In a semi-lubricated state, I was chatting with a chef friend of mine about the price of bacon. It has recently hit an all-time high. I was complaining about how inconsistent and curly my bacon had become. He told me that the bacon I was getting had been frozen and was probably part of a pork belly future.
I had heard of this before but had no idea what it was, other than that band of the same name. He went on to explain to me that pork belly futures are a bet against the future price of pork bellies.
For example, a company buys 10 bellies at $10 per pound. Then the market changes and the belly price is now $9 per pound. The company holding the bellies just lost $1 in inventory and market value. So to take some of the risk out of the market, a company can buy a “bet” or a pork belly contract that will help insure that they will not lose as much money on the price of the bellies. They pay about $.10 per pound to insure the belly so that when the price drops they only lose a fraction of the money. Pork belly futures as a financial instrument came out of the Chicago Mercantile Exchange in 1961.
Wait a tick … does this sound kind of like something else that you might have been hearing about? In the banking world I think the same practice is called a “credit default swaps.” So, some savvy banker thought it would be a good idea to trade homes like pork bellies. Brilliant. Those two concepts parallel each other so well.
Holy crap, I thought, bacon has caused a recession. The inventor of credit default swaps needs to find a way to win a Darwin Award.
Randy King has an MBA and still does not understand credit default swaps. Click to follow Randy on Facebook.