My Deep Think Future™- Dot #2: Finance, money, capital

I have been spending spare moments looking at our farm budget for 2009.  While I know somewhere in my brain that the farm is expanding next year by about 25%, we have invested prodigiously for the future since Aaron returned, and the farm is profitable and [relatively] secure, the huge numbers are freaking me out!

While I have been known to suck it up and plod on, it's not my first instinct. Alas, I don't see many other options, right now.  Therefore, I need to get a firm grasp on my tools for coping with the Money Problem in the next 4-5 years (no reason for this duration, just an arbitrary window).

The most basic question is how wealth will be allocated and traded, or what investing and commerce will look like. Let's look at the economy as a whole and then zero in on farms.

The big picture for the future of wealth is being shaped, I think, by the End of Trust. The idea of handing your wealth over to other people to invest and earn income off of has taken a huge hit.  Consider the ongoing unraveling of the Madoff Swindle.  Even if you had never heard of the guy, a fund you own might own a fund which invested in his imaginary products. And just like financial institutions are frantically trying to find out if they own some "toxic assets" indirectly, many are finding out the hard way, they were connected to Madoff.

The 53-year-old investor, who asked not to be identified to protect his stake, took out about $600,000 this year from his $1.5 million account, using some of it to pay down a mortgage. He and other Madoff clients who withdrew funds as long as six years ago may be sued on behalf of other victims to return profits and even principal, securities and bankruptcy lawyers say. 
...
Under New York state law, which can be invoked for Madoff recoveries, a trustee can seek redemptions going back six years, said Tracy Klestadt, a New York bankruptcy lawyer.
In a similar case, U.S. Bankruptcy Judge Adlai Hardin in White Plains, New York, ordered investors of defunct hedge-fund manager Bayou Group LLC in October to disgorge profits they’d taken out. Investors were required to pay back any gains they’d redeemed involving “fictitious profits.” Before the fraud was discovered, Bayou paid out more than $135 million, according to court papers.
‘Good Faith’ Rule
Hardin also ruled some investors would have to hand back their principal. Only investors who acted in “good faith” -- a legal standard that makes investors prove they didn’t have knowledge or suspicion of fraud -- could protect their initial stake, Hardin ruled. He said investors could show they had good faith if they didn’t see any “red flags” when they withdrew the funds.
That decision could be a guide for Picard, Klestadt said.
The Bayou decision set a high bar for investors who hope to protect their principal, said Carole Neville, a lawyer representing Bayou investors.[More]

As "clawbacks" leave painful "clawmarks" on victims, the hard lesson is being broadcast globally.  Now couple that with the general contempt for Wall Street denizens and corporate leadership and you have a decreasing number of folks you would willingly hand your money to.  Arguably, it might be forgotten if roaring good times return next week, but I suspect something has been broken deep in the engine of American commerce.

So how might this play out in the months ahead?  Has trust left the building?

We were wrong. Madoff's pyramid scheme, far broader than anything MMM dreamed up, was made possible by our own tradition of lawfulness. And now he will help bring that tradition down. Here's a prediction: In the coming years, American capitalism will become slower, more cautious, less productive, and less entrepreneurial. We're still a long way from Eastern Europe of the 1990s or from the Latin America or Russia of the present. But maybe not as far as we think. [More of a great article]

I tend to agree, and think it will take a decade at least to recover.  It might even require generational change to lose the living memory of these fiascoes.  Others think we'll be back with our checkbooks at the first sign of a bull market.

If there is a lasting effect from Madoff, it will be to accelerate a shift already well underway: the idea that, when it comes to their money, the only thing many Americans now truly trust is a specific government promise.

In his inaugural address in 1981, President Reagan intoned that "government is not the solution to our problem; government is the problem."

In this financial mess, government is turning out to be the only solution.

There have been runs on plenty of hedge funds this year, but no run on the banks overall, because the government insures deposits and most people (thankfully) still have faith in that insurance.

Likewise, many investors have been happy to sink their savings into low-yielding U.S. Treasury securities because they're confident that, at the very least, Uncle Sam will return their principal intact.
...
As for the issue of Wall Street's wretched image, history is clear: It's nothing that a good bull market, somewhere down the line, won't make a lot people forget, if not forgive. [More]

Carving a position somewhere in between these two, I believe folks with cash will take about 6 months to get tired of zero-return government paper before contemplating anything a sliver of risk higher. Assuming dramatic stimulus measures are enacted, it would seem at least some stocks will rise. But it may take several months of climbing before even aggressive investors develop much appetite for risk.

A complicating factor is how fear of unemployment freezes our brains when it come to wealth decisions.  Evene though the vast majority of Americans will not lose their jobs, they will likely know well someone who become a casualty.  Further, unlike previous recessions, many of the job losses are coming much higher up the ladder.  The financial sector has essentially disappeared, for example, and along with it thousand very highly paid jobs.

Surviving in the job market will not eliminate some collateral damage to most of us.  Wages will be depressed by the availability of eager (and cheaper) replacement workers right here at home.  At the same time some organizations are experimenting with lower hours to avoid layoffs.  The prospect for income growth as a whole could be impaired for a considerable period, as a result.

Meanwhile, back on the farm, we not still be connnected to those who are on the front line of this misery. Children and other family members may need temporary help. Siblings who inhereited with you may need to liquidate their share of the farm to fund retirement, college, whatever. Landowners may see the same pressures, although I don't think that will have much impact if land prices hold steady while all other assets struggle.

So the combination of these factors could produce these capital characteristics:

• Cheap borrowing for 12-18 months for upper tier operations, especially from deposit-based lenders (banks). (Of course, it looks like every financial institution will be a bank soon.
• Possible relief in inputs, but not until later into 2009, meaning continuing demand for credit for ag.
• Wild ranges between borrowing rates since swithcing lenders will be viewed with considerable risk.
• Credit shortages for farms highly dependent on off-farm income, when such employment is an area under pressure, such as manufacturing.
• Less urgency to expand if it requires massive drains on working capital (new machines, storage, people, etc.). At the same time cash-rich operations will look more favorably on expansion, since cash will be such a poor income generator.  While this strikes me as logical, I tend ot forget cash-rich operations often are not aggressive by nature, so those needing to sell out may struggle to find reasonable value for their operations.
• New paperwork we can't even imagine yet.  If Enron gave us SarBox, heaven knows what bizarre regs will be attched to the flood of government money surging toward us.  This will try the patience of many farmers and their lenders.
• A rare opportunity to lock in historically cheap long-term money.  I'm not sure where it will come from, but if home mortgages hit 4.5% there would likely be some farmland money for similar rates.

Unlike most of the rest of the economy, access to capital is not our biggest problem.  That will be demand for our output.  And we'll look at that presently.

But money?  I think this one is manageable.