I recently read an article about a Florida city that’s down millions of dollars as the result of a fuel hedging program. In analyzing the details, a college professor gave an opinion that “the city’s only strategy appeared to be based on the price of natural gas increasing over time.” The city purchased long-term futures contracts on natural gas. However, the price of natural gas decreased over time, losing the city quite a bit of money. In finance, many high risk strategies are one directional. When you’re right about the direction of price movement, you’re a superstar, but when you’re wrong, you can lose your shirt.
A long-term one directional strategy can be a gamble. Hedging is supposed to reduce risks, not increase them. Prices can go up, down, or sideways, this is a matter of fact. Ideally, the possibility of price movement in all directions should be considered if implementing a hedging strategy. With futures, this is more easily achieved by using short-term futures contracts to help protect against short-term price swings. What’s ironic is the city pays a risk management consulting firm to provide advice on hedging risks. Just because one can lock in a future price, does not mean one will save money. The savings gained by a decrease in a commodity’s price, can be more than offset by the loss of premium paid for futures contracts.
I hate to dwell on Florida, but since I relocated to Florida from New York City, I’ll continue to do so. In 2009, Florida’s State Board of Administration booked a 250 million dollar loss on a questionable investment in New York City real estate. The board, which manages over $100 billion in state employee retirement assets, was apparently warned during audits about their risky 2007 investment in Manhattan’s largest rental apartment complex. The risky investment, made at the peak of the real estate market, imploded to create a 100% loss. Had Florida paid me $5 million for my opinion, I would have produced at least $245 million in savings by advising against losing $250 million, in one of the worst real estate transactions of all time. Note: the total cost of this blunder was closer to $266 million when you account for the fees involved – great revenue for the broker of this deal.
These are just some of the financial blunders government entities have made across the U.S. The strategic direction set by elected officials, along with the various policies they administer, requires a greater level of financial literacy and prudence. A lack of financial literacy by individuals contributes to reckless behavior. A lack of financial literacy among elected officials is conducive to creating another global financial crisis.