Mix the collapse in the financial markets, newly restricted credit and volatile commodity prices and you get the potential for higher margin calls for grain elevators – so high that some may not be able to pay them.
Concern now is growing over what farmers can do to recover losses in the event of an elevator failure.
"This thing is setting up to where it could really be ugly if farmers have a bunch of contracts booked with an elevator that suddenly is no longer in business,” says Tim Recker, an Arlington, Iowa farmer. "If no one picked up those contracts, that would leave a lot of farmers in a tough position.”
Elevators in general have become a lot more cautious in terms of their contracts, says Roger Ginder, Iowa State University economist.
"You will see elevators pull back on far out contracts because lenders right now are more willing to finance real grain inventory than paper contracts,” Ginder says.
In case of elevator failure.
Lately, elevators have been enjoying profitability and margin calls have been relatively placid, Ginder says. "Money has actually been flowing back into elevators because prices have been falling,” Ginder says.
But if there is a run-up in commodity prices again, farmers can expect pressure to come back on elevator balance sheets, says Ginder. "Then we might see more margin calls that elevators or ethanol plants can't meet,” he says.
In the case of grain elevator or ethanol failures, many states like Iowa and Illinois offer a grain indemnity fund that acts as a kind of grain insurance for farmers to recoup their losses. Other states, like Indiana, combine their indemnity fund with a bond system – if an elevator fails, the bond system kicks in first to compensate farmers.
Iowa's grain indemnity fund -- established 22 years ago -- requires state-licensed grain elevators too pay into a fund that would cover farmers who had grain stored in a warehouse (or sold to a grain dealer) licensed by the state. Today, the state fund totals about $8.2 million. In the case of the failure in a state licensed warehouse, the indemnity fund will pay farmers 90% of a loss on grain up to a maximum of $150,000 per claimant.
While the fund has worked well for farmers for many years, dramatically higher grain prices could lead to a situation where one or two big elevator failures would drain the fund, says Recker.
"With beans at $15, it would only take one elevator to go broke and there goes Iowa's $8 million indemnity fund,” says Recker.
Ramp up or revamp?
There is no doubt that the grain indemnity funds and their payment caps established years ago do not match the change in farm size or commodity price increases, says Ginder. But increasing the indemnity fund may not be the best answer.
"Other state agencies like to dip into these kinds of sitting funds,” Ginder says.
Even if the fund were increased, there are exceptions to payouts, including: Grain sold using a credit-sale contract is not covered; only grain sold within the six months since an elevator enters bankruptcy or loses its license is eligible for coverage; and the fund does not cover grain sold from one dealer to another; and the fund does not cover USDA-licensed warehouses.
Farm leaders and regulators in Iowa and other states are beginning to discuss the broad issue of risk and whether the indemnity fund should be enlarged. A bill making minor changes in the Iowa indemnity fund rules was recently passed by the Iowa legislature and signed by Gov. Chet Culver in April 2008.
Right now, Ginder says a state-run indemnity fund really only provides value to producers by creating fast liquidity for farmers who have sold or stored grain in a defunct elevator. This is important even if only partial recoveries from the bankruptcy may eventually materialize.
"Indemnity fund payments can be made promptly so farmers aren't waiting around for 18 months while a bankruptcy gets settled,” says Ginder.
In general, the fund has worked very well in protecting farmers and communities against financial difficulty from elevator failures. But with larger farms and more volatile markets, there is no denying the agriculture industry needs to take a hard look at making changes in grain indemnity funds, says Ginder.