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All Things Considered: June 2009

Waiting to Burst?


May 22, 2009
By Jim Knisley


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Brian Ellsworth, the former general manager of the Egg Farmers of
Ontario, used to caution about rising quota values at general meetings.

Brian Ellsworth, the former general manager of the Egg Farmers of Ontario, used to caution about rising quota values at general meetings.

He’d warn that quota prices were getting up there and that the farmers would have to be careful. Since then quota values have continued to rise and, in Ontario at least, jumped 15 per cent or so again this winter and spring.

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They were at $175 for layers and $75 for broilers in early April. Since quota sells on the basis of willing buyer and willing seller they may be lower or higher than that now.

But even if they’ve slid a bit, owning quota has been a winning investment.

Quota values may stall for a while, but the trend has been ever higher.

A chart of quota prices looks kind of like the stock market did until the middle of last year or U.S. housing prices did until autumn.

In both of those situations enthusiasm was rampant. You had to buy today because prices were always higher tomorrow. You could throw money into just about any stock and be secure in the knowledge that it would rise in value.

Houses were an even better investment particularly in Florida, Las Vegas and Southern California. Prices had been rising for decades and demand was insatiable. Even supposedly flinty eyed, conservative banks were willing to lend 100 per cent of the purchase price or more so certain were they that housing values would continue to rise.

We now know that the whole thing was a bubble. Easy credit, fancy financial engineering and a fair bit of fraud and stupidity provided the hydrogen to inflate the whole thing.

As soon as it looked like the markets might sag a bit the hydrogen flow was increased. Low, low interest rates, unsecured lines of credit, no money down – nothing was too good for anyone who could fog a mirror and wanted to buy a stock or a house. If all that didn’t work then there were fancier and completely illegal schemes such as outright fraud or well-hidden Ponzi schemes.

The problem was many of the stocks weren’t making any money and many of the new homeowners didn’t have sufficient income to afford house payments even at an interest rate of zero. 

But while the music was playing no one worried about any of that and kept on dancing. When the music stopped the bubble burst.

It didn’t deflate slowly. It went up like the Hindenburg in a massive ball of flame. Even those who had tried to stay away had their eyebrows singed or worse.

The problem with bubbles is that they are hard to recognize. When things are going well everyone pretty much assumes that the natural order is that things will continue to go well. As the bubble gets bigger it is hard not to see it as something grand and substantial. It’s hard to see that it is just a lot of gas with a very thin, very fragile cover.

The best way to deal with anything that looks like a bubble is with a very sharp pencil and an even sharper mind.

Poke and prod away at what you intend to put money in. Don’t be easily satisfied. Look for weak spots and poke and prod some more. Check for leaks. While we have become used to the sound of bubbles popping or exploding in the past year, sometimes they just slowly deflate.

When it comes to the price of poultry quota I don’t know if it’s a bubble or not. I don’t know if prices are over inflated or not.

But I do know a dairy producer who a couple of years ago (before the recent run-up in prices) took a very hard look at the price of egg and broiler quota, and calculated that the payback on egg quota was about seven decades, and the payback on broiler quota was more than three decades. I also ran into someone recently who observed that anyone without substantial wealth who is buying quota better have an off-farm job if they intend to make ends meet.

That may be worrisome, or not. Quota is worth what someone is willing to pay for it and what they are willing to pay can be affected, not just by the rate of return, but also tax policy, economies of scale, international commerce and exchange rates, trade policy or even a burning desire to produce eggs or raise chickens.

Buying quota at today’s prices obviously makes sense to those who are buying. It doesn’t matter what anyone not looking to buy quota thinks.

But as someone who owns a home that is decreasing in value and owns some stock that is decreasing in value I have learned that prices don’t just move in one direction. Down is, unfortunately, a possibility.

Ellsworth’s cautionary words may apply more today than they did when he uttered them several years ago.

Or as the sergeant used to say on the television show Hill Street Blues: “Be careful out there.”


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