The Subpriming of Commodities
The logic is simple. If by leveraging housing stock — using the stock as collateral — the process of mortgage securitisation encouraged subprime lending to people who (arguably) couldn’t afford them, could leveraging commodities in the same way be encouraging equally uncouth lending practices?
Leave the massive commodity operators aside for a minute — though, that’s not to say they are not being impacted — and consider smaller corporate entities that utilise commodities in their daily manufacturing processes.
It’s always been common practice for commodity inventory to be financed by banks by being pledged as security for the loans in question.
The problem comes if such enterprises, instead of using the inventory for general business purposes, are encouraged to stockpile for the sole purpose of liquidity provision and the opportunity to punt on the underlying commodities themselves. It’s a process which arguably artificially pumps up demand for the underlying inventory.
Bundle all those loans together, meanwhile — ideally into a product that can be sold to buyside investors seeking exposure to commodities — and suddenly you’ve got a direct source of funding for an ever-more speculative game.
When it comes to the larger players, meanwhile, this arguably transcends ‘trade finance’ even further — especially if it involves the setting up of a large number of special purpose vehicles to accomplish the process.