What Did We Learn from the 80’s and Implications for 2010 and Beyond

1. What Did We Learn from the 80’s and Implications for 2010 and Beyond National Farm Financial Management Training Workshop June 3, 2009 Omaha, Nebraska Danny Klinefelter Professor and Extension Economist Texas AgriLife Extension and Texas A&M University

2. “In times of change, the learners inherit the earth, while the learned find themselves beautifully equipped to deal with a world that no longer exists.” --Eric Hoffer

3. Back to Reality The function of a competitive market is to drive the economic return to the average producer to breakeven through supply and demand responses in both input and output markets. In equilibrium the top end are profitable and growing, the average are hanging in there, and the bottom end are losing money and exiting the industry. Business success and survival depend on continuous improvement at a pace necessary to stay in the front half of the pack.

4. What Did We Learn and What Are the Implications? • Congress and financial regulators are always more reactive than proactive • Markets overreact on both the upside and the downside. • The market value debt to asset ratio tends to be a lagging indicator. • The debt to income ratio and interest expense ratio tend to be better leading indicators of financial problems. • Irrational exuberance: Alan Greenspan, “80 percent of market economics are psychology.” • What appreciates can depreciate, and quickly. • In competitive markets, extended boom periods tend to be followed by a cleansing period which usually takes 3-5 years and can have another 2-3 year hangover. • Interest rates and debt structure are as important as debt levels in terms of the impact of debt on producer’s financial performance, and rates can change much more rapidly. • The “half life” of the lessons learned in a financial crisis appears to be about 10 years.

5. What Did We Learn and What Are the Implications? (cont.) • Black swan events are real. The tails of economic/financial distributions are larger than the normal distribution assumptions. Most risk models only capture “normal” periods, and that includes the rating services, e.g., Moodys, Dun and Bradstreet, etc. • Econometric models are data dependent and backward looking. • Total enterprise risk management is critical, but implementing it is both expensive and easier said than done. Even the most sophisticated financial institutions are still basically silo risk managers. • Don’t treat an income problem as a credit problem. The extra funding pumped into FmHA and SBA direct and guaranteed loan programs exacerbated the financial crisis of the 80s by holding excess resources in the sector and allowing asset values to climb to higher levels before they crashed. • Cash basis income is not a very accurate or timely measure of financial performance. Accrual adjusted income frequency spots developing problems as well as turnarounds 2 years sooner. • Liquidity matters. Cash flow is king, but the ratio of net working capital to gross farm revenue (or total operating expenses) is a better indicator of financial health.

6. What Did We Learn and What Are the Implications? (cont.) • Farm operator’s management ability is the primary determinant of success or failure, and it is hard to capture in risk rating models. • Consulting study, Illinois, Kansas, SPA • Lenders’ ability to match pricing and terms of loan assets and funding liabilities is critical. According to OMB, in the 80s the Farm Credit System lost about as much on the funding side as it did on loans. • The export market is critical for U.S. agriculture and we are more dependent now than we were then. • The Russian grain embargo 13. Financial institutions and their staff do what they are incentivized to do. Incentives that are too volume or efficiency driven are a recipe for disaster. • By the end of 2007 most of the risk premium had been bid out of capital market loans by competitive forces.

7. What Did We Learn and What Are the Implications? (cont.) • Regulations and controls can be politically driven and bureaucratic; but, they are absolutely necessary. • Derivative markets • Glass-Steagall Act 15. Macroeconomics are just as important as microeconomics to the health of the ag sector. • Interest rates- monetary policy, fiscal policy • Value of the dollar- trade, oil prices • Unemployment rates- 80 percent of total farm household income is now derived from off-farm employment 16. There were and will always be a significant number of producers who see themselves as victims. They blame their problems or lack of success on anything or anyone but themselves. They frequently can’t see their own faults, and even when they do, they usually aren’t doing anything significantly to change the way they manage their business, i.e., they basically keep using the same approaches to management and business models that they always have. • One thing that directly or indirectly factors into all issues is the certainty and increasing rate of change. A lot of people not only don’t like it, they resent it. Unfortunately, too many people are only going to change when they feel the heat rather than because they see the light. • Due to budget and personnel reductions, traditional extension programming is limited in its ability to respond to major crises; but, it doesn’t have to be if it is allowed to adapt. • Refer to “To Remain Relevant, Change Agents Also Need to Change”

8. Addendum

10. Qualifying Farm Debt:Asset Statistics • While 70 percent of farm operations carry no debt, debt use is more concentrated among capital intensive and larger operations that depend primarily on farm business income. • Much of the shift away from debt has occurred among farms generating less than $500,000 per year. • Real estate accounts for 87 percent of total farm assets • 42 percent of land in farms is owned by non-operator landlords, 58 percent by active farmers • Of the 58 percent owned by farmers, 61.3 percent is by farmers with less than $250 thousand annual gross sales

11. U.S. Census of Agriculture Data 1982 1987 1992 1997 2002 2007 Number of Farms (Millions) 2.24 2.09 1.93 1.91 2.13 2.20 Gross Farms Sales (Billions) $131.9 $136.0 $162.6 $196.9 $207.2 $305.2 Farms with Sales over $1 million Number 5000 11,000 16,000 26,000 30,000 57,000 Percent of Total Farm Sales 24% 28% 33% 42% 47% 59% Percent of Total Farms .2% .5% .8% 1.4% 1.4% 2.6% Farms with Sales over $500 Thousand Number 28,000 32,000 47,000 69,000 74,000 121,000 Percent of Total Farm Sales 32% 38% 46% 57% 62% 73% Percent of Total Farms 1.3% 1.5% 2.4% 3.6% 3.5% 5.5% Farms with Sales over $250 Thousand Number 86,000 93,000 123,000 157,000 160,000 217,000 Percent of Total Farm Sales 47% 53% 62% 72% 76% 85% Percent of Total Farms 3.8% 4.4% 6.4% 8.2% 7.5% 9.9% Farms with Sales over $100 Thousand Number 302,000 296,000 370,000 346,000 323,000 366,000 Percent of Total Farms Sales 72% 76% 83% 87% 89% 93% Percent of Total Farms 13.5% 14.2% 19.2% 18.1% 15.2% 16.6%

12. Shock Testing Asset Values