The way to fix a flawed compromise is to de-couple “negotiated” from “spot”

 

by Gilles Stockton, Grass Range, Mont.

Opinion - The Fence Post - Jan 7, 2022

 

Senate Bill 3229, is said to be a compromise merging the 50/14 concept proposed by Sens. Chuck Grassley, R-Iowa, and Jon Tester, D-Mont., with a bill that enhances mandatory price reporting advanced by Sen. Deb Fischer, R-Neb. The original version of the 50/14 proposal would require that half of the fed cattle be purchased on the “negotiated spot” market, and Sen. Fischer’s contribution would require mandatory price reporting of all fed cattle sales, along with the publishing of a library of forward and formula contracts.

 

Because less than 20 percent of the fed cattle are sold on the “negotiated spot” market, which is then used to price the remaining 80 percent — this clearly results in inadequate price discovery. Absolutely! The number of “spot” market sales must be increased, and 50 percent is a good target. However, the flaw in this proposal is coupling “negotiated” with spot. A spot market is a cash market for immediate delivery. A negotiated market is one where the buyer and seller agree in private on the sale terms.

 

The problem in any negotiated market is that there is a built-in bias in favor of the buyer. This is because the seller has already invested their money in the cattle and have a lot to lose if the market goes down. Buyers, on the other hand, have time on their side and other cattle from which to choose. This dynamic results in a lower negotiated price than what supply and demand conditions would otherwise warrant. Economic research confirms this downward bias.

 

If half of the cattle are required to be sold on the negotiated spot market, this will result in lower overall cattle prices. The solution is to de-couple negotiated from spot and require instead the use of an electronic/video auction market mechanism for the spot marketing of fed cattle.

 

Here in cow/calf country there tends to be a distrust of auction markets. This is probably because most of us have been burned when a load of calves or culls were sold for less than they should have. As a result of these bad experiences, many ranchers prefer to market their calves by negotiating with a trusted buyer. The feeling is that not only is one avoiding the risk of a bad sale, you are also avoiding the 4 percent auction fee, along with the shrink when your calves wait three or four hours to be weighed after already being on a truck for two.

 

There is, therefore, a legitimate reason to prefer to negotiate rather than sending the calves to the auction barn. However, an electronic/video market overcomes many of those objections. And too, one does not really avoid the 4 percent marketing fee because the buyer with whom you negotiate also has costs that needs to be covered. The only reason that the negotiated market for feeder calves works as well as it does is because a significant number of calves are sold at the auction barns or through the electronic/video auctions. This provides an honest reference. Ultimately, the most efficient and most accurate way to arrive at optimum price discovery is through an auction. It may not be perfect, but auctions are, in the long run, better than all of the alternatives. And as an added bonus, the prices derived at a public auction are open for all to see.

 

In the fed cattle market, there is no honest reference, because all spot market sales are negotiated. We mitigate that to some degree by mandatory price reporting. A better solution would be to require that the spot market be conducted through an electronic/video auction where not only is price discovery more accurate, the market information is public.

 

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