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Have we forgotten the lessons of the 1987 crash?

While I'm no pessimist, in fact I'm known to be an eternal optimist, some of the memories and lessons from the 1987 crash linger on, not only for me but for many others as well.

Those who were severely affected have never forgotten. It is timely to recount some of the effects from the crash, compare what is similar now and consider what do we need to do for the future?

The circumstances surrounding the 1987 crash were: rising prices across all sectors, an overheated share market, previously relatively realistic interest rates, shortage of money in New Zealand, very high confidence and a very high level of debt. As the economy cooled quickly, many were caught up with no liquidity to meet increasing interest bills and running costs.

The rapid increase in interest rates and subsequent panic by many banks saw many forced sales resulting in people losing their land, their equity and in many cases nearly everything. I have met clients who are still driven to try to regain those losses. I met one who is obsessed with recovering his losses and was taking reckless risks to try to rebuild his property portfolio and his mana as well.

New Zealand has now been through one of the longest periods of sustained growth in the history of this country. Interest rates were low, fuel was cheap and world confidence was high. This is changing slowly and we are now facing rising interest rates, rapidly increasing fuel costs, slowing confidence and a depreciating dollar. House and farm prices look to be waning as everything tightens up.

We have become debt junkies, borrowing against everything to build real estate assets for fear the other fellow may be making more than us. This country continues with no real form of capital gains tax, but for how long remains to be seen. To be really honest here, people have been farming inflation to try and make capital gain to build into their businesses, which sends out the wrong signals.

Additionally, we have gone from repaying debt to borrowing interest only, because who wants to repay debt anyway. The good times will go on forever, or will they? There are many farmers who are increasing their debt annually to meet on-farm losses. These losses may just be the personal drawings, but nevertheless, it is still an annual increase in debt. This may be sustainable in the short run and while we have inflation raging and farm prices increasing, that's fine, however if farm prices stop increasing and the debt to asset ratio gets too high, then banks are going to start saying no.

We currently have a weakening New Zealand dollar, which looks likely to increase the pay-out to around $4.50 kg/ms, but the flip side is that on-farm costs have increased at an alarming rate. Farm running costs were 40-50% of Gross Income, but now they have shot up to 60 – 70% on many farms, severely squeezing the margins. An example of this is as follows:
    $4.50 Payout less $2.97 Farm Running costs @ 66% = $1.53.
    Less Debt Cost of $1.20 yields Margin to Taxation Drawings of $0.33
So on a 100,000 kg farm, for some their net profit before tax and drawings are now back to $33,000 or nil.

This is a pretty low return and frightening for some. Those who remember the 1987 crash have kept debt to a minimum, or at least tried to reduce it. The debt reduction has been achieved by repaying debt from revenue, or sale of spare pieces of land.

Keeping some spare cash in the system is an essential part of any business to maintain liquidity. It is available to meet your outgoings in times of difficulty that may well save your farm or business. Allan Bollard talks, hopefully, of a "soft landing" and he is probably right.

An international shock in the form of fuel prices or interest rates could see this small country severely affected. The soft landing may turn into a crash landing and tear the undercarriage off the plane.

In summary, while I have painted some of the worst case scenarios, some of us appear to have forgotten the 1987 crash. It is timely to remember what happened, and why. International unrest, rising oil prices etc. could see New Zealand adversely affected again.

Think about what you are doing, do not over commit yourself, or your farm business. Keep some financial buffer on hand, so that you could weather a storm if New Zealand is adversely affected.

If you believe that you are in a precarious position, then do something now: communicate with your bankers so that you have a fall-back position, which will reduce your down-side risk. Remember if it gets tough, the banks have first security on everything and it will be us that will lose our risk capital.


 

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