymore, we're shoving it out to the food 

 9 manufacturers, and we're shoving it back down to 

 10 the grain elevators, and ultimately the farmers, 

 11 who now have to figure out a way to deal with it. 

 12 And who knows, maybe a whole new industry will 

 13 develop, somebody will come in and guarantee these 

 14 contracts, maybe a new insurance industry will 

 15 develop as a result of it. But there's a real 

 16 reason, you know, this is happening, but the 

 17 solution is going to be a little bit difficult. 

 18 MR. LUKKEN: I think the entire 

 19 Commission is interested in hearing more about 

 20 cleared ag swaps. As well, exact trade options is 

 21 something we've studied, and whether that program 

 22 can be improved. I know, Dave Lehman, you have 

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 1 some views on all of this. 

 2 MR. LEHMAN: Well, and first, thanks, 

 3 Mike, for a summary of the Commodity Markets 

 4 Council meetings. One clarification, I think you 

 5 had mentioned lack of interest in shipping 

 6 certificates, I think that was demand 

 7 certificates -- 

 8 MR. WALTER: Demand certificates, I'm 

 9 sorry. 

 10 MR. LEHMAN: -- that we really didn't 

 11 find a lot of traction within the industry. And 

 12 if I could, before we talk about swaps, I'd like 

 13 to just follow up on a question to Tom and/or Gene 

 14 about convergence. And, Gene, I think you 

 15 mentioned the January soybean contract showed poor 

 16 convergence, and I guess it's in a relative sense 

 17 what we looked at, the data that we have for 

 18 January soybeans showed the that Northern Illinois 

 19 River, back in September, was a $1.50 under the 

 20 January futures, and at first delivery day, it was 

 21 50 under. So we look at that as $1 strengthening 

 22 of the basis, or $1 appreciation in basis during 

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 1 that time period, and to me, that's convergence. 

 2 Now, I know it's not reaching zero, and 

 3 Tom, you mentioned you're -- in Chicago, that your 

 4 basis should be zero in Chicago, but isn't that 

 5 contract working for the short hedger when you see 

 6 that kind of a basis appreciation? So that's one 

 7 comment. 

 8 On ag swaps, and Commissioner, thanks 

 9 for that question, and our Chairman mentioned it 

 10 this morning, we are very interested in clearing 

 11 ag swaps. Many of the commenters in the cotton 

 12 market this morning, I noticed, are suggesting 

 13 that there needs to be more transparency in the 

 14 over-the- counter market, and that's one of the 

 15 benefits of clearing OTC products, that we believe 

 16 that does bring more transparency to the market. 

 17 We're doing it now in ethanol, today 

 18 we're clearing a calendar swap, as well as three 

 19 basis swaps and an option on a calendar swap. 

 20 These are OTC instruments that are traded off 

 21 exchange directly between counter parties and then 

 22 entered into our clearinghouse. When they enter 

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 1 that position into our clearinghouse, we then 

 2 report that volume and that open interest, we 

 3 report it every day on our web site, we report a 

 4 price that that product is margined to, a settle 

 5 price, if you will, so we feel that allowing 

 6 clearing of agricultural swaps in the same way 

 7 that it's allowed in energy products today is a 

 8 way to bring additional transparency, to bring 

 9 this activity onto the exchange, and to allow the 

 10 kind of coordinated surveillance that was 

 11 suggested as needed in the cotton market, where 

 12 now the Commission and the exchange regulators 

 13 will be able to observe more so what's going on in 

 14 the over-the-counter market and how that might be 

 15 impacting the exchange markets. 

 16 Obviously, it's not the entire picture, 

 17 but we did formerly submit this morning, Mr. 

 18 Chairman, a petition to request CFTC's approval 

 19 for corn basis swaps. We think these are tools 

 20 that will help manage this basis risk, and then 

 21 also for corn, wheat, and soybean calendar swaps. 

 22 So thank you. 

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 1 MR. LUKKEN: And the clearing of those 

 2 products for our surveillance purposes allows us 

 3 to see certain large trader information as they 

 4 come into our market, so it is beneficial from a 

 5 surveillance point of view. I know Joe had talked 

 6 about this this morning. And if we can get a mike 

 7 for Joe Nicosia. 

 8 MR. NICOSIA: In regards to, you know, 

 9 convergence, as we tried to look to see what went 

 10 wrong, and obviously it went wrong in the cotton 

 11 market, as well, but even on a more general 

 12 picture, it was mentioned at the end of our last 

 13 session, and I think very properly, that one of 

 14 the major problems that we -- it all boils down to 

 15 financing that we have and the liquidity that's 

 16 available to it, because the people in the market 

 17 place know how to cause convergence, if they're 

 18 able to take the risk and have the liquidity to do 

 19 so and have the financing to do that. 

 20 So we find ourselves today in an 

 21 industry that essentially is under capitalized or 

 22 that needs to reliquidify, and the market will 

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 1 slowly adjust to this over time, and banking lines 

 2 will slowly adjust to it. 

 3 But one of the problems that we have 

 4 with this, and if we look at it is, again, if we 

 5 go back, and I'm not picking on index funds or on 

 6 large funds, but it is the root of the problem 

 7 here, because they're able to come into the market 

 8 place, establish positions as five to ten percent 

 9 of margin money that comes through. On the 

 10 opposite side is a traditional hedger who pays $12 

 11 for beans and puts up a short sale. The amount of 

 12 money that they have when they come to meet on a 

 13 transaction is ten to one against the traditional 

 14 hedger. 

 15 You allow the non-traditional hedger to 

 16 put up one-tenth of the amount of money, or 

 17 smaller in some cases, and drain the liquidity out 

 18 of the industry. Now, if, at that same time, you 

 19 were to require people who want to have 

 20 substantial positions above speculative limits 

 21 that have no cash against that, to require them to 

 22 maintain their exposure to the industry by having 

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 1 a physical presence, that money in and of itself 

 2 reliquifies the industry. 

 3 So instead of being able to use a ten to 

 4 one or a to one leverage, if they were, wanted to 

 5 continue to have a broad based exposure to the 

 6 industry, and they wanted to own an extra 50 

 7 million bushels of corn, or 100 million bushels of 

 8 beans, after the speculative limits, would need to 

 9 go ahead and either -- it's the same thing as 

 10 actually requiring them to say put up a higher 

 11 margin or 100 percent margin, but if they were 

 12 involved in the actual physical commodity, like 

 13 buying gold bars, that money reliquifies the 

 14 industry. So it does boil down on the convergence 

 15 side, is that the lack of it today is because the 

 16 traditional hedger doesn't have the ability to 

 17 continually fund and/or provide the funding to go 

 18 ahead and to make one session, which is 

 19 essentially delivery, which is the only point to 

 20 try to draw that convergence in, and it only 

 21 happens once every 60 to 90 days. And in between 

 22 those 60 to 90 days, they're fully exposed. So 

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 1 that's one of the answers, you said, does anybody 

 2 have an answer on how we try to reliquify the 

 3 industry, that's one possibility. 

 4 MR. LUKKEN: Bob Greer from PIMCO. 

 5 MR. GREER: I'd like to clarify, if I 

 6 could, the way that the typical index investor 

 7 operates, whether it's an investor like a pension 

 8 fund or whether it, indeed, is a fund that 

 9 represents, as I mentioned before, as much as 

 10 200,000 individual investors. 

 11 Those investors typically put up 100 

 12 cents on the dollar. If you want a dollar's 

 13 exposure to wheat, you will have $1 in that index. 

 14 They do not use the leverage that was mentioned 

 15 just a moment ago. And so that is point number 

 16 one. And you heard two other people describe the 

 17 same thing. 

 18 I hope you understand that index 

 19 investors are not leveraging their positions. 

 20 MR. NICOSIA: That's not what I said. I 

 21 said you're leveraging the financing, a very 

 22 different term. I think ten times the position 

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 1 against the money -- have to put up ten percent of 

 2 that versus a hedger, who has to use his financing 

 3 at 100 percent, two very different situations. 

 4 MR. GREER: You are talking about the 

 5 amount that might be deposited with the exchange 

 6 versus the additional collateral backing that, 

 7 which is held an owned unlevered by that investor. 

 8 We might deposit, if it's $100 of exposure, maybe 

 9 $10 is deposited with the exchange, but there's 

 10 another $90 sitting right there with it, so there 

 11 is a full $100 backing it. We're not taking 

 12 advantage of any kind of leverage in our total 

 13 position. 

 14 MR. NICOSIA: No, I understand that. 

 15 You're not leveraging it to the multiple. But if, 

 16 for example, it would be a very different 

 17 situation if you took that $100 and bought a 

 18 bushel of beans with it. Now you would take that 

 19 off of your balance sheet, you wouldn't have that 

 20 on there at all, you would own a bushel. 

 21 That money would come back into the 

 22 industry, on the other side, and that would be 

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 1 money that would be available to provide 

 2 additional purchases of beans, additional delivery 

 3 economics, additional storage, it would reliquify 

 4 the industry, because today convergence doesn't 

 5 take place, because the amount of capital that is 

 6 necessary to fund our positions is substantially 

 7 different. There's a substantially larger drain 

 8 on the traditional hedger than there is on the 

 9 index person. 

 10 MR. GREER: I think that suggesting that 

 11 an index investor should take delivery might 

 12 distort the markets more than what they are doing 

 13 right now, which is before you ever have that 

 14 first delivery month, that investor has sold his 

 15 nearby position and simultaneously bought a more 

 16 distant position, so that they are, again, they 

 17 are looking to have exposure to changes in the 

 18 price of that commodity, they're doing it, as we 

 19 described, for portfolio diversification reasons, 

 20 they're doing it because those people have to buy 

 21 gasoline, they have to buy bread, other things 

 22 that relate to inflation. 

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 1 Those are the reasons that they're in 

 2 the market, and it so happens that they are -- 

 3 MR. LUKKEN: I apologize, go ahead. 

 4 Repush your button, there. 

 5 MR. GREER: Did I say something wrong? 

 6 Again, understand their motives, which are, for 

 7 investment, for diversification, for risk 

 8 reduction, and a byproduct is providing liquidity 

 9 and assuming some price risk from the other 

 10 participants in the market. That is why they're 

 11 there, they are there on an unlevered basis, and 

 12 their activities are very clear in the market as 

 13 far as what they do. As a matter of fact, you 

 14 don't have to worry about index investors suddenly 

 15 standing for delivery for -- in your grain 

 16 markets. 

 17 MR. NICOSIA: But actually, the -- what 

 18 I would say is, you don't have to worry about it, 

 19 I don't think that that's a concern. As a matter 

 20 of fact, part of the answer is going to be, the 

 21 industry is going to make you take delivery, one 

 22 way or the other, that is what's going to happen. 

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 1 Spreads are going to get wide enough 

 2 that the convergence is going to have to take 

 3 place with outside money, outside of the industry, 

 4 and that is what -- whether it be -- come from 

 5 alternative bank financing, but the easiest way to 

 6 solve it is by increasing profit margin, so that 

 7 it becomes so attractive that it attracts capital 

 8 to the convergence, and that's what's going to 

 9 begin to happen. 

 10 And as those spreads widen, index funds 

 11 largest exposure are the spreads as they continue 

 12 to work, and that's how the market place will try 

 13 to solve that. So whether you physically take it 

 14 or not, or whether the interest -- the spreads 

 15 widen to make you have to take that or make you 

 16 feel that pain, convergence will have to take 

 17 place one way or the other, it's just a question 

 18 of how are we going to reliquify the industry. 

 19 MR. GREER: If the market moves in that 

 20 direction, index investors will respond to market 

 21 forces. But that, again, is different from saying 

 22 that you must physically take delivery. 

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 1 MR. LUKKEN: Let's turn to Doug 

 2 Hepworth. I know Doug with Gresham has some views 

 3 on this. And we're going to have to shortly break 

 4 for lunch, so I have time for about three more 

 5 questions. I know Jim has been waiting patiently, 

 6 and Layne here on the end with Minneapolis Grain 

 7 Exchange, that's about all we can probably do 

 8 before the break. And, Garry, we'll try to get 

 9 you in at the end, too. 

 10 But let's start with Gresham Capital 

 11 first, with Doug. 

 12 MR. HEPWORTH: Hi, Doug Hepworth, 

 13 Gresham Investment. Actually, first to Tom's 

 14 point, I still do not understand the mechanism of 

 15 how an index or passive positions in December 

 16 wheat impacts September convergence, but maybe 

 17 come back to that later. I guess in terms of the 

 18 work that Doctor Kunda and the group did, one 

 19 point that David made earlier which I thought was 

 20 interesting is, it might make sense to look at 

 21 some of this basis and convergence in percentage 

 22 terms. I mean you have very different prices than 

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 1 you had several years ago. And the other point I 

 2 would make is, following your methodology 

 3 backwards in time yields other periods, where we 

 4 saw similar failures of convergence. 

 5 In fact, the December, '06 

 6 non-convergence was actually less than the 

 7 September, '99 wheat convergence, which was less 

 8 than the May, '93 wheat convergence. And you saw 

 9 similar things in September, 2000 soybeans and 

 10 corn. It just seems to me that we might use the 

 11 lessons of those periods to maybe help address 

 12 these, and perhaps not focus so much on some 

 13 people who own the futures that aren't being 

 14 delivered against. 

 15 MR. FENTON: May I just respond to that, 

 16 to get back to Dave, too? And in the full 

 17 statement, we have the charts, Dave, that go back, 

 18 as well, and Doug, too, show some of the 

 19 historical patterns. So to answer Dave, the 

 20 convergence itself has these two elements I 

 21 portray, and I sometimes call them the verb and 

 22 the noun, and the noun convergence is during the 

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 1 delivery period, when the futures market becomes 

 2 the spot market, it has no more future, so it is 

 3 the cash, convergence at a point, and that's when 

 4 we talked about the ability to have them at a 

 5 delivery location if it was perfectly one 

 6 location, one point in time. The other 

 7 consideration, and the reason that that may not 

 8 have that convergence as been discussed in some of 

 9 these costs of participating in the delivery 

 10 process, and so as been mentioned, have surely 

 11 increased, even on a percentage term. 

 12 If you look at what Tom Coyle offered in 

 13 terms of the costs in shrinkage, for example, 

 14 that's a complete percentage number. The other 

 15 way that we looked at convergence, and to bring up 

 16 your point about some of those, again, as 

 17 convergence as a noun and the delivery point, some 

 18 of those examples were prior to the change to the 

 19 Illinois Waterway System, which did have 

 20 congestive periods at the terminal markets. 

 21 And again, I think that Tom could 

 22 probably relay some of those situations in the 

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 1 past. And that's why moving to the shipping 

 2 certificate I think helped to alleviate those 

 3 congestion issues, so that grain weren't moving 

 4 opposite of the flow that they should be. 

 5 Now, to sort of get to Dave's question 

 6 about, okay, it started at, you know, a dollar 

 7 some under, did you say the November soybean, and 

 8 then it moved up to about 30 under, and that is 

 9 the convergence sort of as a verb. It's how it 

 10 acts through time. And so now you look at the 

 11 issues again of the costs of the storage and the 

 12 supply and demand for storage in local -- in the 

 13 local market. So that basis, yes, in fact, then 

 14 attributes itself to its predictability. And so 

 15 the second set of research dealt on the 

 16 convergence as a verb, its predictability. 

 17 If it started a dollar under, would it 

 18 move a dollar to come up? Well, if it's, you 

 19 know, so that would help to address pretty much 

 20 the slope of that analysis, if it were $2 under, 

 21 $1.50 under, and moved to $1 or 50 cents under, 

 22 yes, you had a one slope, but then that would 

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 1 effect that intercept on it, and that intercept, 

 2 again, relates back to the costs of the delivery 

 3 process. 

 4 So if, you know, I guess to -- we're 

 5 looking at both convergence as a verb through 

 6 time, because we need to have predictability in 

 7 the basis, as well as we're looking at convergence 

 8 in that noun sense, because now we want to be able 

 9 to make the interaction occur where that linkage 

 10 now meets the cash and the futures markets. So we 

 11 need both types of convergence. 

 12 MR. LUKKEN: Jim Byrum from Michigan 

 13 Agri-business. 

 14 MR. BYRUM:: Thank you. I want to be a 

 15 little more basic and speak about what we believe, 

 16 from a country elevator perspective, may be the 

 17 gorilla in the room, and that is the next six 

 18 months. And it's interesting to talk about 

 19 speculative investment looking forward in future 

 20 contracts and storage changes and things like 

 21 that. 

 22 But if one considers the economic 

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 1 situation of country elevators, and I can't speak 

 2 with cotton or for cotton, we don't do a lot of 

 3 that in Michigan, but if one looks at the 

 4 situation with credit availability, liquidity, we 

 5 have a near term issue from now until harvest, 

 6 about three months for wheat and about six months 

 7 for corn and soybeans, that if we have an upheaval 

 8 in weather, we have a huge issue. 

 9 Margin calls, and I know this is 

 10 probably more of a segue to the next section, but 

 11 it's an issue that can't be lost when, in this 

 12 section we're talking about forward contracting 

 13 and our members, country elevators in the country 

 14 side can't offer instruments, forward 

 15 contractibility, they can't even offer current 

 16 cash sales if the market is not open, that's 

 17 effecting rural America dramatically today and 

 18 potentially in the next six months as I suggest is 

 19 the gorilla in the room. Changes in instruments 

 20 are certainly something that obviously is going to 

 21 be examined and looked at. We encourage 

 22 transparency and we encourage tweaking as opposed 

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 1 to major overhaul. It's significant that the 

 2 market essentially, at least in corn, soybeans, 

 3 and wheat, seems to be reacting to demand, and 

 4 certainly infusions of cash, maybe from 

 5 non-traditional sources, but the challenge is, in 

 6 this period of uncertainty and volatility, 

 7 dramatic change is not the rule and certainly not 

 8 what we should be looking at. Thank you. 

 9 MR. LUKKEN: Layne Carlson from the 

 10 Minneapolis Grain Exchange. 

 11 MR. CARLSON: Layne Carlson from the 

 12 Minneapolis Grain Exchange. Thank you, 

 13 Commissioner Lukken. I just want to comment a 

 14 little bit on Doctor Kunda's -- one of his 

 15 proposals was to change the terms of a futures 

 16 contract to a cash index, and I just want to 

 17 comment. 

 18 There's been some others within this -- 

 19 around this roundtable and mentioned and 

 20 discussed, Tom was one of them, about the cash 

 21 index, and I think the Minneapolis Grain Exchange 

 22 actually offers cash settled index contracts on 

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 1 three wheat contracts, on corn contract, on 

 2 soybean contract, and the topic has been discussed 

 3 a little bit about the cash index, and I thought 

 4 I'd just kind of run by a little bit about what we 

 5 see as some of the terms of these contracts and 

 6 kind of review a little bit what we see as the 

 7 advantages of these contracts, specifically we've 

 8 had these contracts out there for a couple of 

 9 years, this is something we developed, we saw the 

 10 potential option that we wanted to provide the 

 11 industry, for those who didn't want to get 

 12 involved in the delivery process, that they could 

 13 avoid that, and looked for alternatives, and we 

 14 provided something off a regulated contract 

 15 market, and that was the cash sold contract. 

 16 We got the information from a very 

 17 reliable source called DTN, whose -- I think 

 18 everybody in here knows who they are, and what we 

 19 offer is an opportunity where an individual can 

 20 get into the cash -- get into a futures position, 

 21 and there's no reason for them to roll out. 

 22 It doesn't matter going into a delivery 

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 1 month or having to roll out of a position. There 

 2 is -- they can hold simultaneously futures and 

 3 options until the last day of the settlement 

 4 month. Options don't expire before the end of the 

 5 futures trading day. 

 6 So, in essence, there's simultaneous 

 7 expiration. There's no need to exercise options 

 8 on a whim. Convergence, the advantage that we see 

 9 on these cash contracts is that there has to be 

 10 convergence. Doctor Kunda mentioned that in his 

 11 presentation there, that we believe you have to 

 12 force convergence into these -- a settlement 

 13 process. There's no delivery concerns, there's 

 14 nothing to do with convergence concerns, there's 

 15 no storage cost to pay, there's no differentials 

 16 on grade factors when you load out the grain, 

 17 there's actually no concern on position holders. 

 18 It doesn't matter who you are long, it 

 19 doesn't matter who you are short, it doesn't 

 20 matter how many positions are open going into that 

 21 last month or even into the last trading date. No 

 22 one can use inventories at any specific location 

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 1 in order to try to manipulate markets. 

 2 Again, I just -- these are the type of 

 3 things that we believe we've been looking forward 

 4 -- we're forward looking as an exchange trying to 

 5 offer something else into the industry. Each of 

 6 these contract markets are cash sell contracts, 

 7 trade each month, so there's opportunities besides 

 8 a few months out of the year, we offer it every 

 9 month of the calendar year. 

 10 I just think if there's a risk 

 11 management option that people are looking at, the 

 12 cash sell contracts should certainly be one, and 

 13 they factor that it's on the grain exchange, on a 

 14 regulated contract market, should provide a lot of 

 15 that certainty. 

 16 MR. LUKKEN: Well, thank you. 

 17 Unfortunately, we're going to try to break for 

 18 lunch. So we're going to try to make it a short 

 19 lunch to try to get a little bit back on schedule. 

 20 But if we could try to reconvene here 45 minutes 

 21 from now so we can have our last session on 

 22 margin, for which we'll have the Kansas City Fed, 

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 1 as well as the Farm Credit Administration talk 

 2 more on the financing side, which was a big part 

 3 of our discussion this morning. So let's try to 

 4 meet back here in 45. Thank you. 

 5 (Whereupon, a lunch recess was 

 6 taken.) 

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 1 A F T E R N O O N S E S S I O N 

 2 MR. LUKKEN: All right. We're going to 

 3 go ahead and get started here. First off, we have 

 4 the Kansas City Federal Reserve Bank, represented 

 5 by Esther George, to give a presentation on what 

 6 they're seeing in rural credit markets. Welcome, 

 7 Esther. 

 8 MS. GEORGE: Thank you very much. As 

 9 Walt said, my name is Esther George, I'm a Senior 

 10 Vice President with the Federal Reserve Bank of 

 11 Kansas City, where I head their Division of Bank 

 12 Supervision and Risk Management, which includes 

 13 our discount window, our lending to financial 

 14 institutions. And I, too, Walt, want to thank you 

 15 for the opportunity to be here, and to the 

 16 Commission for having this important session. 

 17 It's been most interesting to my colleagues and I 

 18 from the Federal Reserve to listen to the 

 19 discussion this morning. The Federal Reserve Bank 

 20 of Kansas City closely monitors financial 

 21 developments in the agricultural sector given the 

 22 concentration of ag industries in our region, 

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 1 which includes the states of Colorado, Kansas, 

 2 Nebraska, Oklahoma, Wyoming, and parts of Missouri 

 3 and New Mexico. 

 4 As a regulator, the Kansas City Federal 

 5 Reserve Bank supervises approximately 170 state 

 6 chartered commercial banks and nearly 1,000 bank 

 7 holding companies in that region. 

 8 And emerging from our monetary policy 

 9 responsibilities, we also monitor broad 

 10 agricultural and grain market conditions. 

 11 In my comments today, I want to focus on 

 12 the availability of credit from commercial banks 

 13 to the ag sector by providing a general overview 

 14 of current banking conditions, and then 

 15 highlighting the results of your most recent 

 16 quarterly survey of agricultural credit conditions 

 17 in the region. 

 18 Among the issues we've been monitoring 

 19 are grain elevator operations and financing. The 

 20 first signs of financial strain began to emerge in 

 21 January, when bankers were telling us that some 

 22 grain elevator customers were low on cash as they 

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 1 anticipated higher farm input prices, particularly 

 2 fertilizers and chemicals, and has pre-purchased 

 3 crop inputs for spring planting. 

 4 As these grain elevators became 

 5 financially constrained, some began to also 

 6 require pre-payments of their customers to bolster 

 7 cash balances. Since mid February, the surge in 

 8 commodity prices has further strained the cash 

 9 position of grain elevators. 

 10 As some elevators face growing margin 

 11 calls with record prices, business contacts in our 

 12 district began to report that grain elevators were 

 13 requesting additional lines of credit. More 

 14 recently, some grain elevators have limited, and 

 15 in some cases eliminated their offerings of 

 16 forward basis and other contracts to limit further 

 17 strains on their cash flows. 

 18 With grain elevators requesting larger 

 19 credit lines and the deleveraging underway in some 

 20 national credit markets, it is natural to wonder 

 21 about the capacity and willingness of commercial 

 22 banks to extend credit in this environment. To 

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 1 answer that question, let me describe the general 

 2 state of the banking condition briefly. Overall, 

 3 the U.S. banking industry is sound, with $1.3 

 4 trillion in capital. However, in 2007, net 

 5 operating income for all banks fell. A decline in 

 6 income was more prevalent in larger banks and was 

 7 a result of higher loan loss provisions, 

 8 especially in regions with severe contractions in 

 9 the housing market. 

 10 Likewise, net operating income for banks 

 11 in the Kansas City region declined in 2007, but 

 12 remained above the national average, feeling 

 13 margin pressures squeezing those profits. We have 

 14 seen among regional and other small banks with 

 15 large concentrations in real estate, particularly 

 16 construction and land development, increases in 

 17 problem loans, although the current levels remain 

 18 below historic ties. And on the whole, capital 

 19 levels remain well above regulatory minimums. 

 20 Agricultural banks in general have 

 21 faired better than other banks of comparable size. 

 22 For ag banks, the rate of return to assets remains 

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 1 at the historical average, although we have seen 

 2 the rate of return on equity edging down to its 

 3 low in 2001. 

 4 Return rates at ag banks are stronger 

 5 than other small banks, and their net charge-offs 

 6 have remained relatively low. Overall, the 

 7 condition of the banking industry suggests it 

 8 remains well positioned to extend credit in 

 9 today's environment. But beyond the ability to 

 10 lend, one might ask to what extent do banks remain 

 11 willing to lend and under what terms. We look to 

 12 the respondents to our district's agricultural 

 13 credit survey, which surveys over 300 bankers in 

 14 our district each quarter, to give us a sense of 

 15 current credit terms. 

 16 At the outset, I should note that our 

 17 survey indicates that the farm credit system has 

 18 more direct exposure to grain elevator financing 

 19 than commercial banks. In March, roughly 

 20 two-thirds of the respondents indicated that local 

 21 elevators were receiving funding from the farm 

 22 credit system. Less than a third noted that 

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 1 commercial banks were involved in funding local 

 2 elevators. 

 3 Because of the price volatility in the 

 4 commodity markets, we asked a series of special 

 5 questions in our March, 2008 survey, and learned 

 6 that only a quarter of the respondent banks were, 

 7 in fact, actively engaged in grain elevator 

 8 financing. Of these banks, 40 percent of them 

 9 reported that grain elevators had enough cash to 

 10 cover current margin calls. And over a third of 

 11 them reported that local grain elevators had not 

 12 only enough cash to cover current, but expected 

 13 future margin calls. Fewer than a quarter of 

 14 those reporting on this survey reported that local 

 15 grain elevators were struggling to meet margin 

 16 calls. Those that did report customers with 

 17 financial strains were generally concentrated in 

 18 the wheat growing regions of our district, eastern 

 19 Colorado, western Kansas, parts of Oklahoma and 

 20 New Mexico, and even there reports of struggling 

 21 grain elevators tended to be heavily localized. 

 22 One survey respondent noted that the 

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 1 line of credit for a single elevator had risen 

 2 eight fold and required participation of the 

 3 credit with three other banks. 

 4 Contacts with our larger commercial 

 5 banks indicate that bigger grain elevators are 

 6 also tapping and asking for additional lines of 

 7 credit. 

 8 With larger demands for credit, banks 

 9 are reporting increases in the number of 

 10 participation agreements, where two or more banks 

 11 will extend credit to these grain elevators. 

 12 So how are banks responding to this 

 13 increased demand for credit? Across the country, 

 14 commercial banks appear to have funds available 

 15 for such loans. Federal reserve agricultural 

 16 credit surveys for the Kansas City district, as 

 17 well as those in other federal reserve districts, 

 18 continue to report that funds available for loans 

 19 expanded over the past year. In fact, the 

 20 availability of loan funding in the Kansas City 

 21 district reached its highest level in four years 

 22 in March. And conversely, the number of loans 

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 1 refused due to shortages of funds continues to 

 2 fall. The amount of funds available for loans has 

 3 risen as agricultural banks experience record high 

 4 loan repayment rates and a continued contraction 

 5 in loan renewals and extensions by farmers. At 

 6 the same time, farm loan demand has declined in 

 7 the past six months, freeing up additional funds 

 8 at agricultural banks. 

 9 The interest rate environment has also 

 10 been favorable for ag credit. Recent declines in 

 11 national interest rates have led to steep cuts in 

 12 agricultural loan interest rates. In March, our 

 13 district banks reported that farm interest rates 

 14 dropped to their lowest levels since 2004. 

 15 On the other hand, we have seen growing 

 16 attention on the part of banks to underwriting 

 17 standards. For example, collateral requirements 

 18 appear to have edged up, although they remain well 

 19 below 2003 levels. As a result, given current 

 20 market conditions, and as grain elevators seek 

 21 additional lines of credit, they might well expect 

 22 increased scrutiny by lenders of their business 

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 1 operations, risk management practices, and 

 2 financial statements. Let me close by saying the 

 3 banking industry remains sound and able to provide 

 4 credit as grain elevators in other parts of the ag 

 5 sector increase their credit lines as a result of 

 6 margin calls. To date, creditors appear to be 

 7 working effectively with these elevators to ensure 

 8 that financing needs are met, and there is no 

 9 indication that this should not continue to be the 

 10 case. 

 11 That said, while credit is available, 

 12 banks are likely to pay careful attention to the 

 13 strength of risk management of these elevator 

 14 operations when deciding to advance additional 

 15 credit. That concludes my remarks. Thank you, 

 16 Walt. 

 17 MR. LUKKEN: Thank you very much, 

 18 Esther. We now turn to Andrew Jacob with the Farm 

 19 Credit Administration. 

 20 MR. JACOB: I'm Andrew D. Jacob, the 

 21 Director for the Office of Regulatory Policy at 

 22 the Farm Credit Administration. I want to thank 

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 1 Acting Chairman Walter Lukken for inviting me to 

 2 speak with you today on the topic of agricultural 

 3 credit from a financial regulator's perspective. 

 4 We do also appreciate being here today listening 

 5 to the earlier discussions, very informative. 

 6 Today I will briefly provide comments about the 

 7 Farm Credit Administration, the farm credit 

 8 system, and agricultural credit conditions. The 

 9 Farm Credit Administration is the independent 

 10 safety and soundness regulatory agency for the 

 11 farm credit system and the Federal Agricultural 

 12 Mortgage Corporation, also known as Farmer Mac. 

 13 The farm credit system and Farmer Mac 

 14 are government sponsored enterprises. The Farm 

 15 Credit Administration has broad regulatory and 

 16 enforcement authorities under the Farm Credit Act 

 17 of 1971, as amended. The agency's examination and 

 18 policy development programs are directed by a 

 19 full-time, three person board. Board Members are 

 20 appointed by the President of the United States, 

 21 with the advice and consent of the Senate. 

 22 As a safety and soundness regulator of 

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 1 the farm credit system, we strive to be proactive 

 2 in our examination and regulatory actions 

 3 considering the trends in the agricultural credit 

 4 market place. 

 5 We understand that the current 

 6 environment of high commodity price volatility and 

 7 input cost includes risks that must be 

 8 appropriately and prudently identified, monitored, 

 9 and managed. As a result, we are closely watching 

 10 the changing dynamics in the commodity markets and 

 11 the potential attendant risks to lenders that 

 12 provide credit to the agricultural industry. We 

 13 also continue to monitor the general agricultural 

 14 economy. The agricultural economy has experienced 

 15 several favorable years with strong net earnings 

 16 at the producer level. Earnings were supported, 

 17 in part, by high commodity prices and strong 

 18 exports. Exports, in turn, were helped by 

 19 declining U.S. dollar and strong foreign demand. 

 20 However, a weakening general economy, 

 21 growing biofuels industry, rising input costs, 

 22 increasing feed costs, changing farm land values, 

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 1 and evolving government, farm, and trade policies 

 2 are contributing to the potential future 

 3 uncertainties in the agricultural economy. 

 4 These uncertainties have been noted with 

 5 agricultural producers across the board 

 6 experiencing increases in operating costs. 

 7 Increases have been particularly significant for 

 8 livestock producers. 

 9 The farm credit system is a network of 

 10 103 borrow owned, cooperative financial 

 11 institutions and affiliated service organizations 

 12 serving all 50 states and the Commonwealth of 

 13 Puerto Rico. It is established under the 

 14 authority of the Farm Credit Act to provide credit 

 15 and financially related services to farmers, 

 16 ranchers, residents of rural communities, and 

 17 agricultural and -- cooperatives. Entities that 

 18 can borrow from the farm credit system include 

 19 credit worthy grain elevators and other processing 

 20 and marketing entities that meet statutory and 

 21 regulatory eligibility requirements. 

 22 The farm credit system is a $186 billion 

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 1 lender to U.S. agricultural and rural America. At 

 2 year end, it had a total loans outstanding of $143 

 3 billion. Lending to cooperatives and processing 

 4 and marketing entities totaled about 26 billion, 

 5 which is diversified among various types of 

 6 entities. 

 7 While the farm credit system is a 

 8 significant lender to the grain industry, loan 

 9 portfolio concentration in all grains and cotton 

 10 was only about 13 percent of the total lending 

 11 portfolio due to commodity diversification. 

 12 The farm credit system is fundamentally 

 13 safe and sound with adequate capital, strong 

 14 credit quality, good agricultural loan portfolio 

 15 diversification, proven and seasoned management 

 16 and governed structures, strong earnings, and good 

 17 liquidity provided through access to the agency 

 18 debt markets. 

 19 For 2007, the farm credit system again 

 20 posted strong operating performance. As a result, 

 21 it has the ability and willingness, given the 

 22 statutory mission, to meet the financing needs of 

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 1 credit worthy and eligible customers. 

 2 As a financial regulator, the farm 

 3 credit system, I'm sorry, as the financial 

 4 regulator, the Farm Credit Administration 

 5 considers the current commodity markets and 

 6 agricultural economic situation from the 

 7 perspective of its safety and soundness oversight 

 8 responsibilities for the farm credit system. 

 9 Looking back over the first quarter of 

 10 2008, we have seen a significant increase in 

 11 credit provided to elevators and other processing 

 12 and marketing entities. They have drawn down 

 13 existing loan commitments or expanded credit lines 

 14 to cover the margin requirements from using 

 15 commodity futures to hedge their positions. 

 16 As you know, margin requirements have 

 17 increased significantly as a result of higher 

 18 commodity prices and changes imposed by the 

 19 commodity exchanges. The farm credit system has 

 20 met the increased credit demand of elevators and 

 21 other processing and marketing entities. It did 

 22 so by obtaining funds through the sale of 

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 1 securities in the agency debt markets. Debt 

 2 securities outstanding increased by about $10 

 3 billion over the first quarter of 2008, or about 

 4 six percent. Debt outstanding fluctuates based on 

 5 seasonal credit demand factors. This year we are 

 6 seeing seasonal credit demand increasing to a new 

 7 level in light of higher commodity and input 

 8 prices. Along with increased credit demand, we 

 9 observed that the farm credit system did not 

 10 materially change its underwriting standards. It 

 11 has prudently stepped up, though, its risk 

 12 management and credit controls to closely monitor 

 13 and perform due diligence on borrower's assets 

 14 that collateralize their loans. 

 15 As part of their underwriting and credit 

 16 practices, we expect the farm credit system to 

 17 carefully evaluate the risk management practices 

 18 and capabilities of its customers, particularly in 

 19 light of recent commodity price volatility. 

 20 Looking forward, we do expect the farm 

 21 credit system will continue to see strong credit 

 22 demand. From the regulator's perspective, we 

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 1 presently believe that the system is well 

 2 positioned to continue to meet the credit needs of 

 3 elevators and other processing and marketing 

 4 customers. 

 5 Obviously, the issues that we discussed 

 6 this morning have resulted in greater risks and 

 7 uncertainties, particularly given the future 

 8 market issues that you were discussing earlier. 

 9 And this has resulted in more leverage seen at 

 10 some elevators and processing marketing entities. 

 11 Given this dynamic commodity credit situation, 

 12 customers are closely evaluating their future 

 13 borrowing needs. And faced with significant 

 14 demand and working capital, we have heard that 

 15 some elevators and other processing and marketing 

 16 entities may be modifying their marketing options 

 17 offered to agricultural producers. 

 18 It appears that entities that are making 

 19 changes are doing so to manage the financial 

 20 risks, borrowing cost, counter party exposure, and 

 21 leverage given their specific circumstances and 

 22 management objectives. 

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 1 Therefore, some entities may not be 

 2 offering producers the same longer term forward 

 3 sales and hedge to arrive contracts. As a result, 

 4 this situation may lead them to make changes in 

 5 risk management practices and marketing practices. 

 6 These changes might include, among others, using 

 7 options based hedging, requirement revenue crop 

 8 insurance, and increased equity capital, and I 

 9 think we talked about another one, about the use 

 10 of agricultural swaps. 

 11 These changes may further result in risk 

 12 transference to individual agricultural producers 

 13 who may increasingly need to manage the risks of 

 14 commodity price volatility by hedging directly in 

 15 the futures markets and obtaining funding for this 

 16 activity. We further recognize the importance of 

 17 risk management practices at the producer level 

 18 and the importance of the industry responding to 

 19 the dynamic market place environment. 

 20 The Farm Credit Administration continues 

 21 to ensure that the farm credit system 

 22 appropriately maintains internal controls, 

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 1 financial capacity, expertise, and underwriting 

 2 requirements. We have stepped up our examination 

 3 and systemic risk analysis activities to remain 

 4 proactive in our oversight of the farm credit 

 5 system. 

 6 We also continue to provide the farm 

 7 credit system the flexibility, balance sheet, and 

 8 capital management. Flexibility is needed so that 

 9 lending capacity remains available and risk 

 10 exposures stay within the farm credit system's 

 11 risk bearing capacity. 

 12 Examples include raising capital through 

 13 third party sources, managing loan exposures 

 14 through participations within the farm credit 

 15 system and with other lenders, increasing system 

 16 wide coordination efforts, and working with 

 17 agricultural producers as they adjust their risk 

 18 management strategies. 

 19 In conclusion, competition in the 

 20 agricultural lending markets remains robust with 

 21 the farm credit system, commercial banks, and 

 22 other lenders, providing liquidity to the 

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 1 agricultural industry. As a significant financier 

 2 of the agricultural industry, the farm credit 

 3 system has met, and we believe will continue to 

 4 meet the increased credit demand resulting from 

 5 higher commodity prices, input prices, and farm 

 6 land values. 

 7 From our perspective, the farm credit 

 8 system has the financial strength, industry 

 9 expertise, and mission focus to play a significant 

 10 role in meeting the agricultural industry's credit 

 11 needs going forward. I thank you for the 

 12 opportunity to address the Commodity Futures 

 13 Trading Commission's agricultural forum. And with 

 14 that, that concludes my remarks. 

 15 MR. LUKKEN: Thank you very much, 

 16 Andrew. I'd ask Samuel Miller from the American 

 17 Bankers Association if he has thoughts from the 

 18 banking side of things. 

 19 MR. MILLER: Thank you, Mr. Chairman. 

 20 Again, Sam Miller, I'm with M&I Bank in Appleton, 

 21 Wisconsin, representing the American Bankers, and 

 22 work with both farmers, producers, and grain 

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 1 elevators in our agri-business -- production ag 

 2 and agri-business banking activities. And I think 

 3 you've heard from a couple of the regulators what 

 4 the situation is like out in the field, and that 

 5 is that the financial community is supporting the 

 6 efforts that our grain elevator customers and our 

 7 farm customers are finding. There's no doubt that 

 8 increased credit limits have occurred. 

 9 We've had to increase lines of credit 

 10 for our grain elevator customers, we saw it in 

 11 2006 and 2007, and we thought we had done that, 

 12 seen that picture, and then it got worse this 

 13 year, so certainly those issues have continued to 

 14 occur. 

 15 What we have done, again, is increased 

 16 monitoring. We're asking a lot more questions of 

 17 our customers. We want to understand the 

 18 circumstances that they're in, what they're doing, 

 19 who they have contracts with, whether or not 

 20 they're signed, how much is based on inventory, 

 21 how much is based on future delivery, how far out, 

 22 and all the proper and appropriate things to do 

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 1 when you're lending somebody quite a bit of money. 

 2 For the most part, our customers have 

 3 done what they have seen as appropriate for their 

 4 circumstances. In many cases, farmers have said, 

 5 with the rapid increases that they've seen in crop 

 6 input prices, they haven't wanted to take some 

 7 risk out in future years, in other cases they 

 8 have. 

 9 So, again, we see the market places 

 10 working, but everyone is questioning, where is it 

 11 going, and when is it going to come back kind of 

 12 into "normal times." 

 13 MR. LUKKEN: Well, I know there's lots 

 14 of discussion and concern about margin levels, and 

 15 we've asked Tom Farley from ICE to talk a bit 

 16 about what his experience has been in recent times 

 17 for margin calls. And I know people have strong 

 18 views on this. A couple folks that have emailed 

 19 us over time, are wondering about differentiating 

 20 between speculators and hedgers as far as margin 

 21 and whether that's useful. 

 22 I know we have Ken Morrison out there 

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 1 that's asked that in our atrium. He is interested 

 2 in that issue, as well as Mike Sezullo from the 

 3 Midwest. So if these are some of the issues that 

 4 we might be able to address today, I think that 

 5 would be useful for the people listening here 

 6 today, as well as over the Internet. 

 7 MR. FARLEY: Thanks, Chairman, sure, I'd 

 8 be happy to comment on those issues and one other 

 9 issue, if I can, regarding margins and 

 10 determination of margins in a significant price 

 11 rise environment. 

 12 With respect to the direct answer to the 

 13 question from the gentleman in the atrium, 

 14 distinction between margins for hedgers and 

 15 speculators, we do that today pursuant to CFTC 

 16 regs, and we think that that's appropriate the way 

 17 we have it right now. We haven't been looking 

 18 into modifying our initial margin requirements as 

 19 they relate to those two different classes of 

 20 traders. I just wanted to spend a minute or two, 

 21 if I can, talking about the determination of 

 22 margin in an environment where prices spike, or 

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 1 they rise dramatically. 

 2 We've talked a lot today, Diana made a 

 3 very eloquent speech about what's going on in the 

 4 market, and ultimately, Diana's conclusion was 

 5 there's a financing issue where, you know, who's 

 6 going to wear the risk of posting margin when 

 7 prices move dramatically. Tom Coyle brought it 

 8 up, as did Joe Nicosia. 

 9 And I think financing around margins is 

 10 something that we need to continue to talk about 

 11 and work with industry and work with the banking 

 12 industry to figure out how the industry is going 

 13 to be able to post margins in these environments. 

 14 But I'd like to distinguish between a 

 15 gradually rising environment, even if it's -- so, 

 16 for instance, in cotton, going from say 50 cents 

 17 to 80 cents over a period of three or four months, 

 18 that allows -- the three or four months allows 

 19 people to have a little bit of time to put in 

 20 place additional credit capacity to be able to 

 21 post margin. That's one type of financing, and 

 22 that's -- in this day and age, we all know we're 

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 1 in a credit crunch, it's not particularly easy to 

 2 line up financing even for that. Then there's a 

 3 separate type of financing requirement, and that's 

 4 what we experienced in our cotton market in early 

 5 March. That's where, in a single day, the price 

 6 of cotton rises 12 cents or roughly 15 percent. 

 7 In that situation, overnight, you're 

 8 going to have to find financing to be able to post 

 9 margin against your short futures position. So 

 10 I'd like to talk about how we determine margin in 

 11 that environment and some of the issues that that 

 12 raises. 

 13 Before I do that, I'd just like to talk 

 14 about the role of a clearinghouse at a futures 

 15 exchange. We've operated this cotton exchange, I 

 16 say we, but the cotton exchange has been operated 

 17 for 138 years, and the role of the clearinghouse 

 18 has remained relatively constant, it's to act as 

 19 the counter party for every cleared trade while 

 20 preserving the integrity of the clearinghouse. 

 21 And the way we do that is, we require, 

 22 among other things, initial margin and variation 

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 1 margin, which is calculated using the best 

 2 available price, not always necessarily the 

 3 perfect price, but the best available price 

 4 approximating market value. At our exchange, as I 

 5 mentioned earlier, we have a cotton contract 

 6 committee, it has about 20 representatives, many 

 7 of whom are here today, and that cotton contract 

 8 committee is made up of what I'll call natural 

 9 longs, and what I mean by that is, they have to 

 10 sell futures or go short futures to hedge a 

 11 physical exposure. 

 12 These folks, when the price of cotton 

 13 rises, they have to post additional collateral. 

 14 Well, the price of cotton has been rising, it was 

 15 68 cents at the end of the year, it was 94 cents 

 16 on March 4th, an increase of roughly 40 percent. 

 17 And in the beginning of March, the price 

 18 of cotton rose very, very quickly, it went from, 

 19 if I have my statistics right, I believe 78 cents 

 20 on February 27th, 94 cents on March 4th, so this 

 21 is the type of environment that I'm describing, 

 22 this significant price spike environment. 

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 1 And at the same time, the cash market 

 2 for cotton shut down. Why is this important? 

 3 Well, at a very simple level, one way of creating 

 4 financing for yourself is, you sell your physical 

 5 cotton. If you can't do that, that's -- well, 

 6 that's one less source of cash. And so at the 

 7 same time that this price is rising, margin 

 8 requirements are rising, the ability to sell 

 9 cotton was going away. And this combination meant 

 10 that growers and coops and merchants had to borrow 

 11 in order to meet their margin requirements. And 

 12 given that we're in this liquidity crunch, that 

 13 was very difficult. 

 14 In fact, we've heard sad reports of 

 15 farmers and other operations who went bankrupt. 

 16 During this period, the cotton committee came to 

 17 the exchange, and there was an ongoing dialogue, 

 18 which we're very grateful for, and we learned 

 19 quite a bit, and they came to the exchange, and 

 20 they said, well, one way you can ease the burden 

 21 of the industry is, you can -- the exchange can 

 22 use an upper bound to determine margin prices, and 

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 1 the suggested -- on a day-to-day basis, and the 

 2 suggested upper bound was three cents. 

 3 And in effect, what this would do is, it 

 4 would put a cap, a daily cap on margin 

 5 requirements in these price spike situations. We 

 6 held individual calls and group calls with -- and 

 7 meetings with the cotton industry to consider 

 8 this. 

 9 And, you know, we wanted to help the 

 10 industry. As I've said before, we don't make 

 11 money by collecting margin, we don't make a dime. 

 12 But we have to remember to protect the integrity 

 13 of the clearinghouse. And so we talked to our 

 14 exchange board, as well, and our clearing board, 

 15 the CFTC, and ultimately we decided that in a 

 16 severe price spike environment such as we saw on 

 17 March 3rd, we need to use some -- a value for 

 18 margin calculations that approximates the real 

 19 value of cotton as opposed to an artificial price 

 20 limit. And for us to use a price materially 

 21 different would put our clearinghouse at risk and 

 22 put our company at risk, and at the risk of maybe 

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 1 sounding like I'm exaggerating, potentially put 

 2 the U.S. financial markets at risk. 

 3 And just to put it in perspective, on 

 4 March 3rd, if we had chosen not to margin at the 

 5 true value, but instead to margin using artificial 

 6 price limit, we would have collected $600 million 

 7 less of capital into our clearinghouse, which is 

 8 six times our default fund. A default fund is 

 9 what I call the rainy day fund at exchange. 

 10 I mean just to give you an idea of the 

 11 magnitude of the dollars, and we operating at 

 12 clearinghouse feel very uncomfortable with that. 

 13 A complicating factor, and I think a 

 14 very important factor, not just for our market, 

 15 but for the markets that we're discussing today, 

 16 wheat and corn and beans, is the absence of 

 17 trading in the futures markets in these severe 

 18 price spike environments. 

 19 So we have a price limit structure that 

 20 halts all futures trading when the price of 

 21 futures goes up by three cents. These price 

 22 limits in most markets are set, they're triggered 

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 1 once a year, once every five years or ten years. 

 2 In our market, we've actually hit this price limit 

 3 18 times this calendar year along, in the first 

 4 quarter of this calendar year alone. And on March 

 5 4th, the value of cotton increased by 25 cents 

 6 versus the three cent limit. 

 7 So on March 3rd, a complicating factor 

 8 is that the only market where we had trades was 

 9 our options market, which isn't a suitable market 

 10 for everyone, but it was very active, it had a lot 

 11 of volume, and so we looked towards that market 

 12 for price discovery. 

 13 On March 3rd and 4th, just to put some 

 14 statistics to it, the futures markets were not 

 15 open because we were above the limit, but we 

 16 traded over 120 -- we averaged 120,000 options a 

 17 day. And somebody mentioned this earlier, but if 

 18 you buy a call option, you sell -- at the same 

 19 price, essentially you're buying a future, not 

 20 exactly, but it's very close. And the opposite is 

 21 true, and you'd be selling a future. 

 22 We had tens of thousands, dozens of 

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 1 thousands of these transactions on the 3rd and the 

 2 4th, so it was actually quite easy for us to 

 3 discern the price that was being discovered in the 

 4 options pit. And using those prices, we 

 5 calculated our margin requirements. Now, that's 

 6 all context. 

 7 Notwithstanding that, we had, as I said, 

 8 a lot of conversations with many of the people 

 9 around this table, and we have agreed to alter our 

 10 margining policy somewhat. Beginning on March 

 11 11th, in fact, we began a new procedure where 

 12 we'll use this futures limit up price, the three 

 13 cents, we'll use this limit up price in a price 

 14 spike environment to margin our futures, and we'll 

 15 use the price actually traded in the options pit 

 16 to margin options. 

 17 However, similar to March 3rd, if we had 

 18 another day where there was a 12 cent move, we 

 19 need to reserve the right to be able to use a 

 20 price that's greater than the limit up price. And 

 21 our current procedure is, we'll use the limit up 

 22 price until it gets another four cents above the 

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 1 limit price, at which point we're going to use 

 2 some greater figure for margin. As you can see, 

 3 we're creating a bit of a half of a solution here. 

 4 And I just want to note quickly a couple 

 5 of the short comings. First, because there will 

 6 be certain days where cotton will trade above the 

 7 limit up price and we will margin at limit up, we 

 8 have to have an artificially high initial margin, 

 9 and that's how we're going to maintain our initial 

 10 margin. Second, this introduces an interest 

 11 situation where you might be long a future in the 

 12 futures pit, short a future in the options pit, 

 13 and yet you'll owe some margin, even though you 

 14 have absolutely no risk from our perspective. And 

 15 third, and I think this is most importantly, and I 

 16 wanted to bring this out to the forefront for this 

 17 group here, we're only committing to use this 

 18 limit up price when the price of the futures 

 19 trades somewhat above limit up. If there is 

 20 another very drastic move, we're going to use a 

 21 higher price for margin, and we'll have some of 

 22 the same pressures that were felt on March 3rd and 

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 1 March 4th. 

 2 So, you know, in short, as I said, I 

 3 don't think this is the final solution. We've 

 4 learned a lot today, we look forward to continuing 

 5 to work with our cotton committee. 

 6 And we're also going to continue to 

 7 evaluate our price limit structure. As determined 

 8 in 2008, are these limits appropriately set, are 

 9 they a contributor to, or, in fact, a defense 

 10 against volatility that we saw in early March. 

 11 Finally, I'd like to conclude by saying 

 12 that there's a vexing factor here where some of my 

 13 colleagues in Chicago, they actually use a 

 14 different approach for margining, where they more 

 15 typically do use the futures limit up price and 

 16 limit down price. We as an exchange, we're open 

 17 to ideas, we're open to information sharing, and 

 18 we would wholly support if the CFTC wants to look 

 19 into this, we'd be happy to work with you on this 

 20 to see if there are shared best practices among 

 21 exchanges. 

 22 MR. LUKKEN: All right. We'll open it 

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 1 up for discussion. Mr. Dunavant. 

 2 MR. DUNAVANT: Could I go back and talk 

 3 a little bit about the basis that we were 

 4 describing just before we adjourned for lunch? 

 5 MR. LUKKEN: You can do whatever you 

 6 want, that's fine. 

 7 MR. DUNAVANT: Thank you. I want to go 

 8 back to that infamous day, March 4th, when cotton 

 9 made this dramatic move, and traditionally, on the 

 10 basis in cotton, if you'll take a ten year 

 11 average, the basis for our base quality is about 

 12 350 off the near month. On that day, the basis on 

 13 the near month, just to prove the point of a 

 14 broken market, was 2,200 off, and traditionally 

 15 it's around 350 off. 

 16 No sense whatsoever, and you can imagine 

 17 the implications and the margin requirements that 

 18 were generated through this type of movement. 

 19 There was very little cotton traded during this 

 20 period time at this 2,200 off -- were not willing 

 21 to accept that price, but some cotton did trade at 

 22 2,200 off, and some even a greater level than 

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 1 that. And that, again, to me, tells me the New 

 2 York Cotton Market, the ICE market, was broken, 

 3 the option volatility was humongous. 

 4 I think the volatility at that one day 

 5 got to 80 percent, 80 percent volatility, and you 

 6 can imagine what that does to your margin 

 7 requirements. 

 8 Tom, I would certainly ask the ICE 

 9 Exchange to revisit some of their programs that 

 10 they've got in place for the industry. The 

 11 industry really has suffered, and ICE is certainly 

 12 not totally to blame. But I think you guys have 

 13 played some part in some of the defamation and 

 14 margin problems that the industry had, whether it 

 15 was producers, coops, or merchants. 

 16 The other thing that I'd like to mention 

 17 is, if you will translate what futures did during 

 18 that short period of time, that day, it was like 

 19 the Dow Jones going from 12,000 to 15,500 in one 

 20 day, or a 3,500 point move. Never happened, never 

 21 will happen. But that just gives a comparison of 

 22 how dramatic cotton's problems were during that 

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 1 short period of time. Thank you, Mr. Chairman. 

 2 MR. LUKKEN: Thank you. Woods. 

 3 MR. EASTLAND: Since Billy talked about 

 4 margin, I thought it might be a good time for me 

 5 to digress a little bit in time. Before lunch I 

 6 was going to say this. It seemed to me, from 

 7 listening to the comments around the table and 

 8 also the comments from some of the presenters, 

 9 perhaps a consensus that something went on in 

 10 cotton that was not understood. 

 11 And I would urge the CFTC to investigate 

 12 in depth what went on in cotton, because once this 

 13 happened once, it very well may happen again, or 

 14 it may happen in some other market. And I think 

 15 it would be very important for you all to come to 

 16 an understanding so whatever regulatory regime 

 17 needs to be put in place to keep it from happening 

 18 again, if you can do so. Thank you. 

 19 MR. LUKKEN: Thank you. Diana. 

 20 MS. KLEMME: Thank you, Mr. Chairman. I 

 21 want to put something in perspective. Our firm 

 22 works with largely country elevators, we are a 

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 1 futures firm, and in 30 plus years, more years 

 2 than I care to admit precisely, I've never spent 

 3 as much time as I have this year hand holding with 

 4 our customers how they're going to get through to 

 5 the next line of credit, how they're going to 

 6 manage, looking at what they're doing for their 

 7 farm strategies, which bids they pull, what 

 8 service charges they implement, what credit lines 

 9 are going to be available to them. We have some 

 10 that have switched out short futures into put, 

 11 pardon me, put call combinations. I'm spending, 

 12 on a given day, it can be from ten to 90 percent 

 13 of my days working on financial issues out there. 

 14 So I went back -- because I thought, if somebody 

 15 calls me on this, I better have some numbers 

 16 available. 

 17 So I went back and I, to be objective, I 

 18 took six of our customers, coop, private, large, 

 19 small, in soft wheat areas, non-soft wheat areas, 

 20 and I looked at every single one of their 

 21 financial ins and outs, wires in and out, every 

 22 day for the first three months last year and the 

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 1 first three months of this year. 

 2 The largest single call that we had in 

 3 Jan, Feb, March of '07, out of that pool of just 

 4 six elevators was $392,000, I'm sorry, the largest 

 5 out of the three months was $1.2 million. This 

 6 year the largest was $2.95 million. So that's one 

 7 statistic. 

 8 Now, you can, you know, they may have 

 9 different size positions on, but one thing a lot 

 10 of them have done this year is, they've tried to 

 11 get their positions down, especially in soybeans, 

 12 by selling inventory, so the calls wouldn't be 

 13 bigger. So they've already taken defensive 

 14 measures to keep their needs from their lenders 

 15 lower than what they might have wanted to do. But 

 16 this year I also went back and I looked at the 

 17 cumulative out of those six accounts last year 

 18 versus this year, as a percentage, the cumulative 

 19 in and out wires was 583 percent of what it was a 

 20 year ago. It was $40 million, and those six firms 

 21 alone at one point had pushed in $79 million to 

 22 Chicago. Last year that peak was 32 million, so 

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 1 there's a huge difference. 

 2 And I do commend the banking sector. I 

 3 think they've been extremely alert, they've been 

 4 very proactive working with the borrowers. But 

 5 it's also like patching pot holes out here, you 

 6 know, the road is still working right now, but 

 7 we're trying to stay one pot hole ahead of a real 

 8 crisis. 

 9 If we get into something like you've 

 10 seen in cotton, with that kind of a spike, I don't 

 11 think there's enough asphalt to fill the pot holes 

 12 out there. I mean there's just so many things you 

 13 can do, you know. 

 14 They've sold inventory, they've extended 

 15 credit lines, they've cut back their forward bids, 

 16 I don't know where -- we've had a lot of our 

 17 borrowers say that their banks have told them, 

 18 we're with you now, but, you know, and that but 

 19 varies depending on what bank and what customer it 

 20 is, certainly. We can't go much beyond here, we 

 21 can't go beyond some other number, and that's my 

 22 concern, is that if we may be facing a low 

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 1 probability of something really bad occurring. 

 2 We've managed it so far, largely thanks to the 

 3 banks, but I don't know how much further we can 

 4 manage it. And if we would see the elevator 

 5 sector and the commercial grain sector start 

 6 bidding aggressively on new crop grain again as we 

 7 get closer to harvest, once the crops are planted, 

 8 and then the markets explode, we've just 

 9 exacerbated the problems all over again. 

 10 So I'll go back to sort of my areas 

 11 right now, it's an issue of financing, and then we 

 12 can also deal with contract terms. 

 13 MR. LUKKEN: Thank you. Steve Wellman 

 14 with American Soybeans. 

 15 MR. WELLMAN: Thank you, Mr. Chairman. 

 16 As we've gone through the day here, we've 

 17 identified a lot of factors, and I think we've 

 18 gotten to the point now with the financing and the 

 19 funding, at least from a farmer's perspective, of 

 20 the amount of risk that the producers have. 

 21 It's been the past tradition of 

 22 commodity producers to set off -- lay off some of 

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 1 those risks using the heads of the futures 

 2 markets, and now those same markets have turned 

 3 into a product that creates more risk for us. So 

 4 that's where we're at, and what we need to do is, 

 5 find out -- continued discussions like this, and 

 6 open, and very outright thought process, and 

 7 consider what really has to be done and how we can 

 8 reduce the risk that's out there in the futures 

 9 markets, and turn this back to a market that can 

 10 be used by a small investor, a small producer, and 

 11 is not just an investment for the farmer, it's our 

 12 livelihood and it's our business, and our success 

 13 depends on being able to use these financial 

 14 commodity markets. Thank you. 

 15 MR. LUKKEN: Thank you. Justin Towery 

 16 from the Rice Federation. 

 17 MR. TOWERY: Thank you, Mr. Chairman. 

 18 The rice industry is also living through over a 

 19 longer period of time what the cotton industry 

 20 went through in a brief period of time. The 

 21 company that I am with handles many different 

 22 grains, so we have felt this cycle all along. 

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 1 Just for comparison to Mr. Dunavant's 

 2 numbers, in the past, traditional rice basis on 

 3 old crop would be 60 to 80 under at this time of 

 4 year. Right now, the cash market is roughly 200 

 5 to 300 points under. Traditional new crop basis 

 6 this time of year would be about 60 to $1.20 

 7 under. Right now, if you had to compare it to the 

 8 futures market, you would be about 300 to 400 

 9 points under. So much risk has been taken on by 

 10 country elevators, by producers, by the industry 

 11 as a whole, that we have had to prudently say, we 

 12 can't take anymore. Volatility has been the cause 

 13 of this, and assessment of that risk has gotten to 

 14 the point that, as of this past week, there was 

 15 only one commercial player in the rice market with 

 16 a bid index to the Board of Trade. 

 17 In summation, about that point, I would 

 18 say that volatility has got to be reduced in some 

 19 way or the other. One proposal that I would have 

 20 would be to expand the delivery system for rice, 

 21 as it's very isolated and small at the current 

 22 time. Perhaps alternative delivery points, as 

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 1 were suggested in other crops earlier. 

 2 But the base of all of the problem is 

 3 that we are losing opportunity for our producers, 

 4 for our commercials, and for everyone involved in 

 5 the system at this time. And the cost of that 

 6 right now can't be quantified, but it will be real 

 7 and realized as time goes on if these volatile 

 8 times continue. And so we would ask any measures 

 9 that could be taken to reduce volatility and allow 

 10 commercial hedgers, producers, anyone else in the 

 11 rice industry to participate in the futures market 

 12 again would be taken. 

 13 MR. LUKKEN: On the delivery point 

 14 issue, I know there are others in cotton that 

 15 would like to see more western delivery points. 

 16 We heard a lot of comments from Texas growers 

 17 about those issues on the Internet, and if anybody 

 18 has comments on those, we'd welcome those, as 

 19 well. I know we have Garry with the Corn Growers. 

 20 MR. NIEMEYER: Thank you, Mr. Chairman. 

 21 I represent 32,000 corn growers here today, and I 

 22 am a farmer. 

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 1 I just had a phone call that my neighbor 

 2 was planting corn. I know better than that, 

 3 there's water standing in his field, but it sure 

 4 didn't make me feel any better. I wanted to -- 

 5 he's that kind of a guy. I wanted to thank Jim 

 6 Byrum, I wanted to thank Diana Klemme for their 

 7 comments, and I'm leaving with these two people 

 8 right here, Esther and Andrew, because the whole 

 9 problem is convergence. 

 10 The elevators can't get the money from 

 11 the banks because we don't have convergence. 

 12 We, as farmers, can't sell our grain 

 13 because the banks don't allow the elevators to 

 14 have money because of convergence. But I'm not 

 15 really sure we've resolved any convergence issues. 

 16 And like the gentleman that spoke just about rice, 

 17 I would think that we ought to come up with some 

 18 kind of a delivery system, we've had delivery 

 19 systems that -- the current delivery system really 

 20 doesn't work necessarily for farmers, and I think 

 21 that we ought to have some form of a compelled 

 22 load out, and I think it should be a fixed percent 

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 1 of load out on each expiring month, randomly 

 2 distributed, with arbitrary rules, only if futures 

 3 are above cash, but that's the only way you're 

 4 going to resolve bringing the cash and futures 

 5 together. The gentleman who sat across from me 

 6 was wheat, and the gentleman with rice, and the 

 7 cotton, I've heard all about it. We really 

 8 haven't had the problem in corn yet, but it's just 

 9 around the corner, I think, and we're very 

 10 concerned about it. 

 11 It doesn't make a lot of sense to have 

 12 $2.50 basis on wheat, $2.50 below futures price, 

 13 and then we get beat up in the newspaper that 

 14 people are starving to death. Who's making the 

 15 money? 

 16 But my real point is, we've got to get 

 17 back to some form of resolving the convergence of 

 18 this whole issue. And we also have the 

 19 opportunity in our area, because we have a lot of 

 20 trains, train loaders, that there could be train 

 21 load outs for corn moved to any place that need 

 22 be. 

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 1 In the 1990's, I think there was a 

 2 Minneapolis and a Duluth, Minnesota on track 

 3 delivery, maybe that could be revived. Again, 

 4 most of the people I represent are from 26 

 5 different states, and they want to have the 

 6 delivery system that makes convergence work. 

 7 Thank you. 

 8 MR. LUKKEN: Jerry with the Wheat 

 9 Growers. 

 10 MR. MCREYNOLDS: Thank you; Jerry 

 11 McReynolds. This kind of hits right home with me. 

 12 A particular elevator in -- well, I'll back up 

 13 just a little bit. Kansas has had some serious 

 14 problems, they've lost some elevators because of 

 15 the credit crunch, partially margins, partially 

 16 just the requirements of supplies and inventory 

 17 and all those things, good, solid businesses, and 

 18 I'll give you an example of one that has not been 

 19 lost, but the dynamics of what's happened. 

 20 This business is a cooperative, a very 

 21 solid, owes no money, you know, historically, so 

 22 it's in good shape, several locations, used to get 

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 1 by about three -- with about a line of credit 

 2 about $3 million, then it did go to 5, last fall 

 3 it went to 15, which was a big jump, and thought 

 4 maybe sure that that would be all right. 

 5 I talked to the general manager in 

 6 March, he said he was negotiating a 50, I used to 

 7 serve on that board, so I knew a little bit about 

 8 the finances, and he was trying to get a line of 

 9 credit of $50 million, which seemed huge to me, I 

 10 thought, oh my. 

 11 Well, I talked to him the other day, and 

 12 he's found out he's done his planning, 50 isn't 

 13 going to cover it, it's going to take $80 million. 

 14 This is a 40 -- $50 million coop. We're at a real 

 15 critical stage in agriculture. It effects our 

 16 country elevators, it certainly effects us 

 17 producers, because the same thing has happened to 

 18 us, our inputs, fertilizer has gone up at least 

 19 twice, phosphates selling for -- traded for $1,000 

 20 a ton, inputs of all kind have gone up, chemicals 

 21 have gone up three times, so if you did lock in a 

 22 revenue side, and it's more difficult to lock in 

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 1 the input side, you may be coming up on the short 

 2 end of the stick and thinking you actually had, 

 3 you know, made a reasonable, good deal. 

 4 So it's a problem, it's a credit issue, 

 5 I think ag swaps would be helpful. There has to 

 6 be some mechanism. I can't price '09 delivery 

 7 right now because most of the elevators aren't 

 8 willing to take that risk, they don't know what 

 9 the market is. 

 10 And I say, what do you mean you don't 

 11 know what the market is, you know, well, they 

 12 really don't, and if they do price it, it is -- 

 13 the basis is so wide, you just say, well, I can't 

 14 do that, you know, that doesn't make sense. 

 15 So the banking industry, I've got to 

 16 know my banker really, really well, and I hope 

 17 they stick with me, we really like you, we have 

 18 to, and we hope you like us. So it is extremely 

 19 important to the banking industry, it is a part of 

 20 this solution, it's extremely important that we 

 21 understand each other. I'm also very concerned 

 22 about the small community banks, which I think 

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 1 actually fund most of agriculture, most of 

 2 operations my size; without them, we're dead meat, 

 3 and regulations are getting tougher and tougher, 

 4 and it's not necessarily the profit and loss, 

 5 those kind of regulations are really important, 

 6 it's the BSA and all the 911 regulations that, you 

 7 know, are out there. 

 8 It's a big issue. We're in this 

 9 together, we're going to have to really work hard 

 10 to try to solve some of it. 

 11 I think we can do it. But I appreciate 

 12 your willingness to hear some of our concerns. 

 13 MR. LUKKEN: Thank you, Jerry. We're 

 14 going to do Chuck, and then Andy, and then I'm 

 15 going to turn to my colleagues for questions on 

 16 the dais. Chuck. 

 17 MR. COLEY: Thank you, Mr. Chairman. 

 18 Chuck Coley, American Cotton Producers. I'm a 

 19 cotton producer from Georgia, and not to reiterate 

 20 a lot of things that's been said about the cotton 

 21 market, just to give you a perspective from a 

 22 grower down in south Georgia. I look to the 

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 1 futures market for two things, price discovery 

 2 every day and also to transfer risk by forward 

 3 contracting with some of these guys across the 

 4 table. Our price discovery is there no more, and 

 5 obviously we can't contract cotton anymore. So we 

 6 have, like everybody else, have real high input 

 7 cost, increased input cost, and no -- latest 

 8 market off. You know, if the spike caused it, we 

 9 need to determine what caused the spike, because 

 10 we need a good, accurate market so we can know 

 11 which way we're going to price these inputs, and 

 12 we would urge that the CFTC do something rather 

 13 quickly, the sooner, the better, maybe within 60 

 14 days with the cotton market will get us a more 

 15 functional market. Thank you. 

 16 MR. LUKKEN: Thank you. Andy. 

 17 MR. WEIL: Thank you. Earlier in my 

 18 initial statement, I had come up with some 

 19 recommendations that we'd like for the CFTC to 

 20 take action on. One of those was requiring the 

 21 reporting of all swap and OTC contracts by market 

 22 participants and to determine -- for you to 

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 1 determine the aggregation of those positions from 

 2 all those various sources. 

 3 And aggregating those positions, 

 4 especially as it relates to swaps, swaps have a 

 5 hedge exemption. We would like to see that the 

 6 funds are dealing these -- these and similar 

 7 instruments to divulge who is the counter party. 

 8 That's something we're required to do as 

 9 traditional hedgers, and it's something we would 

 10 like the CFTC to look into. And I agree, I think 

 11 Woods and Chuck alluded to it, that we need to -- 

 12 that we would like to see an investigation as to 

 13 what happened in early March, just to determine 

 14 what went on and how it can be corrected. Thank 

 15 you. 

 16 MR. LUKKEN: Thank you. I'll turn to my 

 17 colleagues, if there are any questions from the 

 18 dais, anybody? 

 19 I actually have one, I'll take the 

 20 Chairman's prerogative. This actually comes from 

 21 somebody who wrote in from Underwood Cotton 

 22 Company, Alan Underwood in Lubbock, Texas, but I 

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 1 think he raises a good point. 

 2 All of this was occurring at the same 

 3 time, structurally in the futures markets, where 

 4 we were going from open outcry trading to 

 5 electronic. And I'm interested in the views, 

 6 whether that had some mitigating or some 

 7 problematic factors in that transition from open 

 8 outcry to electronic; whether there were some 

 9 dampening effects that open outcry provided that 

 10 were not seen with the electronic trading that may 

 11 cause additional volatility. I don't know if 

 12 anybody has thoughts on that. I'll turn to the 

 13 exchanges here; Charlie first. 

 14 MR. CAREY: Yeah, Charlie Carey from the 

 15 CME Group. I do think that there's -- a lot of 

 16 things have taken place this year. I think that 

 17 electronic trading takes place so fast, it takes 

 18 that market place from being a few hundred people 

 19 in a room to suddenly the world has access to your 

 20 markets virtually instantaneously. So somebody 

 21 can be in Singapore, that's the good news and the 

 22 bad news, it happens fast. It's like all the 

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 1 markets around the world, they all happen very 

 2 fast, because activity, the way people want to 

 3 trade today, the way people want access, clearly, 

 4 it takes some adjustment. 

 5 And I think that electronic trading is 

 6 definitely -- put it on the list, it's one of the 

 7 many, many challenges that the traditional hedger, 

 8 the traditional user is adapting to. 

 9 But most people wanted electronic 

 10 trading. I was a pit trader, you know, and 

 11 believe me, I preferred open outcry. But I also 

 12 -- I'm sure there were people that preferred a 

 13 horse and buggy to an automobile 100 years ago and 

 14 they didn't do too good either, you know. 

 15 But the bottom line is, I think that -- 

 16 I'd like to go in one different direction. We've 

 17 all recognized the challenges, I think that the 

 18 exchange is providing global benchmarks, I think 

 19 that our over-the-counter offerings that we would 

 20 like approval on will help mitigate risk, because 

 21 the fact of the matter is, one size doesn't fit 

 22 all, we know that from area to area, the basis, 

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 1 this convergence problem that we're trying to 

 2 tackle, and I'm talking about corn, soybeans, and 

 3 wheat, has been, from time to time, it's varied, 

 4 but the fact of the matter is, I'd like to see 

 5 anybody operate without some sort of a benchmark 

 6 pricing, whether it's meeting your needs today or 

 7 not. 

 8 The fact of the matter is, the world 

 9 looks to the CME Group and the Chicago Board of 

 10 Trade products for that pricing mechanism. Now 

 11 it's up to us to fix the issues that are here with 

 12 us domestically, plain and simple. And each 

 13 market is different. Cotton is different from 

 14 wheat, which is different from beans, which is 

 15 different from corn, and I think it's only through 

 16 a process like this that we can get there. But I 

 17 had to take my opportunity to make that statement, 

 18 Mr. Chairman. 

 19 MR. LUKKEN: Thank you. Tom. 

 20 MR. FARLEY: So on Friday, March -- on 

 21 Friday, I think it was actually February 29th, we 

 22 had our last day of pit traded futures in the 138 

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 1 year history of the cotton market. On the 

 2 following Monday, the price spiked 15 percent, and 

 3 on the following Tuesday, we had four price 

 4 swings, any of which would have been the most 

 5 volatile in the history of the cotton market. I 

 6 don't know if I'm courageous or stupid or a 

 7 combination of the two, but I'm actually going to 

 8 argue they had nothing to do with one another, 

 9 despite what can only be described as a pretty 

 10 amazing coincidence. 

 11 And the reason why we have considered 

 12 this, the reason why is, on that Monday and 

 13 Tuesday, we spent the whole day pretty much in 

 14 what we call limit up situation; in other words, 

 15 there were no futures trading. And so whether 

 16 futures were trading on a floor or on a screen, I 

 17 don't think really had any impact. All of the 

 18 trading was done on the floor. 

 19 That said, I agree with what Charlie 

 20 just said, we are in a new world, and I think 

 21 electronic trading is different from pit trading, 

 22 and perhaps we went limit up quicker than maybe we 

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 1 would have done in the floor environment, as 

 2 people were getting used to this new trading 

 3 situation. 

 4 MR. LUKKEN: Thank you. Lee, I know you 

 5 had a question. 

 6 MR. STROM: Well, actually I -- Mr. 

 7 Chairman, it's more of a comment I think, and it's 

 8 been very informative to listen to all the 

 9 discussion here today, and as I hear about some of 

 10 the short term remedies, possibilities, long term 

 11 remedy possibilities here, and the industry, the 

 12 producer segments out there are talking about the 

 13 challenges and issues, and again, being a 

 14 producer, I guess the analogy that I would like to 

 15 use, and Garry Niemeyer, you can probably relate 

 16 to this being a corn producer also, but when you 

 17 plant your corn crop, and then about the middle of 

 18 June, when you get a two inch gentle rain that 

 19 occurs over a two day period, that's what farmers 

 20 refer to as the million dollar rain, because it 

 21 treats the crop just right, gives it that drink of 

 22 water. 

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 1 But when you get that eight inch rain 

 2 that occurs over a six hour period, you end up 

 3 with a mess, you end up with a gully washer, the 

 4 ground is hard, and it does not work well for the 

 5 crop, because most of the water runs off anyway. 

 6 But using that analogy, I think what the 

 7 producer segment here has been hinting to, is that 

 8 there's been the issue in the cotton, there's been 

 9 a discussion about the potential issue in the corn 

 10 arena, and I would simply speak that, again, from 

 11 a producer perspective and then transitioning into 

 12 the -- a regulator in the financial industry, and 

 13 I appreciate the comments about the responsive of 

 14 the lending industry, because we've attempted to 

 15 have the foresight to adapt to this flexible, very 

 16 interesting and dynamic market place, but in that, 

 17 also realizing that we want to ensure the safety 

 18 and soundness of this whole industry and the 

 19 lending industry going forward, too. So I just 

 20 wanted to share that comment. I thank you for all 

 21 of that input, it's been very helpful. 

 22 MR. LUKKEN: Lee is not only a Farm 

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 1 Credit Forward Director, but also has taken the 

 2 series three exam on futures trading, so he knows 

 3 our industry. 

 4 MR. STROM: Yeah, many years ago. 

 5 MR. LUKKEN: Yeah, he knows our industry 

 6 very well, so thank you, Lee. Mike, did you have 

 7 a question, or Bart? 

 8 MR. DUNN: A couple of questions, and 

 9 Layne, maybe I'd like to start with you, to talk a 

 10 little bit about when you add all the volatility, 

 11 where you kept going up I don't know how many days 

 12 in a row, where you were lock limit up, and 

 13 probably the same for the CME, because I've seen 

 14 some charts that said what a tremendous increase 

 15 you've had from this year to last year on lock 

 16 limit ups, and what that causes, the problem it 

 17 causes in the market place, and the inability to 

 18 discover the price. 

 19 MR. CARLSON: Thank you. You're 

 20 absolutely right. When price discovery halts, 

 21 there's confusion in the market place. The grain 

 22 exchange we saw back last fall, after September 

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 1 and December delivery months came through, we saw 

 2 the volatility was increasing. We were trying to 

 3 be proactive at that time, trying -- and we 

 4 discussed with our members, and we actually had a 

 5 proposal into the Commodity Futures Trading 

 6 Commission here to raise the limits just a little 

 7 bit because we anticipated that might happen. 

 8 Before the Commission was able to act on 

 9 that even, the cash markets took off. At that 

 10 point, with the locked limits on the futures side, 

 11 we couldn't keep up. When cash markets would move 

 12 up $1 in the pacific northwest, and our futures 

 13 market could only move up 30 cents, we had people 

 14 just trying to look at ways to find what the true 

 15 market might be. 

 16 We pointed to the individuals and the 

 17 market participants that they could trade 

 18 synthetically. They took -- they learned very 

 19 quickly what they could do on the opting side, and 

 20 as the CFTC, Dave over here and John, pointed out 

 21 quite clearly this morning, is that synthetically, 

 22 they were able to find a cash -- they were able to 

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 1 come to where the cash market was. Only at the 

 2 point in which the futures market was able to 

 3 trade at -- widen the price limit were we able to 

 4 kind of move in sync with the cash market. We'll 

 5 see that despite all those things that happened, 

 6 by the time -- in the March contract in 

 7 particular, when it came to the first notice day, 

 8 the day before delivery, we had almost the perfect 

 9 convergence. 

 10 So what happened was that we had an 

 11 artificial cap that interfered with the price 

 12 discovery process until that price cap was 

 13 removed, then the market took some time to adjust, 

 14 but it came back very quickly where we were at on 

 15 price convergence. 

 16 But again, this is -- I'll take another 

 17 opportunity once more to point out that as an 

 18 exchange, we've tried to develop some new 

 19 contracts, and I'll mention it as I did earlier, 

 20 before the break, that we have corn index 

 21 contracts, and we have a soybean index contract 

 22 that's financially settled, that doesn't involve 

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 1 delivery issues, that doesn't necessarily involve 

 2 anything having to do with a single pricing point 

 3 or a pricing directive. 

 4 We have -- it basically looks at the 

 5 cash market on internal country wide basis. So we 

 6 have an alternative risk management tool that is 

 7 available out there for others to participate in. 

 8 I've expanded beyond the question that you had 

 9 asked, though. 

 10 MR. DUNN: The same for the CME Group. 

 11 I see in all of 2007, you had nine limit locks in 

 12 soybeans, and you've had 122 up through April the 

 13 4th, you had 33 corn contract settlement limits in 

 14 2007, you've had 64 so far through April 4th, you 

 15 had 42 wheat contracts in all of 2007, and you've 

 16 had 88 through this year. So give me a little bit 

 17 of what went on. And, Tom, we heard from you on 

 18 the same concern. 

 19 MR. LEHMAN: Well, Commissioner, as you 

 20 point out, we've had a much higher incidence of 

 21 prices reaching our daily price limit in the 

 22 grains. And if you just stop and think about how 

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 1 the price limits are structured, they're fixed 

 2 numbers. 

 3 In our contracts, they were 20 cents in 

 4 wheat, 30 cents, I'm sorry, 20 cents in corn, 30 

 5 cents in wheat, and 50 cents in beans. And when 

 6 we were at, you know, $5 wheat or 2.50 corn, those 

 7 were pretty large moves. And, in fact, when we 

 8 set those limits, it was in 2000, those limits 

 9 were on average ten percent of the value of the 

 10 commodity. As commodity prices moved sharply 

 11 higher, those fixed numbers didn't adjust. So now 

 12 we were at five percent of the value of the 

 13 commodity, and the volatility in the markets 

 14 really showed that we were, you know, we're 

 15 bouncing between limits much more frequently than 

 16 we would like. What happens when you move to a 

 17 price limit, price discovery stops. That doesn't 

 18 mean that somebody who's got price risk, you know, 

 19 can't manage that risk, they'll go somewhere to 

 20 manage the risk, and we do see an increased use of 

 21 our option markets in that situation, but I think 

 22 you probably also would see an increase in 

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 1 over-the-counter activity or activity going into 

 2 the exchange traded commodities in London, where 

 3 we really don't have the ability in the U.S. to 

 4 see how that activity is impacting the market. 

 5 So we felt it was necessary to increase 

 6 limits in light of the higher flat price levels. 

 7 We implemented those on March 28th. And I don't 

 8 have the numbers in front of me in terms of how 

 9 many times we've touched the limit since then, but 

 10 it's been reduced dramatically. 

 11 We also implemented at that time an 

 12 expandable limit which allows that initial limit 

 13 to increase by 50 percent if we do touch limit in 

 14 the market. So we put a mechanism in place that 

 15 we think allows the markets to better perform 

 16 their role of price discovery and allow them to 

 17 function. 

 18 MR. DUNN: I bring this up because some 

 19 of the questions that we have been getting through 

 20 emails and others, maybe somebody should do 

 21 something about the price limits. But if you 

 22 don't do that, you have a real problem with the 

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 1 clearinghouses; first of all, you have a real 

 2 problem in price discovery, but then the 

 3 clearinghouses have a problem because they're 

 4 making those margin calls that we've heard so much 

 5 about to ensure that they are financially sound. 

 6 We heard Tom say his concerns about what 

 7 might happen not only to that clearinghouse, but 

 8 the entire futures markets if that didn't take 

 9 place. This then backs down to those local 

 10 elevators, backs down to the farmers and ranchers 

 11 out there, all of those folks that have to make 

 12 those margin calls. 

 13 So all of these things are very, very 

 14 much related. Everyone seems to say, well, here, 

 15 if you just fix my one problem, then I would be in 

 16 great shape, but it's a whole -- the totality of 

 17 the thing is what I think we have to take a look 

 18 at, and some of the suggestions, some of the 

 19 things, Layne, that you said that the Minneapolis 

 20 Grain Exchange has come up with, some of the swap 

 21 clearing are some of the solutions that I think 

 22 we'll begin to work towards that will really help 

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 1 us in the end. Let me start back down, and that's 

 2 with the farm and ranch, because that's the one 

 3 that I identify with the most. And, Sam, when 

 4 you're making these loans, and you sit down with 

 5 the producer at the beginning of the year, and I 

 6 imagine a good example is -- what I used to do 

 7 when I was a lending officer, and that was eons 

 8 ago, but you'd try to do an enterprise analysis 

 9 with that individual and see what they are making 

 10 money on, what are they losing money on, what are 

 11 their break evens, and if you come up with say, 

 12 all right, here in the course grains, here's what 

 13 their costs are, here are their break evens, let 

 14 me go ahead and hedge a third of that crop, that 

 15 will cover that expense, and this is something 

 16 that's going up all the time, the input costs that 

 17 we saw from the charts earlier on. 

 18 But you sit down and you do that, and 

 19 when I was a loan officer, I'd say let's go ahead 

 20 and hedge that, and I'd get on a third party hedge 

 21 and I'd make those margin calls, and the producer 

 22 would come in and say I'm really worried, I'm 

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 1 spending all this money on these margin calls, and 

 2 I said that's not a third of your crop, the other 

 3 two-thirds, we're making a lot of money on, and 

 4 furthermore, I'm going to get paid back. And so I 

 5 had no problem making those margin calls in those 

 6 days. But it seems to me what is happening is, 

 7 those margin calls got so high because of the 

 8 problems that we had on going up the limits. I 

 9 would have had a problem going back to my board 

 10 and saying, hey, remember this guy that we're 

 11 working with, and I said we'll do this hedge 

 12 account with him, well, it's a little more than 

 13 $100,000 I thought, it's now 500,000, and the 

 14 board would look at me and say, I don't think so. 

 15 That seems to be a real problem, are 

 16 there things that you're doing out there as a 

 17 local bank on participation and putting together a 

 18 consortium and upstream banks so that you will 

 19 have that comfort level again, that you'll have 

 20 that money to make those margin calls, and with 

 21 the realization that you will get it paid back? 

 22 MR. MILLER: It's a very good question, 

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 1 and I think there's a couple different answers. 

 2 First off, at the producer level, those kinds of 

 3 situations, we're doing that as a matter of 

 4 course, and it's happening every day, and yes, the 

 5 dollars are getting bigger. But, again, bankers 

 6 understand that if you exit out of those 

 7 positions, then you just totally negated the risk 

 8 management plan that you put in place, we get 

 9 that. We haven't talked at all today about the 

 10 milk business. But the dairy markets had that 

 11 last year. I mean I had dairy farmers, 600 cow 

 12 dairy farmers that had million dollar hedge lines, 

 13 that's a lot of money. And they paid it back when 

 14 they got the milk check from the dairy, then 

 15 they'd pay back that month's hedging activity. 

 16 So, you know, it worked the way it was supposed to 

 17 work. And the same thing is happening in the 

 18 grains. 

 19 I would say, yes, farmers are borrowing 

 20 more money because input costs have increased, 

 21 land rents have gone up, fertilizer has gone up, 

 22 seed has gone up, almost anything you can think 

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 1 of, it's gone up, so it takes more money to put a 

 2 crop in. 

 3 And the banking sector handles that day 

 4 in and day out with the farming sector. I don't 

 5 think that's where the issue really lies. I think 

 6 the issue is at the grain elevator sector. That's 

 7 where the dollars get really big. And, yes, we 

 8 are doing participations. 

 9 We're working with our fellow banks, 

 10 we're working with the farm credit system, we're 

 11 sharing across, you know, with other institutions 

 12 that also understand these markets, because we 

 13 don't want to partner on that side of the business 

 14 that also is going to get nervous and say, hey, I 

 15 want to get off the merry-go-round. So we have to 

 16 all understand what's going on in that process. 

 17 But there's one other issue here I think that 

 18 maybe we're missing, and that is, yes, the banking 

 19 sector is providing the capital, but the borrower 

 20 has to provide some capital, as well. There 

 21 aren't too many things you can borrow 100 percent 

 22 on. You've got to put some money in, you've got 

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 1 to have some skin in the game yourself, so to 

 2 speak. And it's those requirements that are 

 3 really ramping up, as well. 

 4 If I lend you 80 cents on the dollar or 

 5 90 cents on the dollar, you've still got to come 

 6 up with ten or 20, and ten or 20, when we're 

 7 hearing about a coop that had a $3 million line 

 8 that's going to 70 or 80, that's a significant 

 9 increase in the amount of capital that they need 

 10 at that level, as well. And that's important to 

 11 take into consideration in this discussion. 

 12 MR. DUNN: Jim, I saw you nodding your 

 13 head on elevator and on the elevator side. Would 

 14 you amplify on that? Because we've heard both the 

 15 fed and the farm credit system say that there is 

 16 capital out there if there's an ability and 

 17 willingness to make those loans, and I think that 

 18 willingness maybe is something we really haven't 

 19 touched on. 

 20 MR. BYRUM:: Well, thank you. I think 

 21 there's three things I'd reference in that regard. 

 22 First is the sheer volume of capital required 

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 1 versus, as Sam just said, the equity base is an 

 2 issue in some situations, and I think that's where 

 3 the real rub is in some matters. Second, overall, 

 4 again, we're talking about the grain industry, but 

 5 if one considers a diversified elevator that also 

 6 handles agricultural inputs and put in their 

 7 normal inventory fertilizer, pesticides, and seed 

 8 this year, the value of that, the cash required, 

 9 the credit required to fund that is roughly three 

 10 times what it was a year ago. 

 11 So a normal agronomy operation, a good 

 12 size agronomy operation, ten million historically, 

 13 30 million easily, in many of the large ones it's 

 14 not uncommon for us to be at 50 to 75 million in 

 15 inputs. Put that on top of the grain exposure, 

 16 the overall credit requirement is absolutely 

 17 astounding. 

 18 Third is, you know, going forward, I 

 19 think we have to recognize that banks have been 

 20 extraordinarily cooperative. We acknowledge that, 

 21 I mentioned that before lunch. And we actually 

 22 have good credit facilities out there. The 

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 1 challenge is, as I suggested, is not where we're 

 2 at today, but where we could be if there's a 

 3 hiccup. If Illinois doesn't plant in a timely 

 4 fashion, if there's a weather upheaval somewhere, 

 5 if there's a run in the weather market, that's the 

 6 fundamental concern we have going forward. 

 7 We also should recognize and 

 8 acknowledge, producers have a very, very good 

 9 understanding of what elevators are going through. 

 10 In fact, I'm actually amazed at elevators, the 

 11 conversations I've been engaged in with growers 

 12 and elevators, understanding the exposure that 

 13 elevators have had because of the margin situation 

 14 and the additional financing requirements of ag 

 15 inputs, understand it, acknowledge it, and 

 16 actually recognize that elevators have always 

 17 handled that function for them in the market. 

 18 Going forward, that's one of the points 

 19 I made earlier, that that fundamental, that risk 

 20 that's been accepted by elevators and moving 

 21 forward, probably is going to be passed off to the 

 22 growers some way, unless there's some new 

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 1 instrument to pass that risk further along or move 

 2 it up the chain, because it's extraordinary in the 

 3 country side right now. 

 4 I'll just make one further point. Our 

 5 winter conference started on January 12th, it was 

 6 a Monday morning. 

 7 Our membership in Michigan we estimate 

 8 ships somewhere between 100 and 125 million to 

 9 Chicago for margin calls that morning. Just that 

 10 analogy, that one little situation, it's 

 11 absolutely astounding the kind of impact that 

 12 we're seeing in the country side. 

 13 MR. LUKKEN: Well, given the lateness of 

 14 the hour, I'll have Garry give some comments. But 

 15 I did want to open it up to the audience present 

 16 here. If there are any other members from the 

 17 public or the Ag Advisory Committee that may have 

 18 a comment or question, we may take one or two. 

 19 And, Neal, we'll get to you as well, but first 

 20 let's turn to Garry. 

 21 MR. NIEMEYER: Jim brought something up, 

 22 and I'm astounded. I am pre-purchasing fertilizer 

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 1 for next year's crop, and my accountant told me to 

 2 get, you know, go to the fertilizer dealer and 

 3 make sure I had some kind of a financial agreement 

 4 with him, and to prove that they were viable. It 

 5 was almost an embarrassment for me. This thing is 

 6 just getting totally out of hand. I mean the 

 7 money is just unreal. 

 8 MR. LUKKEN: Neal. 

 9 MR. GILLEN: Observation question. 

 10 Chicago manages to margin to the futures, future 

 11 to future and option to option. ICE has reverted 

 12 to that now, but says if we get another spike, you 

 13 know, we're just going to have to go back. 

 14 How does Chicago survive doing the 

 15 system that we recommend, and ICE can't figure out 

 16 how to survive? 

 17 MR. FARLEY: Dave? 

 18 MR. LEHMAN: Well, margins are -- we set 

 19 them based on volatility, our clearinghouse does, 

 20 and I'm not involved in that function and that 

 21 role, so I can't tell you specifically how they 

 22 look at situation when we're at a price limit. 

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 1 But they do margin based on settlement price. The 

 2 objective of our clearinghouse is to cover one 

 3 day's expected price move, and that's how margins 

 4 are established. So if we have a price limit that 

 5 won't allow prices to move beyond that level, then 

 6 margins wouldn't be set higher than that level, as 

 7 well. So that's sort of the outer bound, if you 

 8 will, on margins. 

 9 And, of course, when we increase price 

 10 limits, we're very sensitive to the industry that 

 11 this would increase that outer bound of what 

 12 margins could be if volatility, which is 

 13 calculated statistically, and it's done in very 

 14 excruciating detail. If you sat down with our 

 15 risk committee, they look at 30 day, 60 day, 90 

 16 day, 180 day, out to two years worth of data, and 

 17 looking at how the market has behaved in the past. 

 18 And, of course, that's the trick or 

 19 where the judgement comes in, is that past history 

 20 going to be an accurate predictor of the future. 

 21 But in the case of a market that does have price 

 22 limits, which all of our agricultural contracts 

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 1 do, that would be the maximum one day margin. 

 2 MR. GILLEN: So in summary, you're 

 3 satisfied that the real price is the price of the 

 4 future on the closed margin up? 

 5 MR. LEHMAN: Well, certainly we know 

 6 that, at times, prices synthetically that are 

 7 calculated from the option market are different 

 8 than where our futures close. If we're closed 

 9 because of price limits, and the cash market is 

 10 well beyond that, then certainly, the cash price 

 11 is, or the synthetic price, as determined by the 

 12 options, would be a different price. But again, 

 13 since our objective is to cover that one day price 

 14 move, we feel we've accomplished that by using the 

 15 settlement price in a lock limit situation. 

 16 MR. GILLEN: Tom, why can't you do that? 

 17 MR. FARLEY: We have -- the way our 

 18 exchange is set up, we have an exchange board and 

 19 we have a clearing board. Our clearing board is 

 20 made up of, by and large, clearing members and 

 21 risk experts and the guys whose, in addition to 

 22 the people in this room, whose necks are on the 

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 1 line on a daily basis. And we went to them and 

 2 posed that question, because as I said earlier, 

 3 Neal, we don't really have a dog in this fight 

 4 other than protecting the integrity of the 

 5 clearinghouse. We make no money on collecting 

 6 margin payments, and we're successful, and our 

 7 customers are successful. So if the integrity of 

 8 the clearinghouse weren't a concern, we would just 

 9 do as our customers wish. 

 10 So we went to our clearing board, and 

 11 they said, hey, notwithstanding what is done in 

 12 Chicago, and we well know what is done in Chicago, 

 13 we're not comfortable with that procedure. 

 14 I will note one thing about Chicago's 

 15 procedures that I'm familiar with, they also 

 16 reserve the right, similar to us, they reserve the 

 17 right to use a different price other than the 

 18 futures limit up or limit down price. 

 19 In practice, my understanding is they do 

 20 not frequently, maybe even ever, but they reserve 

 21 the right, similar to how we reserve the right. I 

 22 just wanted to, kind of in an abundance of 

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 1 caution, be very explicit about situations when we 

 2 would reserve the right, so that our customers can 

 3 plan around it. 

 4 MR. LUKKEN: Any other questions from 

 5 around the room? I see someone over here. If you 

 6 could state your name and -- 

 7 MR. SEEGERS: Yes, my name is Robert 

 8 Seegers, Jr., and I'm from Crystal Lake, Illinois, 

 9 and I'm with the -- the Grain and Feed Association 

 10 of Illinois, and I have a -- would like to share a 

 11 statement that was made to me by three very large 

 12 banks that lend to the grain industry in Illinois 

 13 at our annual convention in February, and then 

 14 would like to ask Esther George a follow-up 

 15 question regarding the statements. 

 16 The statements that were made to me by 

 17 three of the banks, whether it's true or not, I'm 

 18 hearing in other parts of the country may not be, 

 19 was that the single greatest problem our industry 

 20 has is the lack of convergence, because the banks, 

 21 the lending institutions don't know what their 

 22 collateral is worth. 

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 1 And they are saying traditionally, when 

 2 we had convergence, if they financed a grain 

 3 elevator's inventory that was 20 cents away from a 

 4 delivery point, they always knew their collateral 

 5 was worth 20 cents under the Chicago Board of 

 6 Trade futures. 

 7 As long as their lender, or borrower, 

 8 excuse me, was adequate hedged, square in his 

 9 position, they always knew their collateral was 

 10 worth 20 cents under the Board of Trade. 

 11 Now they are financing purchases at 50 

 12 or 60 under the Board of Trade price, and those -- 

 13 that collateral that they're holding may, in fact, 

 14 end up being worth $1.50 or $2 under, as in the 

 15 case of wheat, and that's what they were 

 16 expressing as the risk of our industry is that 

 17 they don't know what their collateral is worth. 

 18 I would -- believe they are also 

 19 concerned about counter party risk, about the 

 20 farmer producers actually delivering on their low 

 21 price contracts. But I would -- my question then 

 22 for the Federal Reserve, has any banks in your 

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 1 system, have they expressed those concerns, and is 

 2 that just a way to say -- telling us we're just 

 3 not very comfortable lending into your volatile 

 4 environment right now? 

 5 MS. GEORGE: The issue you described is 

 6 really an age old issue for banks in terms of how 

 7 they value collateral. I would guess the greater 

 8 issue that I hear from banks is not so much value 

 9 in collateral, because they are largely also 

 10 relying on cash flow, so they are looking at both 

 11 of those things. 

 12 Certainly, the environment we've been in 

 13 is a different environment. And just as we've 

 14 heard from everyone, it's a different ballgame for 

 15 them to look at how they're going to price that 

 16 collateral. But my sense is, they have been very 

 17 willing to work with that customer to come up with 

 18 a reasonable value that meets the banks' standards 

 19 for safety and soundness, and helps them extend 

 20 the credit. 

 21 MR. LUKKEN: Well, thank you very much. 

 22 Unfortunately, we're going to have to cut things 

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 1 off there. I know many people have planes to 

 2 catch. But it's been a great discussion. And on 

 3 behalf of my colleagues, I want to thank all the 

 4 presenters and roundtable participants, as well as 

 5 members of the public that tuned in here today; on 

 6 the atrium, on the Internet, a variety of ways. I 

 7 thought it was a great discussion. 

 8 In particular, I want to thank Lee Strom 

 9 from the Farm Credit Administration, as well as 

 10 Under Secretary Mark Keenum, for their 

 11 participation. And last, but not least, the CFTC 

 12 staff who worked tirelessly to organize this 

 13 event, and in particular, Mike Otten from my 

 14 staff, John Rogers, Tammy Semega from our Office 

 15 of Management Operations, and her staff, as well. 

 16 We've had a big agenda here today, but 

 17 now we have to close things up. And I would just 

 18 note that we'll welcome additional comments for 

 19 the next two weeks, with that period closing May 

 20 7th. So we appreciate everybody's participation, 

 21 and thank you for coming. 

 22 (Whereupon, at 3:43 p.m., the 

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 1 PROCEEDINGS were adjourned.) 

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 1 CERTIFICATE OF NOTARY PUBLIC 

 2 I, Carleton J. Anderson, III do hereby certify 

 3 that the forgoing electronic file when originally 

 4 transmitted was reduced to text at my direction; 

 5 that said transcript is a true record of the 

 6 proceedings therein referenced; that I am neither 

 7 counsel for, related to, nor employed by any of 

 8 the parties to the action in which these 

 9 proceedings were taken; and, furthermore, that I 

 10 am neither a relative or employee of any attorney 

 11 or counsel employed by the parties hereto, nor 

 12 financially or otherwise interested in the outcome 

 13 of this action. 

 14 /s/Carleton J. Anderson, III 

 15 Notary Public # 351998 

 16 in and for the Commonwealth of Virginia 

 17 

 18 My Commission Expires: 

 19 November 30, 2008 

 20 

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