WILLIAM M. ISAAC
FEDERAL DEPOSIT INSURANCE CORPORATION
A SYMPOSIUM HOSTED BY THE
FEDERAL DEPOSIT INSURANCE CORPORATION
ASSESSING THE BOOM IN U.S. FARMLAND PRICES
March 10, 2011
It’s a great pleasure to participate in today’s symposium assessing the developing boom in U.S. farmland prices. I commend the FDIC not only for hosting today’s symposium but for continuously providing a wealth of information to the industry and public about trends in the economy and the financial services industry.
As I prepared for today, I reviewed a number of relevant papers and articles published by the FDIC. The FDIC has always prided itself on having first-rate economists and academic researchers on its staff, and I can attest that the tradition continues strong.
I don’t know if a bubble is developing in the agricultural sector or what the outcome might be. We have two panels of experts today who are discussing and debating that topic.
I’ve been asked to provide some historical perspective on the last boom/bust cycle in the agricultural sector, which occurred during my tenure as Chairman of the FDIC.
Shakespeare wrote, “What’s past is prologue.” Edmund Burke put it this way, “Those who don’t know history are destined to repeat it.”
Unfortunately, we all too often don’t learn, or we forget, the lessons of history. That was all-too-evident in the recent financial crisis. I’m delighted the FDIC is simultaneously focused in this symposium not only on the here and now but also the past and future.
Speaking of not understanding history, when I tell people I was Chairman of the FDIC during the 1980s, most immediately respond, “Oh, you mean during the S&L crisis, what a difficult time that must have been.”
There are a couple of big things wrong with that response, beginning with the fact that the FDIC did not supervise or insure the S&L industry, although it did have under its watch the mutual savings bank industry, which had the same characteristics and problems as the S&Ls.
A more important point is that the 1980s involved enormous banking problems far more threatening to the nation’s economic well being than the S&L crisis. The bust in the agricultural sector, on which I will focus today, was an important event at the beginning of the decade. It was followed in rapid succession by a collapse of the energy sector, massive losses in the thrift sector, a serious rolling recession in the real estate sector, and the threat of widespread defaults on third world debt that could have forced the nationalization of all of our major banks.
Altogether during the 1980s through 1991, some 3,000 banks and thrifts failed including many of the largest in the country (nine out of the ten largest Texas banks for example). The FDIC’s problem bank list still stood at nearly 1,500 banks at the end of 1991 after 3,000 failures.
The 1970s were dominated by out of control inflation resulting from loose fiscal and monetary policies. The Johnson Administration’s decision to fight a costly war in Vietnam while launching its Great Society domestic programs without increasing taxes to pay for either, set off inflationary forces worsened by overly accommodative monetary policies.
The dollar declined during the 1970s leading to sharply increased foreign demand for U.S. agricultural products, with farm exports jumping from $7 billion in 1970 to $32 billion in 1979. Crop prices received by farmers nearly tripled from 1970 to 1975. Net farm income during the 1970s was roughly double net income during the 1960s.
Inflated crop prices and farm incomes were reflected in rapidly increasing farmland prices. The price per acre of farm land for the nation as a whole rose over 350 percent between 1970 and 1982.
The boom in farmland prices was supported by an explosive growth in farm debt. Farmers and speculators bought more and more land and financed ever more expensive machinery to enable them to farm their new acreage more efficiently. From 1970 through 1983, total liabilities of farm businesses quadrupled from $52 billion to $207 billion.
Credit was available in almost unlimited amounts. The expansion of credit was greatly enhanced by the fact that many banks based their farm loans on the collateral value of land and machinery rather than on analysis of projected cash flows. Farmers would finance the purchase of land with modest down payments and after the land increased in value would use the paper equity to borrow more money to purchase additional land.
As we learned with the recent bubble in housing prices, all good things must come to an end. The beginning of the end occurred in August 1979 when President Carter appointed Paul Volcker as Chairman of the Federal Reserve with the mandate to wring inflation out of the economy. It was an honor to serve alongside Paul Volcker during that period of crisis.
Volcker attacked inflation with a vengeance. The money supply was tightened and by 1981 the prime rate had climbed to an unthinkable 21.5 percent. The impact was felt immediately throughout the economy but particularly by businesses and individuals that were highly leveraged with debt. Farmers and speculators in farmland were among the hardest hit.
A two year plus very deep recession ensued with unemployment reaching 11 percent, dampening domestic demand for energy and other products and commodities. The dollar rose sharply making farm exports less competitive in the world markets.
Banks were limited by law in the rate of interest they could pay for deposits causing money to flee the banking system in favor of newly developed money market funds and U.S. Treasury securities. The outflow of deposits made it even more difficult for banks to stand by farmers and other customers in their hour of need.
The impact of tightening credit, high interest rates, declining exports, and falling prices for crops had a devastating impact on farm income. In 1973 farm income had reached a record high of $92 billion, nearly double the $48 billion earned three years earlier. Farm income fell sharply to $23 billion in 1981 and $8 billion in 1983.
Farmland prices experienced a dramatic contraction as well. For example, after peaking in 1981, farmland prices fell by up to 50 percent in states such as Missouri, Minnesota, Illinois, Nebraska and Iowa.
The deep troubles in the farm economy were reflected in the agricultural bank failures. The farm bank failure rate reached 62 in 1985, accounting for about half of the nation’s bank failures that year.
The trauma of 21.5 percent interest rates, widespread foreclosures on family farms, a deep recession with unemployment reaching 11 percent, and scores of farm bank failures is difficult to describe to those who didn’t live through it. The public was understandably angry and frustrated and a good deal of the anger was directed at the government generally and the FDIC.
Tensions were very high. The FDIC’s job was to take over failed banks and do its best to collect the failed banks’ loans, including through foreclosures. An FDIC field office in Nebraska was firebombed. In another case, a man walked into the Federal Reserve headquarters in Washington wearing a trench coat and sat down on the floor outside the board room on the second floor. Concealed under his trench coat he had a shot gun and dynamite strapped to his body.
This leads me back to today, also a period of great unrest and tensions. Could we be entering another major boom/bust cycle in agriculture?
There are certainly some worrisome trends and similarities between the 1970s and today. Government spending and deficits are growing exponentially with seemingly little political will to address them. We fought two costly wars in Iraq and Afghanistan at the same time entitlement programs were careening out of control.
Monetary stimulus is well beyond accommodative. The dollar is undervalued, farm exports are up, and prices are increasing for most commodities. The price of farm land was pretty stable from 1993 to 2003, but since then inflation-adjusted prices have risen over 10 percent annually.
There are fewer farm banks today than in the 1970s and early 1980s, and they hold a smaller share of the agricultural loan market. The 100 largest banks hold more than 25 percent of all agricultural loans. These banks are diversified and therefore less vulnerable to a significant downturn in agriculture. I hope that all banks today are basing their lending decisions on projected cash flow analysis and not just collateral values.
If there is a bubble in farmland prices, I hope the bulk of any correction is borne by investors such as hedge funds and not by the banking industry. A dollar lost by an investor is a dollar. A dollar lost by a bank results in roughly $8 in lost lending capacity, which has significant economic impact when we can least afford it.
Once again, I very much appreciate the FDIC holding this symposium to examine a budding systemic risk. Walter Wriston, the legendary head of Citibank during the 1970s and 1980s, once said, “Trouble always enters the window you are not watching.” I am grateful that the FDIC is watching this and other windows.