Farmland Is Pricey. The Fed Is Worried
When regulators come inquiring about loan risks at the Bank of Newman Grove, in Newman Grove, Neb., Jeffrey L. Gerhart, the chairman of the $35 million lender, has a “stress test” ready to show how his bank’s portfolio would fare if rural land prices dropped 25 percent. Or 50 percent. Or even 75 percent.
“I hope it’s not going to go to heck in a handbag out here, but this allows us to look at those worst-case scenarios,” says Gerhart, a fourth-generation banker in this 800-person town two hours west of Omaha, in the heart of the corn and soybean belt. He began stress-testing in the last two years after prodding from the Federal Reserve Bank of Kansas City.
Farmland prices were 30 percent higher in Nebraska in the second quarter than a year ago, according to a survey by the Kansas City Federal Reserve Bank, driven by elevated crop prices, soaring farm income, and record-low interest rates. That’s the high end of increases in cropland valuations of 8 percent and more in the region stretching from Oklahoma to North Dakota and from Nebraska to Michigan. Last March these increases prompted Yale University economist Robert J. Shiller to call farmland his “dark-horse bubble candidate for the next decade.”
Shiller’s warning has the Federal Reserve on guard, based on interviews with Fed regulators, economists, and policymakers. His prediction of a housing bubble in a 2005 edition of his book Irrational Exuberance proved prescient. Regulators missed the risks in residential and commercial real estate that led to the subprime crisis. So examiners at regional Federal Reserve banks and the Federal Deposit Insurance Corp. are scrutinizing the lending standards, loan documentation, and risk management at the country’s 2,144 agriculture banks.
Regulators have highlighted the risks in a series of sessions. The Farm Credit Administration hosted a roundtable in February. The FDIC sponsored a “Don’t Bet the Farm” symposium in March. In July the Kansas City Fed organized a conference on “Recognizing Risk in Global Agriculture.” That conference included officials from the FDIC, the Agriculture Dept., Farmer Mac (which functions like Freddie Mac), the Office of the Comptroller of the Currency, the Farm Credit Administration, the Federal Reserve banks of Minneapolis, Chicago, and Dallas, and the Fed’s Board of Governors. The group considered questions such as what would happen if crop prices fell by half, if government subsidies for agriculture or ethanol disappeared, or if land prices tumbled by 30 percent or more.
“It’s not that we think this is going to be the most likely outcome,” says Jason R. Henderson, the Kansas City Fed’s lead agricultural economist. “It’s a discussion of the black swans and fat tails—the low probability events that catch people off guard.”
The Fed’s Beige Book, an anecdotal survey of economic conditions released on Sept. 7, reported that “farmland values rose further” in several districts even as “harsh summer weather strained agricultural activity.” The Kansas City Fed reported land values were 20 percent higher than a year ago. The Chicago Fed reported a 17 percent increase in its district, the fastest increase since the 1970s. Nonirrigated farmland in the Minneapolis Fed district increased 22 percent in price.
At the peak of the housing bubble, real estate prices were rising 17 percent year over year, according to the S&P/Case-Shiller index of property values in 20 cities. Seasoned bankers see a disturbing similarity with the farm boom, as former Kansas City Fed Chief Executive Officer Thomas M. Hoenig told the Senate Agriculture Committee in testimony earlier this year. Hoenig’s big worry, he said, is that imbalances in asset prices “will catch agriculture—and the U.S. economy more generally—by surprise once again.”
Farmland values soared in the 1970s, rising as much as 28 percent in 1976. In the early 1980s the bubble burst, and land prices collapsed. Memories of the 1970s have made regulators and bankers more cautious this time, says David B. Oppedahl, a Chicago Fed economist who compiles the bank’s AgLetter.
On occasion, bankers have found regulators overzealous, says John Blanchfield, who runs the ABA Center for Agricultural & Rural Banking at the American Bankers Assn. “The FDIC is convinced there’s a bubble, and they’re not going to miss this bubble, by God,” he says. Regulators are concerned about banks’ concentrations of agriculture loans, he adds. “How are these bankers supposed to respond to that? Every direction in 500 miles from their bank is cornfields.”