Farmland Booms and Busts: Will the Cycle be Broken?

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1 Farmland Booms and Busts: Will the Cycle be Broken? Kansas Society of Farm Managers and Rural Appraisers Salina, KS February 23 rd, 2012 Brian C. Briggeman Associate Professor and Director of the Arthur Capper Cooperative Center

2 With the start of the 20 th century, farmland values began to heat up.

3 After World War I, farmland values caught fire with surging ag exports and excessively leveraged farms.

4 After a surge in bankruptcies and the Great Depression, the fire was out.

5 After World War II, farmland values started to heat up again as new technology was adopted.

6 New export markets and easy credit set farmland values ablaze, especially in the corn belt.

7 By 1978, Iowa farmland values were red hot and it was spreading throughout the region.

8 The start of the 1980s farm debt crisis began to cool the flame surrounding farmland values.

9 By 1987, forced land sales and a collapse in farm income put the fire out.

10 After the 1980s, a slow, steady recovery helped farmland values recover.

11 At the turn of the century, farmland values held steady until

12 a booming U.S. housing market as well as surging ag exports lit another fire under land values.

13 EXCESSIVE LEVERAGE PLAYED A SIGNIFICANT ROLE IN THE TWO FARMLAND VALUE COLLAPSES DURING THE 20 TH CENTURY TODAY?

14 F Debt-to-asset ratios rose significantly during the 1920s and 1980s. Percent s and 1930s Bust Farm Debt-to-asset Ratio 1980s Bust Today, Low Leverage Source: Agricultural Finance Databook ( ), USDA ( F)

15 F With easy credit, real farm debt levels and asset levels surged in the 1970s. Constant 2010 Billion Dollars Total Farm Assets (inflation adjusted) Constant 2010 Billion Dollars 3,000 2, , , Total Farm Debt (inflation adjusted) Source: Agricultural Finance Databook ( ), USDA ( F)

16 Today, leverage in the farm sector is low farmland bust?

17 Ultra low interest rates are one reason why regulators are warning of a farmland bubble. Percent 6 Fed Funds Rate (Upper Bound) Jan-07 May-07 Oct-07 Feb-08 Jul-08 Dec-08 Apr-09 Sep-09 Jan-10 Jun-10 Nov-10 Mar-11 Aug-11 Dec-11 Source: Federal Reserve Board of Governors

18 Movements in real interest rates also play a role in the farmland market opportunity cost. Percent 20 Real Commercial Paper Rates Negative Real Interest Rates -15 Source: Featherstone, Allen M. and Timothy Gl. Baker An Examination of Farm Sector Real Asset Dynamics: American Journal of Agricultural Economics 69(3): , and Federal Reserve Board of Governors

19 Low winning auction bid, $325/acre (subject to flooding) High winning auction bid, $520/acre

20 While debt is not fueling the recent surge in farmland values today, ultra low interest rates are playing a significant role. Expected Farm Income Interest Rates = Farmland Values Capitalization Rates

21 Percent Capitalization rates and real interest rates tend to move together Kansas Capitalization Rate and Real Interest Rate Kansas Cash Rent-to-Land Value Ratio Yield on 10-year U.S. Treasury Security - adjusted for inflation Sources: USDA, Federal Reserve and BLS

22 Dollars per Acre Historically low capitalization rates help support current Kansas cropland values. 7,000 6,500 6,000 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 Kansas Capitalized Irrigated Cropland Values South Central Kansas Irrigated Cropland Value = $3, % 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5% 8.0% Cropland capitalization rate Authors calculations based on KSU Corn Cost-return Budget in South Central Kansas. Assumed 200 bushels per acre, a corn price of $4.75 per bushel, and 20% of gross revenues capitalized into land. Historical average cap rate, Farmland values drop by 25 percent

23 Dollars per Acre At a historical average cap rate and today s corn prices, current Kansas cropland values are reasonable. 5,500 Kansas Capitalized Irrigated Cropland Values 5,000 4,500 South Central Kansas Irrigated Cropland Value = $3,800 4,000 3,500 3, average corn price, Farmland values drop by 35 percent 2,500 2,000 1, Corn price (dollars per bushel) Authors calculations based on KSU Corn Cost-return Budget in South Central Kansas. Assumed 200 bushels per acre, a corn price of $4.75 per bushel, 20% of gross revenues capitalized into land, and cap rate of 6.5%.

24 In general, interest rates, through exchange rates, also have an impact on farm income. Expected Farm Income Interest Rates = Farmland Values Capitalization Rates

25 Over time, real interest rates and real net farm income tend to move in opposite directions. Constant 2005 dollars (billions) Real Net Farm Incomes Less Government Payments (Left Scale) Real 1-year U.S. Treasury Securities Yield (Right Scale) Percent Sources: USDA, Federal Reserve, BLS

26 If financial market stress were to rise, how might crop prices respond? Exchange Rate and Corn Price Indices Index = Jan Trade Weighted Exchange Rate (Left Axis) Real Corn Prices (Right Axis) 2 Index = Jan Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan Source: Federal Reserve Board of Governors and Chicago Board of Trade

27 WHEN MIGHT INTEREST RATES RISE?

28 Most Federal Open Market Committee (FOMC) participants believe the first, appropriate increase in the Target Fed Funds Rate is 2014 or later. Number of FOMC Participants Source: Federal Reserve Board of Governors (The number of FOMC participants who judge that, under appropriate monetary policy And in the absence of further shocks to the economy, the first increase in the target federal funds rate from its current range of 0 to ¼ Percent will occur in the specified calendar year

29 Could longer term interest rates creep up in mid-2012 or will there be QE3? 2/10/2006 5/5/2006 7/28/ /20/2006 1/12/2007 4/6/2007 6/29/2007 9/21/ /14/2007 3/7/2008 5/30/2008 8/22/ /14/2008 2/6/2009 5/1/2009 7/24/ /16/2009 1/8/2010 4/2/2010 6/25/2010 9/17/ /10/2010 3/4/2011 5/27/2011 8/19/ /11/ month 3-month 6-month 1-year 2-year 3-year 5-year 10-year 20-year 30-year 6% 5% 4% Yield 3% 2% 1% 0% Date Treasury Maturity 0%-1% 1%-2% 2%-3% 3%-4% 4%-5% 5%-6%

30 9/5/ /5/2007 1/5/2008 3/5/2008 5/5/2008 7/5/2008 9/5/ /5/2008 1/5/2009 3/5/2009 5/5/2009 7/5/2009 9/5/ /5/2009 1/5/2010 3/5/2010 5/5/2010 7/5/2010 9/5/ /5/2010 1/5/2011 3/5/2011 5/5/2011 7/5/2011 9/5/ /5/2011 1/5/2012 How does the Fed return to a more normal balance sheet? Billion Dollars 3,500 3,000 2,500 Fed Agency Debt Mortgage-Backed Securities Purchases Liquidity to Key Credit Markets Lending to Financial Institutions Long Term Treasury Purchases Traditional Security Holdings 2,000 1,500 1, Source: Federal Reserve Bank of Cleveland

31 Concluding thoughts. Today, most farmland values can be justified given current market conditions. Yet, plenty of risks and questions surround the sustainability of farmland values. Rising interest rates would likely put downward pressure on land values.

32 Concluding thoughts. John Blanchfield, who runs the ABA Center for Agricultural & Rural Banking at the American Bankers Assn. stated, The FDIC is convinced there s a (farmland value) bubble, and they re not going to miss this bubble, by God html In the end, we have to ask ourselves if talking about a land value bubble is the right risk to focus our attention on.

33 Thank you. Questions? Kansas Society of Farm Managers and Rural Appraisers Salina, KS February 23rd, 2012 Brian C. Briggeman Associate Professor and Director of the Arthur Capper Cooperative Center

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