A bit of a tongue in cheek look at the credit crunch and what it means for those wanting farm finance.

7th October 2008

In a previous article ‘AMERICA SNEEZES, BRITAIN DIES OF PNUEMONIA?’ I waxed lyrical about how Uncle Sam had made loads of money available to the UK and other markets (that which the bankers refer to as liquidity). Just as I inferred then, as soon as credit becomes scarce the whole fabric of the economy can begin to look fragile and this can affect those looking for farm finance or a farm mortgage. I was somewhat complimentary about the American system, though at the time I was not aware of just how haphazard (if not negligent) their system has been. With the demise of Lehmans et al and the other publicised near death bank experiences, it would seem as though the truth is coming out.

And what a truth it is! It would seem that, over the pond there has been a feeding frenzy, where just about every piggy has been to the market. Banks have lent to just about any red neck, with a pulse and a shack, on the back of assuming that house price rises would sort out any risk. It seems that the scale of NINJA mortgages (No Income, No Job) were far higher than anyone could ever have envisaged and it may well be that, whilst the Yanks invented the system (and think they own it), they are also architects of the current mayhem. On the back of these mortgages, the clever money people created financial instruments bought by a variety of institutional investors and it remains to be seen whether any of them were duped in the process. It was as if they were offered a return for investing in a box of mortgages, the only condition being that they could not open the box to see what mortgages they were buying into. In addition, it may be that some of these instruments obtained a credit rating that could not match the reality beneath them. How this was allowed to happen remains to be seen, though I hear the FBI is keen to investigate. As ever – living their lives in a movie.

In the last article, I described the process of Securitisation, which essentially is where mortgages are pooled into mortgage-backed bonds. Put simply, investors buy bonds, issued by lenders, backed by mortgages that have already completed. The interest payments paid by the borrowers then fund the interest payments to the bondholders. There is nothing wrong with the concept, until borrowers stop making payments and have no means to refinance their mortgages because of a dip in house prices or where otherwise credit is not available – as in a credit crunch, which makes the problem self-feeding. Consequently, investors are not paid, they lose confidence and quickly stop investing, particularly when they realise that the value of their bonds is dubious. This leads to a reduction in available credit even where there are banks willing to lend but who simply cannot replenish their own funds to be able to do so. Over here, many lenders withdrew their funds some time ago (Lehmans being one of them).

I would not know how US lenders viewed farm finance, since most of the negligent loans were made to ordinary householders. If over here is anything to go by (given that farm and land prices remain buoyant), they might be regretting not giving the sector a little more attention. But then you can’t tell the Americans anything given that they are consumed by their own arrogance based upon a misconceived belief that they are World saviours which in turn is based on the presumption that the Goddam whole World wants to live the American dream. After all, this is the country that brought us Mac Donalds, Burger King, obesity and discarded polystyrene cartons.

If you want a light-hearted take on what’s happened in the US, click on the link here. I should warn you that there is a little bad language in it.

In the current crisis, things have happened at lightning speed because the Americans have concluded (in my opinion audaciously) that everyone else will have lent just as they have in their unregulated market. This is not the case and banks over here, especially the smaller specialist lenders, cannot raise money to lend even though they have well performing loan books – Commercial First is a good example. The loss of this type of lender has an impact on those looking for farm finance or a farm mortgage or farm loan notwithstanding that as security there is nowt better than farmland or a farm itself. There are, of course, wider implications for the economy.

It seems that just as quickly as the sharks gathered for the feast, they have been as quick to swim for it – an over reaction in what caused the problem and an over reaction in trying to resolve it. Some lenders, for example, are using the buzz term ‘responsible lending’ as unwritten criteria allowing them to turn anything down. It is a tacit admission (were it true) that they have previously lent irresponsibly – a bit like the fair trades jar of coffee on the supermarket shelves suggesting that the other jars, on the same shelf, are of an unfair trade. Come on lads, we are brighter than that – just tell us you ain’t got any money! I believe that only borrowing can be irresponsible as long as borrowers are properly informed and their circumstances plausible. Who would enter into a finance agreement if they could not afford it?

I reckon the Americans [because they invented the system (and therefore think they own it), lent haphazardly and never thought house prices would decline] have automatically concluded that we and every other country in the World have not only lent in the same way but also that we will suffer house price reductions. Accordingly, they have pulled the rug, with the result that credit has become scarce with house prices in retreat. Like I said, if there is no money, people cannot borrow, houses are not sold and a plethora of dependant businesses goes into recession. The result is that banks do not want to lend to each other because they have lost confidence. Those same US bankers that were prepared to sell sub-prime backed mortgage bonds (and get fat in the process) have now become paragons of prudence and virtue – well they would, wouldn’t they, particularly as they want us to pay for it.

The World has gone mad. The devaluation of shares across the globe is not an assessment of the net worth of businesses, but a replacement of confidence with panic. Nobody stopped to look at the HBOS business to actually establish how good or bad it was. The market simply thought that because its business depended upon UK housing, which they thought was in for a bashing, it would sell their shares en masse. The result was a decline in value from £11 per share, around a year ago, to under £1 per share – in other words a huge shift from a market value with a massive positive variance from balance sheet value to a massive negative variance from that net worth.  This has allowed Lloyds to ‘acquire HBOS’ for a song. However, more seriously, we should consider for a moment the effect this will have had on every day people who for example have a pension plan or other equity-based investments. As the blurb says, the value of shares can go up or down and by Harry isn’t that right?

So whose fault is all this mess - capitalism, government, lack of regulation? And what is the impact for those of you who want farm finance or a farm mortgage or a farm loan?

Here is my take on it: -

1. The Americans are to be lauded for creating a system that allowed an influx of money to come into, amongst others, this country. This allowed economic growth by making credit easier to obtain. This fulfilled a demand; it cannot be right to say that, because credit became easier to obtain, banks over here behaved irresponsibly. I have often received a gracious letter from my credit card company confirming an increase in my credit limit, but this has not meant that I needed to spend it.

2. Then the Americans got greedy and a lot of fat cats got fatter. In addition, because the money was rolling in and they thought it would never end, they became less concerned with whom they were lending to and what they were lending on and simply chased the dollar. So desperate were they for their bit of the swill that they simply chewed and swallowed anything put before them and it all went down so quickly that they could not taste whether it was swill or the very dirt they had produced themselves.

3. For this, they are to be criticised because they must have broken the fundamental rules of good banking practice, which has to be caveat emptor or due diligence, or in normal speak, look at what you are getting into. There can only be two conditions; either investors could not give a monkey’s about the underlying value of what they were getting into, or they were duped - time will only tell. And let us remember that the red necks who received the money actually had it and spent it and have decided that it’s a good idea not to pay anymore. An American dream and nightmare all in the fiscal bat of an eyelid.

4. There is actually nothing wrong with sub-prime lending at sensible loan to values. However, sensible loan to values went out the window over the pond. What is irksome is that they have the temerity, over there, to believe that our banks have lent over here in the same way. There may have been some cloning of the model but not to the suicidal extent over there. Their belief that our property market would decline has become a self-fulfilling prophecy because their panic has resulted in a scarcity of credit. In truth, they have been as quick to leap from their own bandwagon, as they were to hitch a lift on it. And now they have created the losses they want us to pay for it. It’s a bit like the second World War where America actually made a profit out of it and emerged stronger than they were before they came in. The rest of the warring nations were virtually bankrupt. We have only recently paid the last instalment under the lend lease agreement. The adage is simple - make everybody pay and if we make a balls of it make everybody pay more.

5. Now, as they go cap in hand to their government they have become all pious, holier than thou and are playing the ‘responsible lending’ card. One or two of you might ask why we or any other taxpayers should bail out the authors of their own destiny and it is a good question. If America was the true bastion of capitalism, without restraint, then why should they not fall as a consequence of their own folly just as they have benefited from the fruits of the good things they did? There may not be a right answer but unless the banking system is propped up confidence will not return, credit will remain scarce and the whole western World may enter a long and painful recession. Merchant Bankers would refer to this as a period of adjustment. But then they are merchant bankers as cockney rhyming slang would have it – you’ll know where I am coming from.

6. The truth is that we are all paying for this mess already, either in higher mortgage rates, reduced pension or investment values and a loss in business and incomes. For me the solution is not further regulation, as this is likely to be draconian based on an over reaction. The answer is for a return to proper banking practice where lenders or investors perform due diligence on the value of what underpins their investment and then organise facilities secured on those values directly. In other words, lend or invest only after a judicious review of the true value of the assets offered as security and following a review of the credit rating system that has apparently allowed junk bonds to receive a far better credit rating to that which they were likely to have been entitled.

7. Is this the fault of capitalism? The answer, in my opinion, is no. If the invention is wrong, then go back to the inventor and capitalism did not invent junk bonds; it merely created the conditions under which they could be invented. It’s a bit like blaming the computer when the computer is operated by humans. After all, what is the alternative to capitalism and the innovation and enterprise that goes with it? Think on and consider whether any of the great inventions in the World could have happened without the motivation that a free market can provide. In the final analysis, capitalism will ultimately sort out the mess. The UK government is likely to step in over here and I can see some form of part bank nationalisation and loans structure as well as an injection of money into the banking system, in the hope that the banks can restructure and to bring some confidence back so that banks will lend to one another. After all, consider for a moment the fact that as the banks will not lend to each other their Chief Executives are actually saying ‘I would not lend to someone like me’. Inspiring and ironic isn’t it, that we all might be part owners in companies to whom we might apply for credit at some time and be turned down on the grounds of ‘responsible lending’. I must be missing something.

8. Lastly, what impact does this have on those looking for farm finance or a farm mortgage or a farm loan? Well, there is no doubt that things have become tougher and finance harder to come by, but the glimmer of hope is that farms and farmland is good security and so there are still lenders out there willing to lend. Perhaps ever more, there is need for expertise in presenting an application, which is where we come in.

Well there you have it – tongue in cheek. We love the Americans really.

Mark Bracegirdle FCCA FMAAT