Tuesday, May 13, 2008

While we were watching corn prices...

The Fed did something astonishing. While we noticed, we didn't really see what it meant.
In December, the Fed had $775 worth of Treasury securities. That stock will soon have dwindled to $300B, give or take. The difference, about $475B, represents an investment by the central bank in risky assets of the US financial sector.

$475B is an extraordinary sum of money. It is as if the Fed borrowed more than $1500 from every man, woman, and child in the United States, and invested that money on our behalf in Wall Street banks that private financiers were afraid to touch. For bearing all this risk, if things work out well, taxpayers will earn about what they would have earned investing in safe government bonds. If things don't work out well, the scale of the losses is hard to predict. The Fed will claim to have done "due diligence" on its loans, to have valued collateral conservatively, and will point to strength of bank guarantees and the enormous diversity of collateral assets to convince us that its actions are safe and prudent. But rating agencies made the same claims about AAA CDO tranches, and turned out to have been mistaken. Correlations often tend towards one when asset values fall sharply. Central bankers struggling to manage day-to-day crises in financial markets might cut corners when trying to value complex securities. They might find it convenient to err on the side of optimism, as the ratings agencies did, albeit for very different reasons. And even if the Fed is cautious and sober-minded, are we sure that central bankers can value these assets more accurately than private investors?

If the Fed were to blow through the rest of its current stock of Treasuries, it would have invested more than $2500 for every man, woman, and child in America. Public investment in the financial sector would have exceeded the direct costs to date of the Iraq War by a wide margin. Would that that be enough? If not, how much more? Just how large a risk should taxpayers endure on behalf of companies that arguably deserve to fail, to prevent "collateral damage"? Have we considered other approaches to containing damage, approaches that shift costs and risks towards those who benefited from bad practices, rather onto the shoulders of taxpayers and nominal-dollar wage earners? Does this sort of policy choice belong within the purview of an independent central bank? [More]
I am not, along with other observers labeling the action incorrect, just monumental in its scope. I don't begin to pretend to understand the subtler nuances and consequences of this magnitude of intervention, but collateral developments seem to indicate the credit markets are indeed not right. At least not yet, perhaps not for a long time.

The most likely places for this effect to be felt for us on the farm are a) ag lenders who depend on investor money versus deposits, i.e. the Farm Credit System, CoBank, etc. and b) agribusinesses who buy and sell to us, as their commercial paper and credit-worthiness comes under new scrutiny in a suspicious market.

One indicator for me is the virtual dismantling of the municipal bond market. Once a haven for tax averse investors, the combination of government money, elected officials, and enormous fees provided a breeding ground for questionable practices and taxpayer ripoffs. That is all coming apart now, making the future for government funding of roads, schools, etc. much more expensive if even possible.
The shrinking of the municipal bond industry means it is going to cost more for states and localities to borrow money. That means the tolls, fees and taxes that support the debt are all going to have to rise.

You can't expect two of the top 10 underwriters of bonds to disappear without consequences. UBS AG said it was getting out of the municipal bond business on May 6. Bear Stearns Cos. is being absorbed by JPMorgan Chase & Co.

We don't quite know how these two events are going to play out -- UBS is apparently transferring a number of municipal bond traders into its wealth-management division -- but taking away two major bidders can't be good news.

We are probably just at the beginning of the cycle of layoffs, cutbacks through attrition and more outright exits. Banks are going to be looking at who makes the money, and if the municipal bond department isn't, you can guess the rest. [More]
It will be some time before the ramifications of this problem flabbergast enough small school boards and county officials to provoke interest in rural America. But farmers could see changes in their lives and businesses much sooner.

The credit crunch shut down forward contracting, and though it appears to be re-emerging, it will be far more self-financing from the farmer perspective than before. I think similar changes in familiar practices as simple as pre-pays or billing cycles will likewise be altered to exploit a new source of investment funds: American farmers.

Bluntly put, we will be encouraged to to prepay to fund vendors, to deliver grain unpriced to fund customers, and fork over deposits on new machines for later delivery. Our prosperity is a poorly kept secret and steadily rising prices on both sides make these actions seem reasonable until we find ourselves an unsecured creditor because a vendor/customer folds under the whopping financial risks being taken on a by fairly staid old industries.

Speaking of paranoia, it has recently dawned on me that one reason I could be having trouble getting delivery windows for my priced grain is it requires cash to settle with me, whereas NPE deliverers can keep the plants running without immediate cash required. My customers seem to want me to carry the storage risk, as well as their credit and margin risk as long as possible.

For an industry still looking at barely enough corn and beans to supply needs, this refusal to take physical and monetary ownership of grain is a risky maneuver IMHO. What will they do in the fall with a 12B corn crop, and little coverage?

New York City is a lot closer to Prairie Township than it used to be.

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