Monthly Archives: June 2013

It might be useful for future discussions to archive a few details regarding the Goodlatte’s amendment #99 to H.R. 1947.

1. The full video of the floor debate:

2. Vote detail.

3. What was the “vote cost” of Goodlatte’s amendment, i.e. how many democrats decided not to vote for H.R. 1947 because Goodlatte’s amendment was adopted? Here’s Rep. Peterson, speaking on the radio one day later:

You know, what happened, it started with the dairy amendment, which got
tangled up in the whole food stamp thing, and the idea, [they] put out
misinformation that my dairy bill was going to raise the price of dairy products,
and so a lot of Democrats defected and it passed by 300 and some votes, which
was a shock. But right there I lost eight votes on the Democratic side just from that situation.

 Full transcript here.

 

What do we (think we) know about the new dairy policy? Based on studies listed below, here’s my take-away:

  • Both dairy policy proposals are likely to be effective in providing catastrophic margin insurance. (Newton et al., 2013)
  • If effective, the stabilization program could reduce duration of low-margin episodes. (Newton et al. 2013)
  • Both policy proposals could end up costing substantially more than the CBO scored them. Dairy Freedom Act is likely to cost more than the DSA.  (Brown, 2013)
  • New dairy policy will redistribute program benefits toward states with large farms. The effect is strong for both competing proposals relative to the current policy, but could be more pronounced for the DSA (Woodard and Baker, 2013)
  • Design of both margin insurance and the stabilization program is fragile, and subject to strategic manipulations by participants (adverse selection and moral hazard). (Newton, Thraen and Bozic, 2013)
  • If risk in the dairy sector is substantially reduced, average milk prices will decline. (Nicholson and Stephenson, 2011)

The list is not complete, as I have omitted some older studies that analyzed early versions of policy proposals, and do not seem to add much beyond these five. In reverse chronological order:

1. (June 2013) Newton, J., Thraen, C. and Bozic, M. 2013. Actuarially Fair or Foul? Asymmetric Information Problems in Dairy Margin Insurance 

There is a wide consensus in the academic literature that asymmetric information in the form of adverse selection and moral hazard has resulted in sizable financial outlays for government sponsored crop insurance programs – ultimately becoming a costly means of transferring risk from farmers to the government. In this analysis we combine simulation and structural modeling techniques to forecast dairy income-over-feed-cost margins and show how asymmetric information problems may drive industry consolidation, production growth, and unforeseen program costs for a recently proposed government-sponsored dairy producer margin insurance program. We conclude by presenting second-best solutions in contract design to the insurance problems of moral hazard and adverse selection.

2. (June 2013) Woodard, J. and Baker, D. 2013. 2013 Farm Bill Dairy Title Proposal Redistributes Program Benefits toward States with Larger Farms.

While a new Farm Bill was not realized in 2012, the failed 2012 Farm Bill proposal would have enacted a significant overhaul of the Dairy Title. This short note highlights and compares some important aspects of the current proposals with each other and with current policy, and discusses differences in the context of who the apparent beneficiaries are of the various programs. Several observations are made that suggest that the current front-running proposal, the Dairy Security Act, which passed out the of House Committee on Agriculture in May 2013, appears to redistribute program benefits toward states/regions with larger farms relative to the main compet ing proposal, as well as relative to current policy.

3. (May 2013) Brown, S. and Madison, D. 2013. A Comparison of 2013 Dairy Policy Alternatives on Dairy Markets

This report provides a comparison of the discussion draft released by Chairman Frank Lucas of Oklahoma and Ranking Member Collin Peterson of Minnesota of the House Agriculture Committee entitled the “Federal Agriculture Reform and Risk Management Act of 2013’’ referred to in this report as “DSA” and the April 25th, 2013 release by Congressman Bob Goodlatte of Virginia and Congressman David Scott of Georgia entitled the “Dairy Freedom Act” referred to in this report as “DFA”. This analysis takes a monthly approach using a structural econometric model to determine what the effects of the two dairy policy proposals would have been over the 2009 to 2012 period. … Each of these programs could spend nothing or billions of dollars depending on the exact margin path experienced.

4. (April 2013) Newton, J., Thraen, C., Bozic, M., Stephenson, M., Wolf, C., and B.W. Gould. 2013. Goodlatte-Scott vs. the Dairy Security Act: Shared Potential, Shared Concerns and Open Questions

This paper reports our analysis, to-date, of expected short-term impacts of two major dairy safety net policy proposals popularly referred to as the Dairy Security Act (DSA) and the Goodlatte-Scott Amendment (G-S). Our results suggest that both DSA and G-S are very effective in providing catastrophic risk insurance and revenue enhancement for farms with stable and moderately growing milk marketings. For sufficiently high DSA participation rate, and sufficiently low price-elasticity of demand for milk in aggregate, the Dairy Market Stabilization Program (DMSP) has the potential to reduce government outlays and accelerate margin recovery in low-margin states of the world, relative to outcomes expected under DSA with low participation rates and high price-elasticity. Furthermore, the DMSP is not likely to provide long-term obstacles to growth for participating farms with an aggressive growth plan unless generous margin insurance induces a long-term oversupply of milk. Both programs share contract design features that may result in strategic annual supplemental margin protection sign-up and reduce demand for private risk insurance products – inadvertently increasing policy cost. Under DSA, this problem is somewhat reduced as DMSP provides disincentives for forfeiting supplemental margin insurance in years when anticipated margins are moderately above long run average. 

5. (October 2011) Nicholson, C. and Stephenson, M. 2011. Market Impacts of the Dairy Security Act of 2011 (H.R.3062) and the Dairy Provisions of the Rural Economic Farm and Ranch Sustainability and Hunger Act of 2011 (S.1658)

Two proposed pieces of dairy legislation could reduce variation in U.S. milk prices, reduce  average milk and product prices, have different impacts on government expenditures, and would not markedly affect milk marketed during the period 2012 to 2018. The programs would reduce the value of U.S. dairy exports, but also reduce the value of U.S. dairy imports. There are few differences in outcomes between the legislation, despite different provisions with regard to suspension of supply management programs.

 

A while back, one dairy industry leader asked me “Could we not have two tiers of margin insurance – one very subsidized and coupled with the stabilization program, and another that is not linked to the supply management, but not nearly as subsidized?” Another comment I received last week after my blog post on lessons from crop insurance for dairy programs was why one of the lessons would not be that insurance and supply controls should not be linked.

I found both questions very intriguing, and decided to modify at the last moment my slides for the 4-State Dairy Nutrition and Management Conference, held earlier this week in Dubuque, IA. I pursued the analysis from a vantage point of Farm bill Title I vs Title XI. “Title I – Commodities” deals with measures with substantial government involvement, such as price floors (marketing loans), sugar and dairy programs. Although we like to think of Dairy Producer Margin Protection Program as an insurance program, insurance programs are really subject of Title XI – Crop Insurance. As I wrote in my earlier blog, DPMPP is in fact a hybrid between a crop insurance and a countercyclical income support instrument, because it is designed to have implied pro-cyclical subsidies. LGM-Dairy, on the other hand, is located in Title XI, and like other programs in that title, it ties the insurable revenue to expected market conditions.

As it currently stands, LGM-Dairy is of very limited use to dairy producers. While it has several important problems that should be addressed, likely the biggest obstacle is its intermittent availability. LGM-Dairy was continuously offered every month from Aug 2008 through Mar 2011. At that point, a combination of successful educational efforts and heavy subsidies have depleted the funds RMA had available for this pilot program. LGM was next offered in October and November 2011, and the only reason it was offered in November is that the RMA’s server crashed after 50 minutes of sales in October, so some subsidy money could not be spent at the first offer event in 2011/12 fiscal year. After 11/2011, LGM was not available until 10/2012. My research with John Newton, Cam Thraen and Brian Gould has identified what kind of policy profiles would work well to substantially reduce margin risk, but our recommendations require a program that is offered continuously, not once in a blue moon.

 

Based on many years of discussions, the dairy subtitle of the 2013 Farm Bill has been revamped and the new dairy policy passed in the Senate last week and the House Agriculture Committee a few weeks ago is based on two intricately linked pillars – Dairy Producer Margin Protection Program, and the Dairy Market Stabilization Program. At this point in time, it would be wise to either reform LGM-Dairy to make it a viable third pillar of the new federal dairy policy, or discontinue it completely. As it currently stands, LGM-Dairy is not fiscally feasible as a serious policy option. However, one way to make it more budget-friendly could be for RMA to limit government financial support to re-insurance of privately offered (and fully paid for by users) LGM-Dairy contracts. If that is what it would take for LGM-Dairy not to break the bank, federal government could consider very low, or even zero subsidy for premiums and A&O costs. But the bottom line is this: federal agricultural policy has enough Ghosts of Farm Bills Past to begin with – let us either make LGM-Dairy work as the third dairy policy pillar, or let us be done with it.

Bozic, M. 2013. “Dairy Programs in the 2013 Farm Bill: LGM-Dairy-The Forgotten Third Pillar”, presentation delivered at the 4-State Dairy Nutrition and Management Conference, Dubuque, IA,  June 13. 

Slides and audio links.

 

I am back in Iowa. I spoke yesterday at the  DairyIowa meeting about alternative strategies with Class III milk options on futures. Usually such talks center on using puts vs. fences, how deep out of money to go, etc. I gave it a different spin, kept it deliberately as simple as it gets, and illustrated that hedging horizon may matter more than anything else. When prices decline, they tend to stay low for a while. Hence, any strategy that is focused on close-by months will fail to protect against a prolonged slump like we had in 2009. Bottom line: 50 cents/cwt can buy you peace of mind, but only if you spend it well, by hedging consistently and using distant months.

Here are my slides and audio.

I gave a talk yesterday at the Minnesota Dairy Leaders Roundtable. I originally thought that would be a closed-doors meeting, so did not plan to upload slides, nor did I bother to record audio like I usually do. However, since reports of my talk have appeared in the press, I thought I should change my approach and make slides public. I envisioned this talk as a meditation on crop insurance, and lessons that can be drawn. Unfortunately, the supply management is such a hot topic that it sucks air out of coverage of other important issues. Therefore, let me use my blog to deliver my points on crop insurance lessons for dairy programs:

The question in the title is an important one – as we design new dairy programs, what can we learn from crop insurance? I think there are several points of interest. First, timing matters. If you want to buy the Crop Revenue Coverage, which protects not just yield, but also total revenue (yield x expected price), you have to buy the insurance before you plant. In fact, you have to buy the insurance by March 15, before even Prospective Plantings report is published. You don’t have to pay for the insurance up front, but you do need to make your selection choice early. That way, you cannot base your protection against production risks based on weather conditions in the current growing season. We should follow the same principle in dairy programs. Insurance should be available, affordable and flexible. But it should be designed in such way that participation is based on risk tolerance, not financial wherewithal to abuse the fragile margin insurance design by utilizing IOFC margin forecasting models to decide when to over-insure, and when to under-insure. A simple way to address this problem is to use the 6-months gap between the insurance selection point, and the beginning of margin protection coverage period. It may make the most sense to align the dairy margin insurance sign-up deadline with crop insurance deadline – March 15. Coverage period would then be fiscal, rather than a calendar year, with coverage starting on October 1, rather than January 1.

The second point we can learn from crop insurance is that payment date does not need to coincide with insurance selection date. In particular, in crop insurance for corn or soybeans, premium billing date is October 1 – very close to harvest date. How would application of that principle look like in dairy? In order to align production date and premium billing date in the margin insurance programs, implementation rules could specify that premiums will be billed at the end of each “two consecutive months” period. For example, if we assume that indemnities for Jan-Feb period would be paid out in March, we could have premiums deducted from indemnities before indemnity checks are mailed. And if no indemnities are due, March would be a good time to bill participating producers for the previous two-month period. Very similar principle is employed since 2010 in LGM-Dairy insurance, and is generally praised by dairy producers as friendly to their cash-flow.

The final learning point from crop insurance regards the subsidy levels. In crop insurance, two-stage process is used to determine policy premiums. First, USDA employs sophisticated models to determine a fair premium level for each individual producer. Then, based on chosen yield coverage level, subsidies are applied as specified in the law. The law does not specify actual premiums, just subsidy as a percentage of fair premium. There might be advantages to not following that principle. In particular, by hard-wiring premiums in the law, subsidies can be made to be pro-cyclical. Coverage option that may be rather pricey in “ordinary” times (e.g. $1.06 for $8.00/cwt supplemental margin protection) may be the politically most feasible way to automatically deliver ‘disaster aid’  if the dairy sector faces a prolonged down period. In a scenario where some ‘black swan’ external factor would cause dairy margins to be below e.g. $5.00 for two consecutive years, which would be rather dramatic affair indeed, what better way to help producers than to allow them to buy “in-the-money” put on IOFC margins with the strike of $8.00/cwt and a premium of $1.06/cwt, a level that would be very cheap in that state of the world? However, while this feature may sound appealing, it is also the point where the newly proposed safety net is the most fragile. For subsidy levels may turn out to be endogenous if we are not careful. What that means is that overly generous margin insurance may spur oversupply, depressing prices, and rendering that $8.00/cwt level designed for extended disaster-aid purposes a level that most producers navigate to because of the price dynamics induced by the program itself, rather than adverse external factors. Hybridizing margin insurance to contain elements of countercyclical income support is tricky business. To add robustness, we must go back to the first point I raised above – timing matters. A lot.

My slides from the Minnesota Dairy Leaders Roundtable are available here.