Last week I responded to a question about what farm bankruptcies tell about the farm economy. This week I would like to comment about a new wrinkle in these situations.
Basically, filing bankruptcy is a way an individual who cannot pay their debts can get out of the downspiral. In general, it uses a legal framework to either sell most assets and distribute the money to those who are owed (liquidation), or refinance over a longer term often with debt reduction, called reorganization. In both cases, once completed, all financial claims terminate, regardless if all creditors have been repaid in full. Hence the term, “fresh start” is often used.
The key point however, is creditors – those owed – will likely not get paid back all or possibly even any of their money. The philosophical idea behind bankruptcy is two-fold.
First, sometimes the major cause is just bad luck, which is true, especially in the case of medical bankruptcies. Second, bringing an end to fruitless collection efforts is good for both sides. And I think blame should also be shared with creditors who made bad financing decisions.
Chapter 12 – farm bankruptcy – is more like reorganization than liquidation. It is essentially a special kind of Chapter 13. The qualification limit mentioned last week, about $4M dollars refers to the values of the assets. When advocates mention making Chapter 12 easier for farmers, they generally refer to raising this limit. Unfortunately, there is little evidence to show doing so makes outcomes any better.
This is a legitimate debate, but the bigger problem I see is ag supplier and bank consolidation impact how farm bankruptcies are eventually paid for, because those forgiven debts come out of somebody’s pocket. When ag suppliers were smaller and more numerous, a farm failure could trigger a supplier failure spreading the loss to not only that retailer but his creditors. And raising prices to other customers to cover those losses meant losing them to competitors. This was a powerful motivator for careful financing decisions. Large suppliers who control the market today can be hit with the same loss, but not only are those debts less likely to threaten their viability, but their considerable pricing power means they can spread their loss over remaining customers more easily. We all have fewer input supplier choices. This means the financial fallout from farm bankruptcies are largely, if not entirely paid by surviving farmers.
Perversely, this ability to pass losses to other customers also can encourage aggressive financing. All of us have sensed this instinctively when the list of creditors is published for a bankruptcy. When it’s your fertilizer dealer, you have pretty good idea where that loss will be made up, and it’s rarely their stockholders. Bankruptcy draws the line between how much debt will be paid by individuals and how much by others. I think we need different splits for different types of failures, but I am wary of making it easier just farmers, due to scant evidence the fresh start theory is effective and the cost passed on to neighbors.