Must Read: US Farmland Values
Oct 24, 2011
The FDIC is convinced there's a bubble brewing in "Farmland." With prices continuing to skyrocket it is becoming tougher and tougher to debate. Three Federal Reserve banks regulate almost three-quarters of the nation's 2,144 farm banks. From what I am told, examiners at the regional Fed banks and the Federal Deposit Insurance Corp. are now heavily scrutinizing the lending standards, concentration levels, and loan documentation and risk management practices in the rural banks. It is really no wonder, when you consider values were 20% higher in the second quarter than a year ago in the district of the Kansas City Fed, which includes Nebraska and oversees 614 agriculture banks. The Chicago Fed, which oversees 538 banks, reported a 17% increase for the same period in its district, the most since the 1970s. Non- irrigated farmland in the Minneapolis Fed district, which oversees 393 banks, reported an increase of almost 14%. These types of gains are being looked at as real concern, and many, like Yale economist Robert Shiller have called Farmland his "dark-horse bubble candidate for the next decade." The big question is what happens if a "Black Swan" type event pops up, or several at one time hit the market? What happens if a massive drought sets in and provides the producers with fewer bushels? What happens if government subsidies are cut? What happens if government biofuel mandates are lifted? What happens if inflation and interest rates take off? What happens if global demand begins to slow? What would happen if crop prices fell by half? As of right now there are really no concerns, especially as The Department of Agriculture recently reported that farm income will jump by more than 30% this year to a record $103.6 billion. The big question is what happens if and when the money dries up. Many influential players, like former Kansas City Fed President Thomas Hoenig, believe "low interest rates" really pose the biggest threat. Hoenig is adamantly against keeping rates at or near zero for any "extended period" of time, as he feels it could lead to a serious build-up of future imbalances, such as "asset bubbles." His prediction of a national housing bubble in 2005 was dead on. Essentially regulators missed the risks in residential and commercial real estate that led to a financial crisis, the longest and deepest recession since the Great Depression, 9.1% unemployment and nearly 400 bank failures since 2008. The concern is that low rates for any extend amount of time allows investors to take advantage of the program and promotes "hot-money" flowing into select asset classes more so than normal. The point is if rates were not this cheap, then the competition for the land would not be so aggressive. Hoenig certainly speaks form experience, as he joined the Kansas City Fed in 1973 as an economist in the banking supervision area, just as farm prices started climbing and then later collapsed. In the early 1980s the bubble burst and land prices notched annual drops of more than 10% in four of the next five years. The aftermath forced thousands of farms into foreclosure, pushed small towns to the brink of depression and brought down 347 banks in the Kansas City Fed's district from 1982 to 1992. Memories of the 1970s bubble and bust seem to be making regulators much more nervous, especially after seeing the damage done by the recent Housing Bubble bursting. By comparison though, at the peak of the housing bubble, real estate prices were rising 17% year-over-year, and to me it just doesn't seem like it's the same set of circumstances. In a survey at the end of 2010, lenders reported to the Kansas City Fed that loans were between 50-90% of the value of the land, with an average of just over 70%. As we have known for years, higher "loan-to-value" ratios certainly pose much greater risk to lenders. Compare this to the numbers reported in 2006 that showed more than 40% of US housing borrowers had actually put "no-money-down" for loans. That is a loan-to-value ratio of 100%, which is much higher than the 70% ratio farmland is currently at. With this being the case, I personally don't see us in a "bubble" as of yet. Are we heading that direction...without a doubt! My main concern is that if the pension funds and other "investors" in farmland start to stumble they will quickly be looking to sell. The only reason they will be looking to sell is if the "producers" who are renting the ground are unable to make the high cash rents work. If that is the case then you have to also figure the "producer" who couldn't pay the high cash rent is struggling himself. Therefore when the "investor" goes to sell the land who will be the buyer. The investor can't get the land to pencil, because crop prices are in the tank, and the producer has no money due to the same reason. Even though I love the though of owning more ground, we need to start being cautious up at these levels.
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