IBA convention report: End of era leaves future uncertain

Economics professor Edmond Seifried declared the era of the investment bank dead on Sept. 22, the opening day of the annual convention for the Iowa Bankers Association. Bankers used the two-day meeting in Des Moines to assess the rapidly changing financial services industry. Seifried and others said recession is likely, $200 per barrel oil is possible, housing in some parts of the country may remain repressed for a decade, and the price bubble for commodities and farmland will burst in a couple of years..The weekend prior to the convention, the last remaining independent investment firms, Goldman Sachs and Morgan Stanley, announced they would seek bank holding company charters. While one era may be ending, Seifried and the 350 people in his audience wondered about the next. Congress was considering a $700 billion package to purchase bad assets in the nation's financial system. While Seifried, an economics professor at Lafayette College in Easton, Pa., said the plan could work, he warned of its inflationary consequences. While at the time of the convention such legislation seemed certain to pass by week's end, the U.S. House of Representatives voted down the package on Sept. 29..Seifried said he expects the rural economy to slide, once the rippling effect of the financial crisis hits grain and farmland prices. Had the federal bailout passed, however, Seifried predicted the bubble would have lasted another two years or so. "Once the bailout effect is over, you will see a bubble burst in Iowa like you've never seen before," he said..Housing is at the core of the nation's economic problems, with 9 percent of mortgages delinquent or in foreclosure. Seifried said political leaders long have wanted to reach a homeownership rate of 70 percent. "Those last few percentage points represented people who never should have gotten mortgages," he summarized. "Fannie and Freddie [which went into federal conservatorship Sept. 8] bought those mortgages," Seifried observed..Financial institutions all over the world bought mortgage backed securities which contained several of the subprime mortgages that constituted the final percentage points in the desired home ownership rate. Seifried cited the example of M&T Bank of Buffalo, N.Y., which purchased $131.7 million in such securities. Regulators required the bank to solicit bids for the MBS and when the highest bid came in at $4.4 million, the bank was forced to take a $127 million hit to earnings. The company's stock dropped $22 the day it was announced.."It is a bad idea to outsource your underwriting standards," Seifried summarized..Dr. David Kohl, economics professor from Virginia Tech University in Blacksburg, Va., said the housing market will remain stagnant for years. Credit will become more difficult to get and those who don't need credit will let prices bottom out before they begin buying. Seifreid said: "Nothing is going to turn housing around soon. We have a year and a half of excess supply to work through.".Kohl further said the economy is slowing because Americans have been borrowing against the strength of their balance sheet. With the value of the assets on that balance sheet declining, credit is becoming harder to get and spending is slowing. Illustrating the phenomenon know as "wealth effect," Kohl said that for every single dollar increase in the value of real estate, typical homeowners on the East and West coasts increase their spending by nine cents; homeowners in the Midwest increase their spending by four cents..Seifried however, said Americans have a bigger problem than real estate. "The long term impact of energy prices is a greater threat to our economy," he said. "We can control housing prices; we cannot control the price of oil.."I think $200 per barrel oil is possible," he said. Kohl offered the same prediction. "I can envision $60 to $100 swings in the price of oil. I can see $7 gasoline, $8 diesel fuel," Kohl said.."What are the implications" of those high oil prices? Kohl asked. "In rural Iowa, eight out of every $10 is somehow connected to oil.".Kohl noted recent record prices in agricultural commodities. "Profits have been extremely high," he said. "When you start looking at 2009 with input costs going up, margins that currently are at $150 per acre of land are now projected in some areas to be $31 per acre next year.".Jim Schipper, 2007-2008 IBA president, said despite the attractive prices, grain remains a risky business. "At a time when we are at unprecedented big numbers on the revenue side, we probably have the highest risk exposure at the same time," said Schipper, American State Bank, Osceola. "Most of my career, we relied on the federal price supports as an indicator of farm income. Today, the federal price supports are at an unprofitable level by a serious margin. We are in a new marketing environment, and that is the risky part.".Eric Walhof, First National Bank of Sioux Center, said the impact of high commodity prices on farmland complicates a lender's job. Sioux County, where the bank is located, recently hosted a transaction featuring farmland sold at $10,000 per acre. "As bankers, none of us in the county are enthused by that transaction," he said. "The ground is decent quality, but not nearly as good as in some of your areas. It has spurred a whole new discussion about what's the real value of land.".Seifried summarized by putting the probability of recession at 50 percent. He predicted GDP growth for all of 2008 would come in at 1.0 percent to 1.5 percent. Kohl said "it feels like we are in recession. We are coming off 25 years of GDP growth of 3 percent to 4 percent. Now we start growing at 0.6 percent [4th quarter 2007]. It makes us feel like we are in recession.".Seifried said inflation is a threat. If Congress passes a massive bailout bill, "The Fed will have to raise rates to protect the value of the dollar," he said..Iowa Superintendent of Banks Tom Gronstal acknowledged difficult economic times for banks. "Banks with a high loan to deposit ratio and a relatively low capital to asset ratio, are going to need to figure out a way to reduce their non-core funding. Asset quality is going to remain extremely important for us," he said. "If your asset quality declines, your funding sources will dry up. Liquidity and funds management are the most important things to worry about right now. They are more difficult than at any time in the last 50 years.".Community banks in the Midwest, however, are not suffering like some of the largest banks. "The good news in Iowa is we are in far more stable shape on average than the rest of the country, and our community banking is possibly in better shape than any state in the country," commented former congressman Jim Leach, who spoke to the group via videotape..Gronstal concurred. "I have to say the vast majority of community banks in Iowa are doing quite well. There are a lot of our banks that will probably have one of the best years they've ever had. What we can't do is become over-confident, complacent. We have to take a serious look at where we are going next year and make good plans for how we are going to deal with the economy going forward."