If you're borrowing money short-term, you're going to pay more for it.
June 19, 2008
The banking world has created another mess the public is going to have to pay for through higher interest rates. For growers and everyone else, subprime loan scandal means it will be more expensive and more difficult to borrow money. Likewise, more consumers are facing foreclosures, losing equity in their homes and stretching to make ends meet for the bare necessities. How inclined are they going to be to buy plants when they can barely pay for food and gasoline?
Debt wise, growers tend to fall into three categories:
• Older operations that are debt free
• Expanding operations that borrowed money to increase size and invest in technology
• Others are very leveraged just to pay for operating costs to run the business.
Warning to growers with considerable debt: If you’re borrowing short-term money, you’re going to pay more for it. And those who have credit lines with variable rates are finding risk factors that were acceptable two years ago are no longer acceptable. Interest rates are too high.
The latest banking industry scandals surround subprime loans, the bankruptcies of Bear Stearns’ two subprime funds, the foreclosure on home loans because people cannot afford the increased interest rates and the loss of the home’s value to below what is owed on the property. Over $200 billion in subprime adjustable rate mortgages will reset upwards from low teaser rates with monthly payments increasing by 40 to 50 percent. Since the average subprime borrowers already spend 40 percent of their after-tax income on housing, they cannot afford the resets. Also the value of single-family homes will fall about 20 percent from the 2005 realty boom.
Borrowers need to cover the losses and find money to cover the increase from subprime to conventional loans. Banks are tightening the amount of money they will loan. You must have a very good credit rating and also have a higher share of equity in your home or business if you are to secure a loan.
A. Gary Shilling in his article, "The Bear Bust," which appeared in the August 13, 2007 issue of Forbes, predicts that, perhaps by the end of the year, American consumers will retrench and precipitate a big recession as the home equity that supported their spending evaporates.
Banks use teaser loan rates to attract money in their advertising. An example is student loans that you don’t have to pay until six months after you complete college, but when you start paying, you have to pay that actual principal and all the interest for four years and six months tacked on to the principal. Unfortunately, they don’t advertise this fact. Some say practices like this are deceitful. Some say they are criminal. But, if you read the fine print (very fine print), they think they have themselves covered.
Banking On A Death Wish
How low can Wall Street and the banks go? They are now selling "death bonds," trying to profit from mortality. Death bonds may be the most macabre investment scheme ever devised by Wall Street. Even while the subprime mortgage was crashing, many of the biggest financial players had a conference in New York to talk about the next exotic investment.
More than 600 participants descended on New York for a three-day meeting. The group included Bear Stearns (the firm that just had two hedge funds go bankrupt in the last three months), Deutsche Bank, Lehman Brothers, Merrill Lynch, UBS, Wachovia, Wells Fargo and others. They were all learning how to profit from people dying.
How does it work? Banks and lenders offer to pay the insurance premiums for people who can’t afford to keep their life insurance, if they agree to sell their policies to the investors. The investors then take a percentage of the insurance benefits when the person dies. For the investors, the quicker the death, the more profit they make.
Most transactions are made by firms called settlement providers that sell the policies to hedge funds for a fee. These hedge funds offer investors huge profits if the schemes work out, but when they go bust, the hedge funds and their investors go broke!
Since the hedge funds, brokers and banks have lost a lot of money on subprime loans – some of them going bankrupt – they now need a new source of great profit. So why not make it on those who are close to death? How ghoulish can Wall Street, banks and brokers become?
If you want to see just how low the financial industry can go, read "Profiting from Mortality" by Matthew Goldstein in the July 30, 2007 issue of Business Week.
Bait And Switch
After this past month, my opinion of people on Wall Street – the brokers, the hedge funds, the investors and the bond raters – is that they are somewhere between deceitful and criminal. The federal government should closely watch the schemes that the financial community develops.
The subprime interest rates, the college loans that you don’t have to pay for until you graduate, and now the death bonds are all sold by telling only part of the details involved. All the rest is written in very small print, usually in the last few paragraphs of the documents. They are usually sold to you by an individual who comes to your home after dinner asking you to sign anywhere from five to 60 pages of documents. You never get the whole story until you get your first statement from the bank that bought the loan from the broker you dealt with.
Remember, if the deal is too good to be true, it probably isn’t true!
A home loan I was supposed to get for 2.5 percent for 60 months was true, but they forgot to tell me that the real interest rate was 8.34 percent. If I paid only 2.5 percent, I would owe 20 percent more at the end of five years than I had borrowed originally because the additional interest was tacked on at the end. Deceitful? Yes! Criminal? Maybe.
The people you trust to help you make money and keep it may be the same people who are taking it from you. The bottom line: make sure you have a great lawyer, a great accountant and a great banker. Don’t look for the cheapest deal. Look for the best deal.
The best deal is one where you get the people who take care of your money and your business, as well as you, so you can take care of your plants. In all my experiences, the best financial people I’ve met are the ones who live in the same town or area and truly have a concern for you and your company. They are an important part of your family and business life.
Make sure you have the right financial and legal people, and beware of the something-for-nothing hustlers. Again, experience is the best teacher, but the tuition is too high!
Will Carlson is a long-time industry consultant for growers and retired Michigan State University professor. Respond to his columns or drop him a line at firstname.lastname@example.org.