Ag Economist Goes Over The Anatomy Of A Financial Crisis
May 1, 2009 Renowned ag economist Dr. David Kohl describes the events of how we found ourselves in the current economic crisis in a language Floridians know well — it was like a category five hurricane coming on shore.
As we hit the turn of this century, U.S. political leadership saw fit to overturn the Glass/Steagall Act, which had been in place since the Great Depression and separated investment banking from commercial banking. This opened the door to an array of imprudent lending practices from the “shadow” banking system, including the likes of Bear Stearns and Lehman Brothers. These institutions did not accept deposits like depository banks, and therefore, were not regulated in the same way and did not have to keep as much money in the vault relative to what they loaned.
In essence, these shadow banks borrowed short and loaned long. They borrowed money in short-term, liquid markets that had to be repaid frequently, while at the same time, they loaned money on long-term, harder assets like mortgage-backed securities (toxic assets). When the housing bubble popped, all the long-term money disappeared, and the shadow banks could not pay back or obtain their massive short borrowing. Within days, the entire system was on the brink of disaster.
While the shadow bankers were devising all of these elaborate means of moving money, U.S. political leadership decided that everybody deserved to be in a home and encouraged the banks to give exceedingly risky loan terms, which was facilitated by Freddie Mac and Fannie Mae. This high-risk lending, in part, led to the housing bubble.
“All of this no-doc, 100% loans, cheap money, and lucrative terms were spontaneous combustion waiting to happen,” says Kohl. “Not everybody deserves to be in a house. You earn the right to buy a house and earn the right to stay in a house. We have got to get back to prudent lending and business practices.
“So we had the perfect convergence of events that got us here, including imprudent lending of the shadow banks, then the movement to get everybody in homes, followed by cheap money from China, which lowered interest rates.”
Great Depression?
A Great Depression is defined as -25% growth for two consecutive quarters, which Kohl notes we are a long way from, but he adds this is the first synchronized global downturn since the Great Depression.
“In North America, we (USA) are growing at a -6.3 GDP, Canada is -3.4%, and of course, Mexico has its own turmoil,” says Kohl. “That is 5% of the world’s population, but it makes up 29% of the world’s economy. The entire region is in recession.
“The entire Euro-Sector is growing at -5.8% GDP and it makes up 7% of the world’s population and accounts for 25% of the world’s economy. Then you look at Japan, the world’s second largest economy, and it is -12.1% GDP. Taking all three of these regions, they make up two-thirds of the world’s economy, and they are showing very negative growth rates.
“My assessment is this is a pretty rough downturn, and it is going to be awhile to see some recovery,” he says. “We could be 24 to 27 months out. I would encourage growers to be wary of dead-cat bounces in the economy. It might recover for a period, then we could go right back into it, because this is an economy, not just in the U.S., but around the world, that we are artificially propping up with all these stimulus packages.”
Advice Down On The Farm
Kohl advises growers that they should really have two strategies in place to deal with the volatility of this market. While the economy is in a deflationary period right now, he says that in the next several years we could go into an inflationary phase of high interest rates driven by the government’s non-stop printing of money and handing out stimulus packages.
“You really have to have two strategies,” says Kohl. “One for deflation, which says cash is king, and one for inflation, which says financial liquidity is king. We are in a period of volatility, so you have got to maintain flexibility in finances, in your contracts, marketing plans, and management plans, so that you are able to move fairly quickly if world or local economic conditions change real fast.
“I would also say business planning is not an option, it is a requirement, because what happens in this type of environment is people get very emotional. The business plan brings objectivity to a very, very emotional environment. When you do your plan, you need a revenue strategy, an input strategy, and an interest-rate strategy.”
Opportunity
While there’s a lot of doom and gloom in the current crisis, Kohl says there are some bright sides.
“There will be more opportunity in the next 10 years, than we have probably seen in the last 30 years,” he says “But, you are going to have to be innovative and very selective on those opportunities and make sure they are synergized with your business, personal, and family goals and your operation’s finances, marketing, and management. So I would express it this way — some of the best business models are built during tough economic times.
“But, it will require the grower to realize they are no longer in the minor leagues, in other words, he or she is in the World Series. Fully realize you may select the wrong risk and it could put you out of business.”
So is it a good time for a grower to expand or buy equipment? Kohl says yes, if No. 1, the plan is consistent with your business, personal, and family goals. And, No. 2, you must expand prudently.
“Make sure that it is an economical and profitable expansion and that it is going to return greater than your borrowed money, your interest costs, and inflation rate,” he adds. “Then No. 3, if you expand, be sure you have cash or items that can be turned to cash — at least 10% to 20% of your revenue. So if you should have a sniffle after your expansion, it doesn’t force you to sell those assets on a declining market. So be very prudent and push the pencil.”
to read the entire transcript of Dr. Kohl’s interview.