NOV 30, 2012

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A Bubble to Remember—and Anticipate?

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“It is very difficult to understand when expectations are misinformed—compounded by the fact that farmland is an infinite life asset.”
 “Land values appear to reflect current high returns in agriculture [and are] not obviously overvalued.”
 “Values are dependent on interest rates remaining low and/or sustained growth in agricultural incomes.”

This is well hedged—a balanced and professional display of the difficulty of foresight.

How has farmland compared over the last 10 years with other investment categories sometimes also thought to be hedges against inflation? It is apparent that over the decade farmland prices have escalated far more rapidly and have been, unlike the other two, without a severe correction—so far.

Where does this leave us overall? The story of the farmland bubble and shrivel of the 1970s and 1980s is clear. Does financial history necessarily repeat? “Farmland values have risen sharply over the past five years, though comparisons to the late 1970s seem unfounded,” wrote the chief economist of the Department of Agriculture, Joseph Glauber, in 2011. “Increases,” he continued, “appear to be generally consistent with the rise in farm income and low interest rates.”

Looking at the housing market in 2004, the Federal Reserve Bank of New York concluded, “the marked upturn in home prices is largely attributable to strong market fundamentals: home prices have essentially moved in line with family income and declines in nominal mortgage interest rates.”

Making judgments about future risks of farmland prices involves considering plausible arguments about agricultural productivity, yields, exports, ethanol and other subsidies and incomes; interest rate forecasts; judgments about the psychology of expectations; and investment alternatives and strategies.

It is typical in such circumstances to have a debate about whether we are in a bubble or not. In 2005, the senior vice president in charge of risk policy at Fannie Mae, having considered the escalating risk factors in housing finance, declared, “No one can say a bubble exists until after the fact.” Yes, the future is always the kingdom of uncertainty.

Can the government do anything about this possible bubble? Well, it can try to analyze the relationship between farmland prices and underlying economic factors, as the Department of Agriculture and FSOC have done. It can hold conferences on the risks involved, as the FDIC and the Federal Reserve have done. It could stop subsidies to ethanol, which help inflate farmland prices. It could stop manipulating long-term interest rates through its central bank. But given the uncertainty involved, overall, there does not appear to be much it is likely to do. Besides, if this really is a bubble, it is already too late.

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