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The Peregrine Financial Scandal: An Explainer

A man releases his peregrine falcon inside the WC2010 Nelson Mandela Bay soccer stadium on May 14, 2010 in Port Elizabeth.

So we meet again.

That didn't take long.

I've been seeing the names "Peregrine Financial" and "PFGBest" all over the news and I know I should try to understand it, but it's hard to commit to reading it without an explanation, you know? What do these companies do?

Well, the thing with these financial stories is that they seem really alien and complicated. Think of it this way: this is a story about the Farm Belt.

Peregrine Financial is a futures brokerage, based in Cedar Falls, Iowa, that helps customers - mostly farmers - hedge the prices of crops, like corn or wheat. The farmers give their money to Peregrine and ask the brokerage for advice and help in betting that the future price of corn, or wheat, or pork bellies, will go up or down.

I'm surprised that farmers are such big investors. Why do farmers need to hedge crop prices? Isn't it enough that they grow the actual crops?

The markets can be used for two purposes: speculation - the stuff that makes everyone mad, and many people rich - and hedging. Farmers generally depend on hedging. Farming is actually not such a profitable business. Most farmers basically scrape out a living, and they borrow a lot to keep their farms running, as this great Kansas City Federal Reserve paper shows.

Still, it's not as if farmers invest money to make a fortune. Primarily, they want to protect themselves if their crops fail. Imagine you're a farmer, for instance, and you've spent a lot of money and time growing corn. Then, in a year like this, all that goes to waste because a drought hits and the corn plants are stunted in arid, dusty soil.

Farmers try to protect themselves financially by investing their money in futures. Futures are like contracts that say, "I will buy x amount of this commodity on y date, at z price." That allows the farmer - who doesn't know what his crops will be worth in the future - get a firm price from the person who buys the futures contract. Those contracts are relatively standardized, so they get traded on exchanges like the CME Group.

So futures are based on a guess about the future price of a commodity, or currency?

That's exactly right. They're actually a kind of derivative. In fact, the very oldest kind of derivative is rice futures, which were traded in Japan in the 1700s.

Wait, so this is about derivatives? Derivatives? Again with the derivatives!

We know, we know.

So what happened at Peregrine?

Details are still coming out, but it looks like the company lied about how much money it had on its books. It told  the National Futures Association, a self-regulator, that just three weeks ago that it had $225 million in the bank - but it actually had only $5 million.

Whoa! What happened to the money?

No one knows yet. As you can imagine, it's a huge scandal. Peregrine has filed for bankruptcy, the Commodity Futures Trading Commission filed a lawsuit, and the FBI is looking into it. Authorities think Peregrine may have been lying about its finances for two years.

What's clear, however, is that the missing money belongs to the firm's customers. So those farmers have no access to their money any more, if it even exists.

That sounds like what happened with MF Global, that place that was run by Jon Corzine.

Yes, exactly. MF Global was another futures brokerage and it went under and took $350 million of customer money with it. The prevailing theory is that when MF Global was struggling for money, it just dipped into its customers' accounts - which are supposed to be separate - and used that money to keep the firm going instead. It's the same thing as if your bank was in trouble, so it just decided to drain your bank account. Peregrine promised its customers it was safe after MF Global's collapse - but it ended up doing the exact same thing.

So now there are real questions about how well the futures market is regulated, especially when we're so obsessed with financial reform. It was one thing when it looked like MF Global was an anomaly. But if other customers in the futures market can't trust that their money isn't just going to go poof, that would be bonkers.

Ugly. So, back to Peregrine, how did we find out about all this?

Apparently, the National Futures Association only just recently switched to electronically confirming that its members were telling the truth about their finances.

This all came to a head on July 9. That day, the company fired all its employees, effective immediately, without giving them any notice or severance or vacation pay.  That was also the day that the company's founder, Russell Wasendorf, tried to kill himself in his car by hooking up his exhaust pipe to his passenger compartment. He did it in the company's parking lot, so some employees found him. He's in the hospital now.

Wasendorf is a pillar of the community in Cedar Falls, according to the Des Moines Register, which reported, "Wasendorf also owns three restaurants in town, sits on the University of Northern Iowa Foundation Board and is a member of the board of the Greater Cedar Valley Alliance economic development group. He has been recognized by the city twice in the last three years for business excellence." He also has a family charity and his son, Russell Wasendorf Jr., is the president of Peregrine.

His financial ruin also means the financial ruin of 125 employees. One of them, Ronald Kotulak, is suing Peregrine on behalf of his colleagues, alleging that the firm illegally left them high and dry.

What happens next?

Wasendorf is in the hospital, his son is running things, and the company has to get through the bankruptcy process and find its money. The family is ruined and Peregrine's customers are missing their money. It's a mess. It will take a long time to work through it and find that missing money.

Oy.

Yeah.

 

About the author

Heidi N. Moore is The Guardian's U.S. finance and economics editor. She was formerly the New York bureau chief and Wall Street correspondent for Marketplace.
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