The Housing Bubble

The Pioneer Press reports from Minnesota. “According to the U.S. Department of Agriculture, the price of farmland, averaged across the whole country, fell in 2015. That puts the official seal on what people involved with farming in the Midwest have felt for two years — that the peak of the farmland price boom has passed and that there is considerable potential to fall. This drop also gives teachers like me examples to use when discussing the work of a broad range of economists. British economist David Ricardo of early 19th century, laid out how interest rates and the income derived from some asset combine to determine the market price of that asset. If the applicable interest rate rises, the price of the asset — whether it be a share of stock, a bond or an acre of Jackson County farmland — falls. When rates fall, as they did in 2008-09, asset values rise.”

“Similarly, when the net income rises from an asset such as interest on bonds, rents on South Minneapolis apartments or net profits from growing corn, the value of the asset itself rises. But when such annual income drops, the market value of the asset itself also drops.”

“For a perpetual asset, one such as farmland that can conceivably produce income forever, the rational market value at any time is simply the annual income divided by the interest rate expressed as a decimal. This assumes that both the interest rate and annual income will not vary in the future.

Note these careful qualifications. The calculated value is that which a rational person would pay. There is nothing of buying out of ‘irrational exuberance’ or selling in a herd mentality. And the calculation depends on assumptions about the future that we all know will not hold true. Yale economist and Nobel laureate Robert Shiller. He is tied to the USDA announcement in several ways. First, he is an expert in the economics of real estate who correctly identified the housing price bubble leading up to 2006 and predicted its collapse. Secondly, he has been studying U.S. farmland price patterns over the last decade and argues that there now is an unsustainable bubble in those prices. Third, he is a leader among those contemporary economists who question Ricardo’s ‘what would a rational person do’ theorizing as inadequate.”

“So as someone who predicted at least four years ago that farmland prices would drop and whose work focuses on why bubbles develop in the first place, Shiller is the economist of the hour. The implications of the drop in farmland prices reach further, however, to macroeconomists like Federal Reserve Chairwoman Janet Yellen, former Minneapolis Fed chief Narayana Kocherlakota and Paul Krugman, another Nobel economst. All have been champions of the ultra-low interest rate policy pursued by the Fed over the past seven years.”

“And all three discount the effects of such low interest rates on asset prices. That is a serious error. Now the Yellen-led Fed is inching interest rates up, but the bubble in land prices has already happened.”

The Cattle Network. “Midwest and Midsouth farm income and quality farmland values continued to decline during the second quarter of 2016, according to the latest Agricultural Finance Monitor published by the Federal Reserve Bank of St. Louis. The survey was conducted from June 15-June 30, 2016. ‘In general, farmers in our region have only been able to survive declining commodity prices the past 24 months due to conservative spending, improved efficiency, and good crop yields,’ an Arkansas lender said. ‘A reduction in the yield or quality of crops, increases in input costs, or continued low commodity prices could be the tipping point for many under-capitalized operations. No producer can out-yield low prices.’”

The South Bend Tribune. “Across the nation, farmland has dipped in value — a trend that began last year. Recently, a tract of farmland in neighboring Illinois sold for $11,800 an acre. Less than two years ago, it might have fetched $14,000 an acre. In Indiana, the average price paid per acre for top-quality farmland declined $500 between June of 2015 and June of 2016 to $8,700, according to Farmers National Co., a farm and ranch management and real estate sales and appraisals firm.”

“‘The rise was caused by a big shift in demand from two sources,’ said Craig Dobbins, an agricultural economist with Purdue University who compiles the survey. ‘The Chinese decided to buy a lot of oil seeds, or soybean seeds, and the other was an energy policy that said we should make ethanol from corn.’ Farmers were benefiting from unexpectedly high profits and the low long-term interest rates that existed during and after the recession, he said.”

The Corn & Soybean Digest. “Now that grain prices have dipped below the break even mark, the next cost to decline is rental ground. That was one of the major findings in a report out by Rabobank Aug. 16. The report said that rent values need to begin dropping in 2017-2018 in order to balance with lower commodity prices over the long term. This will mean the value of land will also fall lower. If rental costs don’t fall, then the land assets will face deeper devaluation because farmers will cut and abandon nutrient and crop protection programs.”

“According to Rabobank, land rents have not fallen because many farmers still had ample working capital from the profits made in 2006-2013. The availability of cash in the farm business and farmers’ desire to control land in the longer term, combined with land owners’ reluctance to accept reduced income have to led to bidding wars which has kept rental values above breakeven levels. As working capital dries up it will mean an end to the bidding wars for land at rates above the breakeven marks.”

“Three factors farmers need to keep their eye on when it comes to land values is weather volatility. This year, farmers may see even bigger losses because of the bumper crops expected in corn and soybeans which will mean low land values this year. Another concern is interest rates. They are the most significant threat to land values. A substantial interest rate increase would drive mortgage payments higher and require land values to decline in order for farmer to make a profit.”

“The final factor is the aging farmer and their impact on agricultural land values. As more farmers reach retirement, more will be pressed to sell their land because they won’t want a declining net worth and decreased annual income from rental payments. This would increase the supply of commodity land for sale is likely to depress land values.”

The Gazette. “With corn and soybeans prices continuing to languish at low levels, Iowa farmers slashed their capital spending in 2015, according to new data from the U.S. Department of Agriculture’s National Agricultural Statistics Service. Farmers spent $610 million in 2015 for tractors and self-propelled machinery, down 34 percent from $920 million in 2014. Spending on farm improvements fell 31 percent to $880 million last year from $1.3 billion in 2014.”

“Deere and Kinze have felt the impact of lower farm implement purchases. Both companies have reduced their payrolls through layoffs as sales have declined in recent years. Truck and auto purchases by Iowa farmers were down 30 percent to $210 million in 2015 from $300 million in 2014, and miscellaneous capital expenses dropped 25 percent to $30 million in 2015 from $40 million the previous year.”

The Progressive Farmer. “A year ago, university economists warned that typical Illinois corn farmers would need to shave $100 an acre off average cash rent and production costs if they hoped to break even in 2016. Renters hesitated, landlords balked, most input suppliers held firm. Big savings didn’t happen. Now, worse prospects for 2017 grain markets mean many cash renters will have little choice but to plead poverty when renewing leases this fall. What’s different this time is that farm lenders will be the referees making sure rent gets knocked down a serious notch or two, some analysts caution.”

“Three consecutive years of falling farm incomes from 2014-2016 will have ‘evaporated’ working capital below acceptable credit standards for many producers, cautioned Sterling Liddell, an economist with Rabobank’s Food and Agribusiness Research group. In a new report on cash rents and land values, Liddell wants landowners to get a wake-up call when land rents are renegotiated this fall.”

“‘Right now, from what we gather, farmers are on the edge of their liquidity. In other words, they’ve burnt their liquidity due to high land rent and negative returns. They are now financing with equity or dipping into the wealth accumulated over their lifetimes, just to finance production. That’s a fairly ominous position to be in,’ he told DTN.”

“Mid-year reports from bank regulators confirm deteriorating credit quality among crop and cattle producers. Last week, a Kansas City Federal Reserve survey estimated that as of June 30, 7% of farm loans had major or severe repayment problems, but the share of loans with at least minor repayment issues had bounced to 22%. In the mountain states, 30% of farm loans had some type of repayment problem. Results in that region reflect a high dependence on wheat, cattle and energy leases, all of which have experienced steep declines in recent years. Lenders in the Corn Belt estimate that roughly 20% to 25% of borrowers could have some financial difficulty by next season if profitability doesn’t improve.”

“Now the multi-year farm recession has taken a toll, Liddell said. ‘At the end of the day, the real gatekeeper on this is credit, the ability to finance. If you simply cannot finance because you don’t have [enough] working capital and value of crop isn’t strong, you won’t have the money to bid into land,’ he told DTN. Bank standards generally require liquid, working capital reserves of at least 20% of cost of production to qualify for credit, he added, and many operators risk flunking that test.”