Recalling DeAngelis amidst credit turmoil and near crash

by Morton Sosland
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In 1963, a former butcher who had sought to establish himself as an international commodities trader, with the name of Tony DeAngelis, created a huge uproar in markets by walking away from losing trades in soybean oil futures financed by loans against inventories of the product allegedly stored in New Jersey tanks. It turned out that Mr. DeAngelis not only defaulted on his trades by not meeting margin calls, which resulted in several sizable brokerage companies failing, but that the vegetable oil stocks he purportedly owned were non-existent. Yes, it was outright fraud.

This episode, which prompted food traders to adopt rules to prevent its repeat, comes to mind in reaction to the terrible turmoil that hit financial markets beginning late last summer and climaxing with government intervention in September. While the fraud Mr. DeAngelis committed involved trades and loans with a total value of about $30 million and the more recent situation threatened losses in the trillions, a similarity exists that uniquely fits the businesses of food manufacturing and processing.

The common theme between 45 years ago and today is defining what constitutes collateral against which loans are made by banks and similar financial institutions and in the food industry among processors and traders on exchanges and in private transactions. While many explanations have been heard for the credit crunch at the heart of the near implosion of the global financial system, the fault that looms loudest is the failure of traders to understand the collateral against which they were both lending and borrowing. Asset-based lending, which was central to the creation of various forms of structured credits as well as asset-backed bonds, was suddenly assigned greater weight and credibility than other factors. As long as the instrument being bought or sold was asset-based, it was to be accepted, usually without question.

Just like those lenders who failed to determine if the DeAngelis storage tanks really held vegetable oil, accepting only the photographs of the tank "farm" supplied by his infamous Allied Crude Vegetable Oil Refining Corp., no one saw fit to check the reality of this asset-based collateral. This approach was facilitated by the outrageous complexity of many instruments, where even the most astute traders could not explain cash flow sources that would have to be called upon if the assets were truly good collateral.

A particularly acute description of what was happening pointed to "the fetishisation of collateral which had become an unquestioned article of faith." This approach was gained by relying on credit ratings for collateral debt obligations and asset-backed securities that in the end proved useless. No one heeded the way that the values of assets used as collateral for credit were rising bubble-like. By disregarding appropriate credit analysis, which became essential in food trading and processing in the wake of the DeAngelis fraud, the financial sector neglected underwriting standards on the various investment vehicles that were used to supply funds to investment bankers. In turn, the way these bankers utilized leverage only magnified the ills of the credit crunch and the drying up of liquidity,

This single-minded reliance on asset-backed credit was hardly questioned before it fell into shambles and threatened the underlying economy. It is Peter Fisher, a highly regarded financial guru, who warned, "We should not be surprised that our financial system has been re-engineered into an asset-based process that presumes rather than inquires into the cash flow of borrowers."

Food manufacturers may derive some satisfaction from their absence from the maelstrom that struck investment bankers and financial markets. Yet, it would be wiser to recall once again incidents like DeAngelis. These show that acceptance of assets as a given for collateral is not always reality, that safeguards must be in place, that cash flow sources must be understood, and that vigilance is just as essential in trading among peers as it is in dealing with commercial banks.

This article can also be found in the digital edition of Food Business News, February 17, 2009, starting on Page 9. Click here to search that archive.

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