The world is a complex unpredictable place. Private firms, with the help of creative financial markets, have developed a range of risk management tools to mitigate, price, and share risk. Nancy Birdsall and I argued years ago that the innovation of Wall Street could be better applied to problems in developing countries. Colleagues Vij Ramachandran and Ben Leo show how the World Food Program could be greatly enhanced by simple hedging. And Guillermo Perry makes a persuasive case that the multilateral development banks should move beyond lending to provide tools for countries to manage volatility and create stability, such as hedging and insurance.
Thus, I should be extremely pleased to read today, on page A13 of the Washington Post that:
The [World Bank] and J.P. Morgan are setting aside $200 million each to help finance what World Bank President Robert B. Zoellick described as “plain vanilla hedges,” allowing agriculture-related businesses in developing nations to lock in prices well in advance of a harvest or commodity purchase. The lack of such financial tools in poorer nations — and even in better-developed economies such as Brazil — means that farmers, agricultural cooperatives, food processors and similar businesses can’t plan well or get bank loans. That limits investment and, ultimately, production, Zoellick said.
I’m absolutely in favor of these kinds of initiatives and have been thinking through other possible ways to apply financial instruments like derivatives to development problems. So I should be cheering this latest announcement.
But one nagging obstacle has been skepticism (some practical, some ideological) that poor people and poor countries will get screwed by people selling such instruments. If subprime lending in the United States was predatory, so the thinking goes, then what’s likely to happen when brokers start selling complex financial instruments to rural African farmers? This is something I think has been over-stated and can be dealt with through project design. But it continues to be a real worry. So I was also glad to see that, according to the Washington Post, “safeguards have been put in place” in the new J.P. Morgan-World Bank initiative to prevent speculation or abuse. Without details it’s hard to know if these are for real (or, like some safeguards, so stringent that they effectively kill the idea). As Perry argues, the key is getting a credible organization, like a multilateral development bank, to intermediate.
Then I turned the page to A14:
J.P. Morgan to pay $153.6 million to settle fraud suit….J.P. Morgan Securities sold investors a complex instrument that was secretly designed to help a hedge fund profit at their expense, the government alleged Tuesday.
Clearly having credible private sector partners will be essential too.