Don't forget stupid government policies like corn ethanol. The government subsidy for ethanol is 51 cents per gallon and the government tariff on sugar cane ethanol (from Brazil) is 54 cents per gallon.

Farmers have a limited amount of land, so by growing more corn due to the subsidy for ethanol, the supply of other grains decrease, e.g., wheat, oats, etc. Corn is also used as feed for livestock, so the cost of producing meat, eggs and dairy contribute to price increases in those products as well. The increase in the price of corn is also driving up prices for farm land as well.

References:
WSJ.com: Amber Waves of Ethanol
Four of every 10 rows of U.S. corn now go for fuel, not food. http://online.wsj.com/article/SB10001424052748703...

Excerpts:
In 2001, only 7% of U.S. corn went for ethanol, or about 707 million bushels. By 2010, the ethanol share was 39.4%, or nearly five billion bushels out of total U.S. production of 12.45 billion bushels. Four of every 10 rows of corn now go to produce fuel for American cars or trucks, not food or feed.
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This carve out of nearly half of the U.S. corn corp to fuel is increasing even as global food supply is struggling to meet rising demand. U.S. farmers account for about 39% of global corn production and about 16% of that crop is exported, so U.S. corn stocks can influence the world price. Chicago Board of Trade corn March futures recently hit 30-month highs of $6.67 a bushel, up from $4 a bushel a year ago.
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Demand from developing nations like China is also playing a role in rising prices, and in our view so is the loose monetary policy of the U.S. Federal Reserve that has increased the price of nearly all commodities traded in dollars.

But reduced corn food supply undoubtedly matters. About 40% of U.S. corn production is used to produce feed for animals. As corn prices rise, beef, poultry and other prices rise, too. The price squeeze has already contributed to the bankruptcy of companies like Texas-based Pilgrim's Pride Corp. and Delaware-based poultry maker Townsends Inc. over the past few years.

WSJ.com: The Farm Belt Boom
Land prices are soaring. Is this another Fed asset bubble? http://online.wsj.com/article/SB10001424052748704...

WSJ.com: Ethanol's Grocery Bill
Two federal studies add up the corn fuel's exorbitant cost. http://online.wsj.com/article/SB12438996638527441...

IBDeditorials.com: Ethanol And Hunger http://www.investors.com/NewsAndAnalysis/Article/...

John,

It's insurance. If you take out an insurance contract and you pay the premiums what is the collateral? What is it worth? An insurance policy protects against a loss. If there is no loss, it has no value.

Take an options buy contract. It may be based on a stock, but if the stock is trading at or below the strike price the only value the option contract has is based on the volatility of the underlying stock and the time to expiration. When it expires, voila! it's worth nothing if the stock price hasn't exceeded the strike price at expiration.

Then there is the writer of a buy contract. If he/she doesn't actually own the stock, the the stock price shoots up and exceeds the strike price by 4 times, he/she is now liable for difference.

The fact that you keep arguing this "based on NOTHING!" point only shows your ignorance of how derivatives markets work. Yes, one can take on a great deal of risk if one does not know what they are doing but these instruments are extremely useful in managing risk.

The second issue is the Federal Reserve. The Federal Reserve's monetary policy has been extremely easy over the past 15 or so years. This is the reason for the tech bubble and the reason for the real estate/mortgage bubble. This has not been just a US phenomenon either, as Europe's central bank and Japan's central bank have had very low interest rates (greater money supply) that contributed to a world wide glut of pension fund money (as much as $40 trillion in 2005) looking for a home. This drove up asset prices, which lowered market rates of return on assets. For example it wasn't uncommon to see smaller multi-family properties being valued at capitalization rates of 3% to 5% in Los Angeles. Historically one would expect these rates of return on a longer term Certificate of Deposit, not a time consuming riskier asset.

The reality is that many investment managers started to ignore risk in search of the historical rates of return to which they were accustomed. When you combine this with the concept of "guaranteeing" benefits in public retirement programs, it is a sure recipe for disaster.

A few more comments on your chapter:

"As Shaun Yde, the school district’s director of business services, put it, the goal was to 'guarantee a secure future for our employees without increasing the burden on our taxpayers or decreasing the funds available to our students to fund their education.' "

This was their first mistake. There are not guarantees in life and guaranteeing future benefits is the reason why so many public pension funds are in trouble. There is a good commentary on that in today's Wall Street Journal - see: "Public Pension Deficits Are Worse Than You Think - How can fund managers assume an 8% rate of return?" http://online.wsj.com/article/SB10001424052748704...

Three: The person that you profile in your story should have known better than to "invest" in derivatives without first understanding what he was doing (just because someone is a "doctor" doesn't mean they have the experience to perform heart surgery). There are sales people in every industry that will tell one the benefits of their product but not the detriments. A prudent person should always look for the detriments, especially someone in charge of investing substantial sums of money. The government can't stop people from being stupid, nor should they try.

Four: Government regulation in most cases is the reason for many economic problems. It’s called the law of unintended consequences and it’s always the typical pattern. A problem occurs due to government imposed regulation. The government blames some populist scapegoat. The government rides to the rescue with more proposed regulation and consumer protections. It’s a vicious cycle. I believe the definition of insanity is doing the same thing over and over and expecting a different result.

Les,

One: If you had read the rest of my posts and the links to the articles, which I listed, you would have seen that the reason those underlying assets were rated AAA was due to the very regulations that people believe are necessary to protect them.

Two: Derivatives are a tool. Blaming them for the failures of humans is absurd, just as absurd as blaming guns for robberies. They serve a purpose if used correctly. If used incorrectly they can be devastating. Should we regulate "swamp land" because some fool bought a piece of property sight unseen? Should we ban "Junk Bonds" because someone lost their shirt by investing their life savings in them?

Yes, I would agree it is generally subjective but unfortunately, society doesn't care. Greed usually has a negative context and by its mere definition, they have defined anyone with "ambition" as greedy. I am saying there are many "greedy" people who benefit society in the process of benefitting themselves.

If Progressives/Socialists define all the "rules" then Capitalism, Ambition, Greed, the American Dream, etc. will always be bad things. They are by definition trying to group any anti-Socialist behavior as immoral based on their secular moral values (e.g., collective is good, individual is bad). I am trying to take back the ground by differentiating ethical greed from unethical greed (not everything that is legal is ethical and vice versa).

John,

Traders who trade futures generally do not take possession of the actual commodity. They are only trading on the price volatility, so the majority of futures contracts are offset against other futures contracts. Do you think the airline in my example actually takes possession of the crude oil?

As far as the CDS's being based on nothing, this is not true. It is no different then having multiple people placing insurance policies on your life. If you are an executive of a large corporation which depends upon your expertise it wouldn't be uncommon to have your company hold an insurance policy on your life, your wife could hold an insurance policy on your life, and your mortgage company could hold an insurance policy on your life in the event you die and can't pay your mortgage.

They are contracts based on the value of an underlying asset. Another type of derivative, Interest rate swaps have been around for many years and large institutions use them to hedge their cost of funds. For example a bank that takes deposits and pays interest based on the Fed Funds rate but lends money at the LIBOR rate, may find a counterparty that is willing to swap Fed Funds rate for LIBOR based on an amount the bank feels it needs to "lock in". In this way the Bank will not be "squeezed" if the Fed Funds Rate rises but LIBOR stays constant.

In any derivatives market there are people that give risk and there are people that take risk. As long as the risk is relatively known, the market is efficient in its pricing

continued...

WSJ.com: Let's Write the Rating Agencies Out of Our Law
By Robert Rosenkranz
http://online.wsj.com/article/SB12308607373834805...
“We should not, but the regulators have, and that is the problem. Regulators of banks, insurance companies and broker dealers have all incorporated the work of the ratings agencies into their regulations in myriad ways. Most importantly, bond ratings determine -- as a matter of law -- how much capital regulated institutions need in order to own the bonds.

For every dollar of equity that insurance companies are required to hold for bonds rated AAA, $3 is needed for bonds rated BBB, and $11 is needed for bonds rated just below investment grade (BB). For banks, the sensitivity of capital requirements to ratings is generally even more extreme.
…..
Indeed, that is the entire raison d'être of the $6 trillion structured-finance business, which serves little economic function other than as a rating-agency arbitrage. Subprime mortgages (and all manner of other risky loans) held directly by financial institutions are questionable assets with high associated capital charges. Each one alone would deserve a "junk" rating. Structured finance simply piles such risky assets into bundles and slices the bundles into tranches. The rating agencies deemed some 85% of the tranches by value as AAA, and nearly 99% as investment grade-- thus turning dross into gold by a sort of ratings alchemy."

The Price for Fannie and Freddie Keeps Going Up
Barney Frank's decision to 'roll the dice' on subsidized housing is becoming an epic disaster for taxpayers.
http://online.wsj.com/article/SB10001424052748703...
“There is more to this ugly situation. New research by Edward Pinto, a former chief credit officer for Fannie Mae and a housing expert, has found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A.”

Congress' Financial Mess
http://townhall.com/columnists/WalterEWilliams/20...

Maybe the Banks Are Just Counting Wrong
http://online.wsj.com/article/SB12218651556215867...

AmericanThinker.com: Why the Mortgage Crisis Happened
By M. Jay Wells
http://www.americanthinker.com/2008/10/what_reall...

Video of the CSPAN congressional hearings on the Fannie Mae and Freddie Mac Accounting scandal which came to light in 2004.
see: http://www.youtube.com/watch?v=_MGT_cSi7Rs

Clinton administration's "BANK AFFIRMATIVE ACTION"
Andrew Cuomo references a Federal Reserve Report that was later discredited.
http://www.youtube.com/watch?v=ivmL-lXNy64

IBDeditorials.com: How the Fed, Media and Academia Aided and Abetted Lending Debacle
http://www.investors.com/NewsAndAnalysis/Article....

WSJ.com: A Mortgage Fable
http://online.wsj.com/article/SB12220407816126118...

WSJ.com: The Fannie Mae Gang
By Paul A. Gigot
http://online.wsj.com/article/SB12167705016067539...

NationalReview.com: Inside Obama’s ACORN
By Stanley Kurtz
http://article.nationalreview.com/?q=NDZiMjkwMDcz...

IBDeditorials.com: Congress Tries To Fix What It Broke
http://www.investors.com/NewsAndAnalysis/Article....

WSJ.com: Faith in Ratings
http://online.wsj.com/article/SB12221266858956522...

WSJ.com: The Moody's Blues
http://online.wsj.com/article/SB12030364147827021...

WSJ.com: AAA Oligopoly
http://online.wsj.com/article/SB12039875459239226...

WSJ.com: Most Pundits Are Wrong About the Bubble
http://online.wsj.com/article/SB12242827064124604...

WSJ.com: Another 'Deregulation' Myth
http://online.wsj.com/article/SB12242820141024601...

WSJ.com: Spitzer and Sarbox Were Deregulation?
http://online.wsj.com/article/SB12254160910938672...

WSJ.com: The Ratings Racket
http://online.wsj.com/article/SB12143505139130151...

WSJ.com: Information Haves and Have-Nots
http://online.wsj.com/article/SB12220338206886094...

WSJ.com: The Meltdown That Wasn't - A primer on credit default swaps, the latest Beltway scapegoat.
http://online.wsj.com/article/SB12267041190972968...

WSJ.com: Bad Accounting Rules Helped Sink AIG
http://online.wsj.com/article/SB12216932042144984...

WSJ.com: Behind AIG's Fall, Risk Models Failed to Pass Real-World Test
http://online.wsj.com/article/SB12253844972278463...

NYTimes.com: Dear A.I.G., I Quit! http://www.nytimes.com/2009/03/25/opinion/25desan...

SeattlePI.com: Activists vent at AIG executives http://www.seattlepi.com/business/404117_aigbus22...

continued...

Here are my sources:

A Silver Lining to the Financial Crisis: A More Realistic View of Capitalism
http://online.wsj.com/article/SB10001424052748704...
A bank's capital reserve represents funds that are not borrowed--funds that, therefore, need not eventually be paid back to someone, such as a bank's depositors. Thus, an important source of a bank's capital reserve is funds from selling shares of stock in a bank. These funds can be costly to acquire, as one expert has pointed out:

For corporations (including banks) not eligible for Subchapter S earnings pass-through treatment, the after-tax cost of equity capital, say 12 to 15 percent, is substantially greater than the after-tax cost of debt, which is generally in the 3 to 5 percent range.

By reducing their capital holdings, banks can, at least in principle, increase their profitability.

But under the recourse rule, "well-capitalized" American commercial banks were required to spend 80 percent more capital on commercial loans, 80 percent more capital on corporate bonds, and 60 percent more capital on individual mortgages than they had to spend on asset-backed securities, including mortgage-backed bonds, as long as these bonds were rated AA or AAA or were issued by a government-sponsored enterprise (GSE), such as Fannie or Freddie. Specifically, $2 in capital was required for every $100 in mortgage-backed bonds, compared to $5 for the same amount in mortgage loans and $10 for the same amount in commercial loans.

The Latest AIG Story
http://online.wsj.com/article/SB10001424052748704...
Will regulators ever coherently explain why AIG could not be allowed to go bankrupt in September of 2008?

At yesterday's House hearing, Secretary of the Treasury Timothy Geithner and predecessor Hank Paulson said they didn't bail out AIG to save its derivatives counterparties. Instead, said Mr. Geithner, the now-famous 100-cents-on-the-dollar buyouts of credit default swap contracts were necessary to prevent a further downgrade of AIG by credit-ratings agencies.

This topic probably deserves another hearing on its own. Remember, the Federal Reserve Bank of New York, where Mr. Geithner was president, had by that time already seized AIG. We're guessing that a ratings agency is pretty comfortable with the creditworthiness of a firm 79.9%-owned by Uncle Sam. Yet Mr. Geithner is saying that the same credit raters that applied triple-A ratings to tranches of junk mortgages somehow got the yips when the world's most respected borrower was standing behind AIG.

If the agencies had applied to AIG the credit rating of its new owner, there wouldn't have been much need to send more collateral to such counterparties as Goldman Sachs. Instead, AIG could have demanded the return of some of the collateral it had already posted. Bad news for those counterparties.