ANALYSIS: Cheese market under federal investigation

You've questioned it for years, pizza operators, and now the federal government is doing the same. It's launching an investigation into how cheese is priced on the Chicago Mercantile Exchange.

According to the May 2006 issue of the Milkweed, a dairy industry watchdog publication, the Commodities Futures Trading Commission (CFTC) is actively examining alleged irregularities in cash cheddar markets. Unnamed dairy industry sources told The Milkweed they had been questioned by the CFTC back in the spring.

But perhaps more compelling than the CFTC's investigation is six U.S. senators want the comptroller general of the General Accountability Office (GAO) to "conduct a study on the cash cheese market at the Chicago Mercantile Exchange and its role in federal milk pricing." A copy of the July 13 letter, obtained by PizzaMarketplace, is signed by Sen. Russell Feingold (D-Wis.), Sen. Arlen Specter (R-Pa.), Sen. Hillary Rodham Clinton (D-N.Y.), Sen. Charles Schumer (D-N.Y.), Sen. Herb Kohl (D-Wis.) and Sen. James Jeffers (I-Vt.)

Call me presumptive, but such an assembly of heavy hitters poking around the li'l ol' dairy business surely hints at something serious. Anyone who's watched the news lately knows this sextet has bigger fish to fry both at home and abroad, so it makes one wonder why the CME issue is on their radars. Apparently, it's very important, especially since all six represent big dairy states.

Their letter reads, "There has been concern in the past that this 'thin' market for cheese is susceptible to price manipulation because the price of essentially all cheese is linked to the sale of less than 1 percent of the cheese that is actually delivered in the cash market."

My translation: "We're worried this "thin" market can be exploited at the expense of our constituents, and we want to know, CME, if you know anything about it."

We've all heard experts say the cheese market roller coaster ride is hilly and harrowing because of shifts in supply and demand, and there's a lot of truth to that. But as a study published in 1996 showed, throughout the 1980s and '90s, big cheese buyers and sellers have successfully steered the market in directions that profited them alone. What's become clearer in the last few years is supply and demand aren't the only entities getting a turn at the tiller.

No one's talking ... yet

Since this is a sticky issue, I'm not surprised no one in the dairy industry wants to talk. One anonymous source's comment was simple but telling: "It's serious business. ... The do-do just might hit the fan."

Even calls to the senators' offices weren't returned. (Well, OK, I can understand that oversight. I can hear them now: "Who did you say called? He's from Pizza what?") Even when times are good, cheese makers say nothing, so their reticence isn't shocking.

So let's turn to what we do know.

The aforementioned 1996 study is called "Cheese Pricing: A Study of the National Cheese Exchange," and was published by the Wisconsin Department of Agriculture. You'll notice it studied the National Cheese Exchange, not the CME, to which cheese trading moved in 1997 after years of — you guessed it — suspected price manipulation at the NCE in Green Bay, Wis. The NCE's problems basically boiled down to the issue of "trading against interest." The term describes a situation in which a cash market trader buys and sells, when typically he is one or the other. The study showed how the biggest the cheese buyer-seller, Kraft Foods, used its market-dominant position to buy or sell in ways that influenced market prices favorably. When, for its own profit, it needed to depress prices, it flooded the exchange with product. When it helped to keep prices high, Kraft scooped up lots of product and tightened supplies.

The result in either case was some group other than Kraft took a beating. When cheese prices were high, farmers made money, but consumers paid more at the grocery. When cheese prices were low, dairy farmers took the hit and consumers rejoiced.

From late 2001 through early 2003, cheese prices hovered near or below government support levels. But as the nation emerged from the post-Sept. 11 recession and the economy began humming again, demand increased and cheese prices responded. ByJuly of 2003, block cheese rose to an unusual high of $1.60 per pound and held there almost to the end of October. According to Bunting's report, "Coincidental with this strangeness was the need of DFA to establish a credit level necessary to sell some bonds. When that was accomplished, and the bonds were sold, the price crashed."

Interesting, huh?