FACTS VS. THE FUROR OVER FARM POLICY The heartland of America is bleeding. The challenge for lenders and politicians is to balance compassion with the realization that not all farmers can be saved.
By Aloysius Ehrbar RESEARCH ASSOCIATE H. John Steinbreder

(FORTUNE Magazine) – NEARLY 100,000 U.S. farmers, many of them among the most efficient in the world, are about to go broke. Many are in their 30s and 40s, men who just a few years ago saw rich, prosperous lives ahead. Now confidence and pride have been replaced by defeat and soul-destroying self-doubt. The lucky ones will be left with a few of their acres or will rent their farms back from lenders who foreclosed. The rest will try to build new lives off the farm. The devastation in agriculture -- and its spillover to farm suppliers, grain elevator operators, and retailers across the Midwest -- has become one of the most visible economic tragedies of the decade, so visible that it has obscured the fact that many of America's farmers are doing all right. Common sense calls for fashioning government agricultural policies in a way that minimizes the losses that farmers, their creditors, and their communities are suffering. The policies should also minimize the subsidies paid directly by taxpayers and indirectly by shoppers in the supermarket. Most important, they must restore U.S. competitiveness in the world market for food. American farmers can never truly prosper unless they sell their output profitably overseas. Two potent forces are working against sensible solutions. One is Congress, which is bent on applying the conventional fix to farm problems. Sometime before Thanksgiving, Congress probably will enact a farm bill little changed in its essentials from the misguided policies of the past half-century. Those policies -- using price supports and acreage set-asides to boost farm incomes -- will only prolong the troubles and delay the adjustment to world market conditions. The other force, the fear that farm defaults might unsettle the banking system, makes an early end to the agriculture crisis doubly unlikely. Even if farmers overcome Washington's attempts to help, the mishandling of farm credit by lenders and politicians could keep them mired in a furrow of despair. Indeed, intelligent handling of the farm credit situation is likely to be the greatest challenge in agriculture over the next few years. The discussion of farm policy has been clouded by widespread misconceptions of how badly farmers and their creditors are hurting and why. Advocates of massive government aid describe farming today as a tragedy of plenty that leaves even the best farmers operating at breakeven or worse. Recent movies like Country and media events like the Farm Aid concert depicted a world in which the family farm will be plowed under unless something happens quickly to boost prices and farm incomes. As for farm creditors, the economic forecasting firm of Wharton Econometrics predicts that lenders will have to absorb up to $25 billion of losses over the next few years. Some press accounts have cited estimates of up to $100 billion in losses -- nearly one-half the total debts of all U.S. farmers. Farm economists warn of widespread failures by small country banks. The federal Farm Credit System, an unusual national cooperative that accounts for one-third of all farm debt, says it may need a multibillion- dollar bailout from Congress. The overall condition of U.S. agriculture isn't nearly so bleak as the footage of foreclosure auctions on the Nebraska plains. Lower crop prices do mean that farmers are earning considerably less than they did at the height of the ag boom in the late 1970s. But two-thirds of the 650,000 or so full-time farmers are coping. (About 60% of the nation's 2.3 million farmers till part- time, often to qualify for tax deductions, and get the bulk of their income from nonfarm employment.) Emanuel Melichar, a senior economist at the Federal Reserve Board, estimates that, after adjusting for inflation, the aggregate cash profits of farmers before interest expenses were slightly higher in 1984 than they were in the pre-boom years of the early 1970s. Interest rates are higher and farmers carry more debt now, but inflation-adjusted cash profits after interest payments were exactly the same in 1984 as they were in 1970 and 1971. Surprising as it may seem, the 25,000 largest U.S. farms -- the 1% or so with annual sales of over $500,000 -- look like dandy businesses. Melichar estimates that they reaped an average return on assets of 18% in 1983 and had returns on the farmers' equity that averaged a bounteous 24%. Most farmers in deep trouble have sales of $40,000 to $500,000 a year. The U.S. Department of Agriculture estimates that roughly one-third, or about 200,000, are in imminent danger of failing or are ''financially stressed.'' They are overwhelmingly concentrated among Midwest grain growers. California wine-grape growers are ailing too. The prospects for wine grapes seemed limitless in the 1970s as Americans shifted from hard liquor to so-called light alcoholic beverages. Sales of California wine soared, and so did the number of farmers planting vineyards. But domestic wine sales leveled off just as many of the new vineyards matured. Imports also became much more popular as the dollar took off. Now hardly any Americans can make money in wine grapes. In the grainbelt, many farmers simply paid too much for their land after Soviet crop failures helped to send wheat and corn prices soaring in the early 1970s. When the lean harvests continued, farmers, bankers, and even the U.S. Department of Agriculture began to behave as though bad weather had suddenly become the norm in the Soviet Union. Farmers bid Midwest land prices to heights that were justified only if crop prices continued to rise. The average price per acre of Iowa land shot up 170% from 1974 to 1980. Land prices rose 133% in Nebraska and nearly 100% in South Dakota. BY THE LATE 1970s farmers were convinced that inflation and continued growth in exports would keep prices rising even if Soviet crop yields recovered. Lenders encouraged farmers to borrow against their appreciating land. Some borrowed to buy better tractors than their farms could justify before crop prices rose. Some put up new buildings. Some who paid dearly for land in anticipation of future increases in crop prices borrowed to cover operating losses, confident that inflation or more bad weather abroad would soon make them whole. But mostly what the farmers borrowed to buy was land. In the early 1980s inflation collapsed, harvests came in record levels worldwide, and crop prices and land values fell. The value of Iowa farmland is down 55% from its peak in 1980, and land in Nebraska is down 53%. Farmers reawakened to the long-term reality of agriculture: world food production is growing faster than population, and crop prices are likely to continue falling as long as technological advances keep boosting yields. Grain prices have now dropped so low that any grain farmer with high leverage is operating near the edge or has tumbled over it. But the devil impoverishing these farmers isn't high interest rates or high leverage per se. The very large farms that generate such lush profits are, on average, the most heavily leveraged of all. Nor is the problem that crop prices are ''too low.'' Most farmers who have little debt or who rent their land still make adequate profits on corn and wheat. The real problem is that Midwest farmers are saddled with interest on the money they borrowed to buy land at or near the peak, while the land is generating only enough cash to support much lower values. The central role of land prices in the Midwest has resulted in a singularly capricious pattern of losses. Some of the most industrious and capable farmers have been socked hard, just because they happened to buy acreage at the wrong time (see box). Unfortunately, there isn't any practical way to help the farmers who bought at the top. They already have suffered huge capital losses, much like the hapless investors who bought Avon and Xerox just before the glamour stocks crashed in the early 1970s. What remains is to determine how those losses are recognized and distributed. The only form of farm aid that could give farmers substantial relief without enormously expensive side effects would be direct cash payments. But is that fair or desirable? Could farm-state Congressmen justify handing out moola to a businessman whose untimely investment had cut his net worth from $600,000 to $250,000? And if it is right to make farmers whole, why not the independent gas producer who sunk wells in the Anadarko basin when energy prices were hitting the heavens? SCHEMES to boost crop prices are more politically palatable, but they carry the cost of insulating farmers from lower world crop prices. Adjustment to world prices is what farm policy should hasten, not delay, since U.S. farmers increasingly are producing more crops for export and less for sale at home. The U.S. now consumes only 75% of the output of domestic farms. More than half of certain crops -- including wheat -- already go to the export market in some years. With total foreign production also rising faster than population, U.S. farmers will have to hammer costs down to keep sales and profits up. The quickest way to get costs down is to accept that the losses of the past few years are permanent and that the value of farmland has fallen. Land typically represents 75% of the assets in a farm; as the price of land goes down, a farmer can charge lower prices for his crops and still get an acceptable return on assets. Any action that artificially supports crop or land prices raises farm costs and erodes the ability of U.S. farmers to compete in world markets. The farmers losing their land and the creditors suffering big loan losses are unmoved by the salutary effects of letting the market run its course. Lately they have raised the specter of a credit crisis as a new reason to put off accepting the reality that many farmers will have to go bankrupt if America is to compete. The statistics on bank loans to farmers can look scary on first inspection. The number of agricultural banks with nonperforming loans -- loans that no longer are accruing interest, have been renegotiated, or are more than 90 days overdue -- that exceed total capital jumped from 102 last December to 167 at midyear. (The Federal Deposit Insurance Corporation defines a commercial bank as agricultural if its farm loans make up 25% or more of total loans.) Forty- six agricultural banks have failed this year, up from 29 for all of 1984, and the number on the FDIC's ''watch list'' of troubled institutions has risen from 340 last December to 390 recently. Even so, the professionals who worry full-time about bank safety don't seem terribly alarmed. The Kansas City Federal Reserve district has more troubled agricultural banks than any other. But Roger Guffey, president of the Kansas City Fed, says he sees nothing looming on the horizon that could spark a regional or statewide crisis in commercial lending. One reason regulators are sanguine is that the percentage of agricultural banks in jeopardy is quite small -- the 167 with non-performing assets in excess of capital comes to just over 3% of the 5,000 U.S. agricultural banks. Another is that agricultural banks have comparatively high capital -- an average of 9.6% of assets vs. 8.6% for nonagricultural banks -- and the vast majority could survive worsening conditions on the farm. Robert Craig West, an economist in the bank & supervision division at the Kansas City Fed, calculates that 665 of the 1,163 agricultural banks in his district would make money this year even if they had to write off all their nonperforming loans immediately -- an extremely pessimistic assumption. Altogether, commercial banks, including agricultural banks, have $50 billion of farm loans, or nearly 25% of the total farm debt. In 1984 commercial bank losses on farm loans totaled $900 million; this year they could double. That's a huge loss rate. But the total for the two years -- some $3 billion -- isn't the stuff to rattle the banking system. The biggest worries about debt concern the Farm Credit System, a string of quasi-banks set up by Congress from 1916 to 1933. The System's lending practices and bookkeeping would make a Latin American loan officer shudder. The System includes 12 regional Federal Land Banks, 12 Federal Intermediate Credit Banks, and 12 Banks for Cooperatives. A 37th bank, the Central Bank for Cooperatives, operates nationwide from Denver. Land Banks make mortgage loans to farmers through 431 local Land Bank Associations. Intermediate Credit Banks advance funds to about 370 local Production Credit Associations, which in turn make short-term loans for seed, fertilizer, and other operating expenses. The Credit Associations also make home loans for up to ten years, and 15-year loans for the purchase of boats and other commercial fishing gear. Banks for Cooperatives lend to agricultural, aquatic, and public utility cooperatives. The Farm Credit System is the biggest farm lender, with $74 billion of loans outstanding as of June 30. The banks aren't really banks in the sense that they don't take deposits. Most of their funds come from $70 billion of bonds and notes sold through the Federal Farm Credit Banks Funding Corporation, the fund-raising arm of the System. Investors treat the securities as government agency debt, which means the Funding Corporation can borrow at interest rates only slightly higher than the rates on Treasury securities. But the debt is backed only by the Farm Credit System's 37 banks. The System operates autonomously, indeed, one might say anarchically. The local associations have set their own lending policies, and the regional banks have devised their own accounting rules, practices that are only now beginning to change. The boss of record is Donald Wilkinson, 63, the governor of the Farm Credit Administration, the federal agency that regulates the banks and associations. Wilkinson's staff routinely examines the books and lending practices of the banks and associations, but it has no authority to move against unsound banking practices by issuing a cease and desist order; all it can do is recommend a change. Wilkinson precipitated much of the furor over farm credit when he announced in September that the Farm Credit System probably will need federal assistance in 18 to 24 months. Of its $74 billion in loans, $9.8 billion are listed as nonperforming; of the nonperformers, $2 billion are not accruing interest. Although that sounds like serious trouble, it's difficult to tell whether there's less or more to the crisis than meets the eye. The confusion arises partly because the Farm Credit System doesn't classify loans in the same way commercial banks do; some of its nonperforming loans would be performers at Citibank. Furthermore, the potential losses on the nonperformers are far less than $9.8 billion. More than half are mortgage-backed land loans. If the borrowers default, the System could sell the land and get back some of its money. And the Farm Credit System is much better capitalized than most commercial banks. It has $4.2 billion of retained earnings, $675 million in loss reserves, and $5 billion of capital paid in by borrowers -- more than enough to sustain larger losses than now seem likely. HOWEVER, that assessment must be qualified because it's impossible to tell what may lie hidden in the System's convoluted books. The Price Waterhouse accounting firm performed the first outside audit of the System this year. Among other things, it discovered $6 billion of Land Bank loans that are current on interest payments, but are undercollateralized by $930 million. The $6 billion will be added to the nonperforming loans. Two regional Intermediate Credit Banks -- in Omaha and Spokane -- had to be bailed out by other System banks this year. (Spokane went broke on fishing- boat loans.) Peter Carney, president of the System's Funding Corporation, estimates the System will lose $350 million to $400 million this year, its first loss ever. The General Accounting Office says losses could reach $2.6 billion in the 12 months ending next June. While it is far from certain that the Farm Credit System needs federal help, the first reaction of Congress to farm problems seems to be to do something -- anything. In this case, the politicians should repress that instinct until they know help is essential. Any aid for the Farm Credit System could be exceedingly costly. Agricultural bankers, always a lobbying force to be reckoned with, view the Farm Credit System as their competition, and will insist on getting the same breaks as Wilkinson's agency. ''Would we insist on bailout money if the government shored up the Farm Credit System?'' asks Alan Tubbs, president of First Central State Bank in De Witt, Iowa. ''We sure would.'' The wave of farm foreclosures presents one clear danger. If the Land Banks, the commercial banks, and the Farmers Home Administration, a branch of the Department of Agriculture that makes subsidized loans, all try to sell the farms they have foreclosed on, they will push land prices artificially low. Lower values would increase the creditors' losses by reducing their proceeds from land sales. Several groups, including the Farm Credit System, have a solution -- a new federal corporation that would buy foreclosed land and rent it until the land could be sold without precipitating falling prices. The idea makes a lot of sense, but a new agency isn't required to bring it off. Congress could simply empower the Farm Credit System to hang on to the land and rent it out. The most important challenge for bankers now is to remain calm in the face of rampant defaults, to continue doling out working capital to farmers, and to refrain from calling in every weak loan to cut losses. The bankers will have to exercise acute judgment in separating the hopeless borrowers from those who, with a little more forbearance, could make it. Good judgment is essential to prevent the shakeout in the grainbelt from exacting an even greater toll.