NOV 30, 2012

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A Bubble to Remember—and Anticipate?

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This led to the 1986 Farm Credit Act Amendments. Among these were two particularly interesting provisions: the Farm Credit System could defer provisions for loan losses, and it could also defer recognizing interest expenses on some of its high-coupon bonds. Such cooking of the books of course violated proper accounting standards and mirrored similar desperate accounting by insolvent savings and loans in the same decade—in the latter case, under the direction of the government in the form of the Federal Home Loan Bank Board. It did not work in either case.

This brings us to the Agricultural Credit Act of 1987. The bailout could no longer be postponed: the act accepted “the inevitability of Federal financial assistance to the Farm Credit System,” Congress concluded, and it committed $4 billion of taxpayer funds. A Farm Credit System Assistance Corporation was authorized “to issue federally guaranteed bonds and to purchase the preferred stock of system institutions...thereby funneling the federal ‘bail-out’ funds.” Among its other provisions, the act mandated and facilitated the consolidation of the component institutions of the Farm Credit System into fewer, bigger entities.

The restructured Farm Credit System continued as a GSE. Farmland prices, after five years of painfully falling, began to rise in nominal terms again in 1988. From that point, in inflation-adjusted terms they remained basically flat for six years, from 1988 to 1994. By 1994, it had been 12 years since the 1982 peak (and 13 years since the inflation-adjusted peak in 1981) and real farmland prices were still merely at their early 1970s level of more than 20 years before.

Then, in 1995, real farmland prices began a new ascent, with particularly rapid acceleration after 2004. The inflation-adjusted prices have far surpassed their bubble peak of 1981.

Of course, the bull market in farm prices looks even more dramatic when shown in nominal terms. These prices increases were only modestly reduced by the financial crisis of 2007-09 and have since accelerated. Real prices have been rising for 17 years, and if you are 40 years old now, you were only 10 when the last farmland bubble burst. If you are 35, nominal farmland prices have been rising since you were 10. How does anyone under the age of 40 subjectively assess the probability of a price collapse?

Where are we now? It is not quite clear. Is this a new bubble waiting to collapse? Or do these prices reflect some fundamental structural trends and new developments? Each time, it is the same debate.

In November 2011, the Federal Reserve Bank of Chicago held a conference on “Rising Farmland Values: Causes and Cautions” to address “the risks facing agriculture and the banking industry from rising farmland values.” Earlier that year, the Federal Deposit Insurance Corp. had a conference titled “Don’t Bet the Farm: Assessing the Boom in US Farmland Prices.”

Between 2000 and 2011, Farm Credit System mortgage loans grew at a compound rate of about 8%, with double-digit growth in four of those years (2001-02 and 2007-08). This is rapid credit growth, although it does not match the more than 11% compound growth of residential mortgage loans in the bubble years of 2000–07, of which five years (2002-06) were in double digits. Farm Credit System mortgage loan growth did slow to about 3.5% per year in 2010-11, then increased to an annualized 6.7% for the first half of 2012.

As always, the future is the “kingdom of uncertainty” and can be seen though a glass darkly, at best. As reported by Iowa Farmer Today in May 2012, “It’s tough to know if you’re in a bubble,” said the director of the Food and Agriculture Policy Research Institute at the University of Missouri. Economists from the university “gathered at a seminar recently to discuss ‘a possible bubble in farmland prices,’ but they all stopped short of actually calling the current situation a bubble.”

The new Financial Stability Oversight Council, a big committee of financial regulators, has published a 217-page annual report for 2012. This report devotes about a half a page to farmland prices, saying they are being “driven by increasing crop yields, rising commodity prices, favorable crop export conditions, and low interest rates.” The report adds, “Adjusting for commodity prices and improvements in crop yields, agricultural land values have retreated somewhat.” It has a graph that appears to argue that farmland prices are in line with the value of crop income yields.

So, not to worry? The report adds that “forecasts for production and demand are positive” and that “delinquency rates on real estate farm loans at commercial banks declined.” It does not mention that loan delinquencies always decline in a bubble.

We are in a remarkable period when it comes to interest rates. The Federal Reserve has committed itself to an extended period of exceptionally low rates, while it manipulates long-term interest rates lower through large purchases of bonds and mortgages. This is an attempt, among other things, to support house prices, but it has apparently succeeded in, among other things, helping stoke the record inflation of farmland prices.

Thomas Hoenig, the former president of the Kansas City Federal Reserve, now on the board of the FDIC, has pointed out the interest rate risk in farmland prices. “Cheap money [has] artificially boosted farmland values,” he argued. “Hoenig predicts when current low interest rates reverse and trend higher, land values will drop dramatically.” It is certainly true that when interest rates, and thus the discount rates for calculating present values, rise, all asset prices tend to suffer. Hoenig remembers the 1980s bust well: “In the Federal Reserve Bank of Kansas City’s district alone, I was involved in the closing of nearly 350 regional and community banks...Farms were lost, communities were devastated.”

So are we in another bubble or not? The director of the Center for Commercial Agriculture at Purdue University, Brent Gloy, had the following sophisticated reflections when grappling with this question:

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