Jan 20, 2009

Growers Should Prepare for a Credit Crunch

As growers prepare for the new production year, there are a few things they need to know about money.

First, money this winter could get as cheap as it will probably ever get, so if you have good plans for expansion and growth, it’s a good time to borrow money and go for it.

Second, however, credit is tight – an odd counterpoint. The $700 billion rescue of the financial system was supposed to loosen credit, especially long-term money for homeowners in distress, but the money failed to trickle down through the layers of fear and greed that sucked it up without apparent benefit – to the amazement even of gurus like Alan Greenspan, who believed the free expression of individual self-interest would make everything better.

While there’s been a lot of “happy talk” about how good farmers’ balance sheets and bottom lines are, and some assurances that money is available, the fact is that money may not be available. Check with your lender to find out whether your line of credit for spring operations is still there. Your bank may be ready to welsh on previous arrangements.

The “black swan” of 2008 – high oil prices – appears to be gone, and government appears poised to resort to “the twisted yield curve” to stimulate the housing market. It has undone “the Fisher effect” by getting banks in other countries to work in concert in lowering interest rates. And if all else fails it will take “the nuclear option,” another name for “the helicopter drop” – injecting cash into the economy by other means.

In any event, the economy will recover, but questions about how soon, inflation rates, unemployment rates, interest rates, export levels and consumer spending remain. And everybody seems to be waiting for Barack Obama.

That was the condition of things when Washington state fruit growers and packers gathered for their 104th annual meeting in Yakima. The annual Batjer Address was given by Ed Seifried, an economist from Lafayette College, who traveled west from Easton, Pa., to tell them, in economic phraseology, the meaning of the unnerving new facts of life. The “general slowdown” in the economy was officially declared a recession the day he spoke.

“Black swans,” as he described them in economic parlance, are rare events, like oil going to $145 a barrel. They are like bubbles in some ways but come unexpectedly, while bubbles gradually grow. So the black swan of hyper oil prices came and helped burst the real estate bubble, both by depriving people of income and creating dead zones at the edge of commuting distances.

Plummeting real estate values undercut the value of mortgages and left bankers too paralyzed with fear to lend – even as they were given taxpayer money to do just that.

Seifried seemed to be optimistic, despite everything that has happened. The government won’t let the economy fail, even if it means using “the helicopter drop.” The government need not work through banks; it can print all the money it needs, build bridges to nowhere or give it away. It can drop bundles of cash from the sky.

Before that happens, with all the inflationary effect that would have, the next move should be, in Seifried’s view, to “twist the yield curve,” boosting the short-term interest rates, which are now about zero, and reducing long-term rates to put money into the economy for capital investment, especially in the housing industry.

But, Seifried noted, Federal Reserve Chairman Ben Bernanke is sometimes called “Helicopter Ben” by his friends at Princeton University. While Alan Greenspan was willing to inflict pain to avoid inflation, Bernanke is not, he said.

One explanation for the prolonged economic downturn, he said, is “the Fisher effect.” One member of the Federal Reserve Board, Richard Fisher, voted against interest rate cuts last year, arguing that unless the banks of the world acted in concert, lower interest rates in the United States would draw away money to those paying higher rates. After several months, he won his point and the United States began working with banks in Europe to move rates down everywhere.

As a result, the dollar became stronger and the price of oil fell.

Seifried had some soothing words for bankers assessing values. When bubbles burst, he said, values generally return to pre-bubble levels, plus what normal inflation would have given them. Not everybody lives in a real estate bubble area of the same size, but you can fairly assess the final resting price using his rule of thumb in your area.

The key problem in the economy remains the weakness in housing, he said. During the bubble, housing starts rose from normal levels of about 1.7 million per year to more than 2 million. Then they fell, to a very low level of 791,000 last September.

“Housing starts are weak and we need to correct this,” he said.

He expects the Fed to push long-term mortgage rates to below 5 percent, reinforcing his view that it’s time to invest.

David Schweikhardt, an agricultural economist at Michigan State University, is not convinced that banks can be enticed to lend. Currently, investors are choosing to own Treasury bills, even though they are paying near zero interest, because they have no trust in any other investment. Just having a safe place to store money and getting it back is good enough for now.

In November, Schweikhardt spoke to the Michigan Commission of Agriculture, expressing his concern.

“At the present time, there is an assumption that agriculture will face only a minor impact from the credit crisis,” he said. “This assumption is primarily based on the extremely favorable outlook for farm income and agricultural exports in recent years. In my opinion, however, such optimism is unwarranted. Agriculture cannot escape the larger trends now occurring in credit markets.”

Reducing the federal funds rate has had limited effect on the availability of credit. The reason is that “the credit crisis has transformed from a liquidity crisis (the lack of available loan funds by banks and lenders) to a security crisis (a lack of confidence by investors/lenders in other banks and/or borrowers).”

Because of this, “investors have fled many sorts of commercial paper and are transferring their loanable funds into U.S. Treasury bills in pursuit of higher quality investments of known risk.”

What about farm real estate? Schweikhardt predicted it will be an “ugly winter” as farmers and landlords talk it out, but both the falling prices of commodities and the lack of assurance of operating credit “can’t support the land rent levels” of the last year or two.

Lending by rural banks may dry up as well.

“Smaller banks were not involved in subprime mortgage lending,” he said, “but they will be affected by the collapse of the real estate market, especially if contractors can’t repay construction loans. Regional and local banks may be more exposed to construction loans and commercial real estate loans. Such loans are also experiencing a dramatically increased rate of default with the collapse of the housing market.”

Moreover, Schweikhardt believes home prices have fallen about 15 percent, only half of what they need to fall to reach their pre-bubble “historic relationships with income, population and construction costs.”

The declining price of oil, while a boost for the economy in general, is not great for agriculture since corn prices and oil prices have become linked through ethanol.

“As a worldwide recession worsens, the demand for agricultural commodities and the demand for oil, now a major determinant of corn prices because of their relationship in the ethanol market, will decrease,” he said. “Such a development would lead to downward pressure on commodity prices.”

As a result of these forces, “I believe that the availability of agricultural credit – both short-term credit and long-term credit – will be affected in a dramatic fashion in coming months.”

He told the commission he sees these effects coming:

1. All borrowers will be required to provide additional information on their ability to repay loans from current earnings.
2.
3. A strong balance sheet will not be enough to obtain short-term credit in the existing environment; the emphasis will be on the liquidity of the borrower. Borrowers’ ability to repay loans from current earnings or cash reserves will likely play a much greater role in judging the creditworthiness of borrowers.
4.
5. Credit provided by some input suppliers could be particularly affected by the lack of credit available in the commercial paper market.
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7. Greater competition for all forms of credit could affect the interest rates paid by borrowers.
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9. The outlook for the economy is highly uncertain. Some analysts believe that excess industrial capacity will make deflation a possibility in the near term. Others believe that the recent actions of central banks around the world have set the stage for a period of more rapid inflation. Finally, some analysts believe that both are possible – a period of deflation followed by a period of inflation. Virtually all analysts believe that a recession is a certainty and that it will be a deep recession that will last for an extended period.
10.
“Consequently, it is my opinion that the credit crisis will have a much larger impact on the agricultural sector than is now being recognized,” he said. “Producers, lenders and state government should be prepared for that possibility.”