Thursday, October 02, 2008

What's the deal with my bank?...

A commenter below points out my musing about the credit crisis doesn't jibe with his information.
John, you seem to be convinced that credit is about to become unavailable. I do business with several different banks. Each of my bankers assures me that they are happy to continue to extend me credit at the same rates they have been. That they see no liquidity problems and that they feel very solid. The bankers and I believe inflation is a very real possibility. One banker predicts we will see interest rates jump Decemberish. So what do you think? Are my bankers lying to me? Are they ignorant? 
This deserves some clearer words, obviously.

First, one crucial aspect of bank involvement in the credit crunch is oddly, size.  Small banks like mine operated the way we tend to think of banks working:  take in deposits and make loans to customers.  These banks, especially if they were small AG banks (mostly ag loans - operating, machinery, and even farmland mortgages) are correct in saying they are in great shape.

Nonetheless, I believe they are mistaken if they think the credit crisis will not reach them, if only in a good way (for the banks).  Here's how.

First, any banks with whom they are linked by common ownership who do have "toxic assets" or for the most part many residential real estate loans at all, could cause a drain on the lending resources.
The banks' losses might seem poetic justice after their abominable performance. But costly feedback effects on the rest of us are in prospect. Uncertainty over the quantity and valuation of banks' "toxic assets" has meant that many cannot count on loans from each other to meet daily needs, and this illiquidity in the markets has impaired their ability to lend. Among banks that had excessively leveraged their capital through borrowing and other devices, the losses wiped out much or all of their capital, and this near-insolvency has dampened their willingness to lend.

The resulting credit contraction is starting to crimp working capital and investment outlay at small businesses and is having wider effects on business activity through its impact on interest rates, exchange rates and consumer loans. This feedback is causing a fall of employment on top of the direct effect of the housing contraction on employment in construction and finance. The added fall in jobs will in turn add to mortgage defaults. [More]
Many banks - big and small - owned some Fannie and/or Freddie shares, for example, because they had a higher return during the last few years than they could make loaning elsewhere.  That's one reason many rural banks are mildly nervous.

Second, if your local bank has been bought out by a regional bank like Fifth Third, the problem is more significant.  Medium-sized banks such at these tried to emulate the big boys and started investing in exotic debt instruments for the earnings boost they needed to satisfy board members.  Note how stockholders feel about such banks now.  Lending at the banks cannot continue as usual, although ag could be treated as special, since it is one of the few lending bright spots.

Third, lenders who depended on selling commercial paper such as Famer Mac, and the rest of the Farm Credit System have a challengeNot because they have bad paper, but because many of the the normal buyers of their bonds, like Merrill Lynch, are well, gone.  And other buyers are fleeing to T-bills.

Can they still sell bonds?  I think so.  Will the price change? Almost certainly.  Will this mean tighter lending standards and higher rates for farm borrowers at these institutions?  That's my prediction.

So will my teeny bank have money to lend to me? Definitely.  But suddenly I think I will be seeing neighbors who were borrowing elsewhere waiting in the lobby.  My banker is in a much stronger position as she smiles and offers a new op loan rate.  FCS was the dominant loan price-setter in my area.  If they change rates/standards even non-FCS lenders will feel it.

In an extreme case it could turn out to be a situation where farmers with expanding credit needs (my operating loan will look like the GDP of Rwanda, for example) will simply suck dry the resources available at small conservative banks.  It could also be that big banks in good shape will take a new look at ag lending, especially if prices rebound. Regardless, competition for ag loans will be strong, I think.

Bottom line: all banks will be affected by the credit crunch.  Some will be affected positively, after years of limping along with low margins due to competition by the more risk-taking lenders.

Another factor will be in-house credit like Case Credit or terms at your fertilizer dealer[Update: This morning I discovered the rate on my JDFP note for my new combine was 1.2% higher than quoted 3 days ago.] These are funded often with corporate bonds - commercial paper - and those stacks of certificates just aren't moving.

Finally, farmers will not be untouched by a surrounding economy that is being strangled by the credit lock-up. Not only will neighbors and family members lose jobs, our demand will erode.
 But the crisis has spread well beyond US shores and beyond the financial sector. Top automakers including General Motors (GM) gathering in Paris warned of tough times amid concerns that slowing demand could force production cuts and job losses. [More]
It doesn't matter if your bank is rock solid.  The credit crunch will reach your farm.

Ours is one interlinked economy and the quiet schudenfraude of seeing high fliers taken down will be short-lived when we notice we're all tied together at the wallet.


ralphrr said...


one has to be naive to believe that we as farmers will affected. Even ones that don'd borrow much will be paying more to suppliers,machinery companies ,ect. who WILL be directly affected with financial fallout.
On the JDFP interest I find them easy too work with but my calculations on true interest cost never seems too be the same as they figure---regards-kevin

ralphrr said...