How is the economy treating Americans? Let us count the ways:

--A 20 percent drop in home prices.

--A subprime mortgage market collapse reaching $300 billion.

--A near-failure of Fannie Mae and Freddie Mac, which supplies the secondary market for mortgages.

--A severe banking crisis (with the Federal Deposit Insurance Corporation using 15 percent of its funds to bail out a single bank, IndyMac of California).

--A credit crunch, with a debt to disposable income rate of 140 percent, up from 100 percent in 2000 and total credit losses possibly topping $2 trillion.

--A U.S. recession of a magnitude not seen since the Great Depression.

These were the predictions of Dr. Nouriel Roubini, a professor at New York University's Stern School of Business-nearly two years ago.

Emphasizing the accuracy of his predictions, Roubini, in an interview for a recent issue of the financial weekly Barron's, said that more than 200 subprime mortgage lenders have gone bust in the past year alone. And many community banks will go bankrupt.

"Community banks usually finance everything: the homes, the stores, the downtown, the commercial real estate, the shopping center. If you are in a town or a municipality where there is a housing bust, the bank is gone," Roubini told Barron's.

"Of three dozen or so medium-sized regional banks, a good third are in distress. That includes the Wachovias and Washington Mutuals of the world. Half of this group might go bankrupt. Even some of the majors could end up technically insolvent, though they might be deemed too big to fail."

Rainy day funds

Despite the continued gloomy predictions Roubini offers from Wall Street, thoughts on nation's Main Streets are a little more cautiously optimistic, with plenty of room for understanding how the bad times may hit home soon.

Take the thoughts of Doug Allen, Hanover, Kan., branch president of the Citizens State Bank, Marysville, Kan., with an additional branch in Waterville, Kan. Allen is chair of the Ag and Rural Development Committee of the Kansas Bankers Association.

With grain prices at spectacular levels, Allen and his colleagues are offering several recommendations to producers to navigate their way through these turbulent times.

"We're encouraging (putting away money for a rainy day) all we can," Allen said. "We also think there are opportunities to protect these higher crop prices into 2009 and even 2010 without spending a tremendous amount of money to do that.

"Whether we're using put options or forward contracting, these are the kinds of things we're pushing our guys into to at least look at and consider."

While big bank economics have their own worries, small community banks like Allen's have their own kind of concerns.

"We're kind of into a new era," said Allen, whose bank is the successor to the Community State Bank of Hanover, which merged with Citizens State to create a $286 million bank in 1996. "The last two years, if you chart the grains and livestock markets, we have to throw them out the window. We've seen grain prices jump to record levels. Along with that, we've seen farmer input costs go up substantially."

Allen sees the biggest concern ahead is in producers having two or three more bumper grain crops in a row.

"If that happens, I think grain prices will come back to their more historical levels," Allen said. "If our input prices don't adjust with that, then we're going to be in for some tough times."

The biggest input price concern is the cost of diesel fuel spurred by the cost of crude oil.

"Oil prices are what everything hinges on. If we get oil back down to the $70 to $80 range, we'll get input costs sliding down, too," Allen said. "I think a lot of these input prices are artificially high because grains are high and they think farmers can afford these prices."

A perfect storm

It does not help that what Allen calls a "perfect storm" of droughts in major growing regions of the world creating low grain stocks, a weak U.S. dollar, and fairly good production in the U.S. is creating a skyrocket of export numbers.

"Along with the government's alternative energy policy promoting mostly (corn-based) ethanol, it's brought a lot of outside money in to trade commodities," Allen said.

"We've got a stagnant stock market; so, a lot of funds traders have shifted over to commodities, both grains and oil. As the big investor starts chasing those things, pretty soon the small investor jumps on the bandwagon. Usually, they are the ones who get hurt when it goes the other way."

Much of the cautious optimism Allen has about the economy comes from the way he and other small community bankers do business through keeping in close contact with customers and making sure business is done correctly.

"A lot of these problems in the subprime situation came because these loans were done over the Internet and e-mail," Allen said. "They'd get a local appraiser whom they knew nothing about and find a local abstracter to close it. Then the people the customer originally did business with would sell off the loan."

These people had loans with what Allen calls a "teaser rate" to last one or two years that would balloon up after that, or a loan with a short-term fixed rate.

"They were maxing out their repayment ability based on that original rate and not thinking the bubble would never burst on home values," Allen said. "A lot of those loans were strictly interest-only loans. Interest rates stayed too low too long.

"For the most part, we keep our own loans. We know the people. We demand down payments. We know their repayment ability."

However, with loan defaults and subsequent credit crunch, Allen sees that rules for borrowers may swing too far.

"What may happen now is a lot of people may not get loans that probably deserve them," Allen said. "We were not involved with it but we'll likely pay the price for the subprime mortgage loan situation through increased regulation."

Seller's market

Still, despite the price uncertainties, things are pretty good in rural America and, in particular, in Hanover, Kan., Allen said. He said it's pretty fortunate that a lot of young people are preferring to stay in the community to raise their families.

"Whenever there's a house for sale, there are usually three or four people looking to buy. It's quite a seller's market. We've got several businesses with sizeable employment, from the hospital and the schools, to Midwest Products, which is a concrete business.

"We've got D&W Electric and Hanover Electric. Ricky's Café is a local legend and the Union Pacific Railroad has a crew change terminal in Marysville, so a lot of those folks live here. It all makes this little community kind of unique."

That means offering young people the same kinds of services large banks do, including Internet banking and bill paying services.

"What we've also tried to do is be a great community lender and set up strategic alliances with other smaller banks to work in participating in loans in metropolitan areas to compete with bigger banks," Allen said. "It gives us a way to diversify our loan portfolio without us having to establish another branch. That's worked well for us."

The economy is still in flux in rural areas and it's not known if input price inflation will be temporary or long-term.

"We've seen people go to a lot of no-till, and to cut back on expenses where they can," Allen said. "We're still dependent on Mother Nature. It will be interesting to see what happens. We have to make sure that we cover ourselves for any uncertainty."

Larry Dreiling can be reached by phone at 785-628-1117 or by e-mail at ldreiling@aol.com.

8/25/08

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Date: 8/21/08

www.hpj.com/archives/2008/aug08/aug25/Ruralbanks-Sub-primedebtwoe.cfm