A Perspective On U.s. Farm Problems And Agricultural Policy

Lance McKinzie

• Publisher: CRC Press
• Year: 2019
• ISBN:
  9780429712722
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Agricultural Public Policy
• Index: Politics & International Relations

A Perspective on U.S. Farm Problems and Agricultural Policy provides a framework for evaluating national policy alternatives and attempts to improve our understanding of the nature of U.S. farm sector and its problems.

1
Introduction

American farmers of the mid-1980s are struggling with an enormous financial crisis. Lenders and businessmen who primarily serve the farm community face similar distress. Hardly a week passes without news reports chronicling yet further dreary episodes in this unhappy saga--foreclosures, protests, governmental debates, distress sales.

Worse, no one seems to know what to do about all of this. Some propose continuing price supports for this or that critical commodity. But the problem is not peculiar to corn farmers or strawberry growers, cattlemen or cotton farmers. The financial crisis prevails throughout the agricultural community.

Some observers think farmers should take their chances in the marketplace like other businessmen. They entered farming to make a profit with a full awareness of the risks, those observers contend, and when adverse situations arise, they should either discontinue their venture or not--like people in other fields.

In some important ways, though, farmers differ from many businessmen. Any attempt to understand their dilemma or find a solution for it has to start with that assumption. For farmers face their risks alone. The typical farmer, facing the need for extra capital, does not issue more stock as a typical manufacturer does. He tends not to enter into limited partnerships as venturers in oil exploration and other kinds of real estate often do. His source of money tends to be his bank, or a similar lender. And all he has to bank on are his land holdings and his potential crops. All for good reason. Farmers are independent souls--often that is a virtue. Here it may be a flaw. More important, agricultural policy and social setting have made this so. People have opposed the idea of corporate farms for some reason. And policy directions which create cheap interest and support commodity prices have urged this approach to farm finance. If all does not go well in terms of land values or yields, he faces his debts alone.

And debt is a major part of the problem in agriculture. The USDA, with its sure statistical grasp, defines the problem in terms of leverage problems. Basic is the notion that a businessman must finance all assets--either with equity or with debt. Thus, assets equal equity plus debt. For a farmer, the primary asset is land, and that is a relatively stable factor. A farmer is unlikely to be able to alter that holding quickly or substantially. To increase profits, the farmer must typically add debt, or use leverage. Leveraging multiplies profit, but it also multiplies risk.

If a farmer finances, say, $100,000 worth of assets with $30,000 in equity and $70,000 in debt, then his debt-asset ratio is 70%. If he wishes to increase profits, he might decide to assume more debt, perhaps $120,000. Now his debt-asset ratio has risen to 80%. When all goes well, that will dramatically boost the profits of his operation. If his return holds at five percent, his profit will rise from $5,000 to $7,500. Conversely, if crops are poor, prices go down, or land values plummet--all conditions which have plagued farmers in recent years--then the farmer realizes how dramatically his risk has increased. And he may well have severe problems dealing with that risk.

In fact, according to the ÜSDA, as many as 145,000 farms may have extreme financial leverage problems (the USDA defines "extreme" in terms of debt-asset ratios greater than 70%). As many as 243,000 farms may have serious financial leverage problems (debt-asset ratios between 40% and 70%). That is, almost 16% of the 2.5 million farms are experiencing serious or extreme leverage problems.

Following developments between 1980 and 1985 makes the problem seem even more severe. Consequences have not yet worked through the systems. Apparently farmers will continue to feel distress for some time to come. Rates of failure may well increase.

The number of farms experiencing extreme leverage problems rose during those years by 94 percent, and the number with serious leverage problems rose by 26 percent. The average net worth for very highly leveraged farms ranged from trivial to negative across all sales classes. This indicates that about half of these farmers (72,000) were technically insolvent by January 1985. Cash shortfalls range between 12 percent and 33 percent of net worth for farms with debt asset ratios between 40 and 70 percent. Cash shortfall and equity conditions suggest that few farms in the highly leveraged category could survive more than three or four additional years unless conditions change, and almost none of the very highly leveraged farms could continue more than two years. While less highly leveraged farmers fared better, as many as 85 percent of all farms experienced cash shortfalls in 1983.

Financial stress among farmers also directly concerns agricultural lenders. As of January 1985, ag lenders faced losses on approximately 12 percent of their loans. If the trend were to continue two or three more years past that point, the proportion of technically insolvent loans would double at least to 24 percent. Many lenders will have to face the possibility of failure and reorganization if more than a few percent more of their borrowers default on their loans. So the financial stress extends to the agricultural credit sector.

On the surface, the fundamental financial problem for many farmers appears to be related to capital investments. From the current vantage point, it seems clear that a great many farmers invested in assets that were overpriced and used too much debt financing to do so. The present high interest rates only compound the problem. However, it is unlikely that anyone--farmer, banker, extension advisor, farm consultant, or university economist--would have thought the investments bad ones on the day they were made. At least, few of these people were issuing words of caution. After all, during a thirty year period, our economic community issued strong signals to farmers to use financial leverage and to invest aggressively. Underlying those signals were a variety of assumptions: land and exports would continue to appreciate, commodity prices would continue to increase or at least hold steady, the financial climate--interest rates, inflation, and so on--would follow present trends.

Suddenly economic conditions changed. Society elected to end rapid inflation. The financial community adjusted money supplies and values accordingly. Exchange rates altered markedly. Interest rates responded. And the agricultural sector found that the assumptions on which it had made those investments were no longer valid. As a result, what had seemed a reasonable action was now a "bad investment." Suffering farmers heard from all sides that they were simply paying the price for bad management. Clearly, the situation they found themselves in was far more complex than it seemed on the surface.

A more probing examination of the agricultural sector's financial problems reveals that they follow from a deeper historical source. The farm sector is readjusting to the disruptive effects of the boom period of the 1970s. Actually, agriculture is currently more profitable than it was during the 1950s and 1960s. Estimates of returns to agricultural assets show that they exceed those characteristic of the pre-land boom period. But the quantity of new debt which farmers assumed during the 1970s and the recent high real interest rates result in an increase in the cost of debt which offsets the increase in returns to assets.

In general, land booms bring about increased debt. Substantial land transfers take place at prices which changing economic conditions may later invalidate. That is, society invalidates the assumptions underlying those conditions, these now bad investments bode ill for the sector as a whole in spite of the fact that agriculture is currently relatively profitable. Returns to management and equity are on the whole about zero.

Numerous observers of the agricultural scene attribute the financial troubles of certain farmers to bad management. Although that may be true in some cases, in many others, the most severe difficulties appear to visit those who in other times would be thought to be among the shrewdest of managers. Financial conditions vary greatly among individuals, but there are some broad generalizations which obtain:

• Farmers with little or no debt are fairing quite well after the boom period with much new wealth and higher income returns to assets.
• Farmers with average debt, average return on assets and paying an average rate of interest have about zero return to management and equity.
• Farmers with higher than average proportions of debt, but earning an average return on assets and paying an average rate of interest, are suffering negative returns to management and equity.

Those who acquired high levels of debt during the boom period may well be some of the better entrepreneurs and managers, although it is possible to state after the fact that they should have known better than to assume land values would continue to increase. It is possible to argue that these people were simply born at the wrong time.

Interestingly, this situation of extreme financial stress in the agricultural sector of our economy is not unprecedented. There have been several parallel series of events whose patterns are remarkably similar to what we are seeing now. Working backwards in time, there were land booms followed by severe busts during the Great Depression of the 1930s, in the 1870s, and following the Napoleonic Wars in the 1820s.

These events suggest a set of interesting conclusions. If a problem situation is a chance occurrence--a one-time circumstance, then some kind of intervention to tide people through the crisis period makes sense. In general, that is how governmental agencies and others concerned with farm policy are reacting at present. But, if the events seem to be part of a larger historical sequence, then such, intervention will never really work for it treats only superficial aspects and fails to come to grips with the real dilemma. Many people, of all political and economic persuasions, implicitly acknowledge this when they admit that price supports or production controls do not really produce satisfactory results.

The problem, then, must be structural. Its roots must derive from factors Inherent in the institution--in this case, the institution of agricultural finance. When that is true, then there is an illusory aspect to success. Lacking a sound institutional basis, apparent success is a fragile thing. At present, the remarkable rise and fall of a number of agricultural entrepreneurs lends support to those conclusions. Those people ran their farms just like the best farm business thinkers said they should. During the boom, theirs was a phenomenal success. When the situation changed, though, they were among the first to fall, and theirs was a colossal fall.

Nevertheless, recognition of a historical pattern in these events provides hope that we can extract a solution for the financial plight of farmers which will be more than a stop-gap. The historical pattern points up structural problems in our system of farm finance. Accordingly, we should look for an institutional correction rather than satisfying ourselves with treating symptoms as we have previously tried to do.

Given the severity of these problems, the historical precedent and the widespread dissatisfaction with traditional policy answers, we wonder why policy makers and agricultural financiers have not recognized this. Two reasons suggest themselves immediately.

First, we tend to focus on the present and tend to lack historical perspective. These boom-bust sequences are long, spanning two or three generations. And they are separated in time so that the actual crises are even farther apart. As a result, grandsons lack real awareness of what their grandfathers may well have learned from experience. Each crisis becomes an occasion to reinvent a financial wheel.

Second, and probably more basic, we seem to have discovered a situation where people are trying to operate using an old, worn out conceptual framework--or paradigm. And to attain any real solution will require a reorientation of our thinking--adopting a new paradigm.

Policy makers, financial people, farmers--everyone, in fact, with a share of concern in the matter of farm finance--tend to see the farm financial problem in terms of income problems. Given that income is his problem, then any of the traditional policy responses should provide an adequate solution. But they do not. Commodity price supports, for instance, may help farmers cope with an immediate crisis, but they encourage more debt, they invite expansion where most other market signals urge otherwise, they create trading problems in both domestic and overseas markets, and they undermine the stability of banks and other businesses that serve the farm sector. In short, in exchange for a minuscule temporary benefit these policies create numerous long lasting problems. So it is with virtually every policy approach.

Actually, that describes well what happens when people in any science try to solve problems in the context of a worn out paradigm. The attempt only leads to a bewildering array of new problems. As we argue that the real financial problem for farmers concerns asset values, not income, we are in effect urging adoption of a new paradigm. For we think that once all of us with concerns in this area reconceptualize the farm finance problem along the lines we suggest, an interesting approach to a solution will suggest itself--one which promises farmers both short and long term aid and seems to avoid the unpleasant side effects of traditional policies.

This, then, is the thrust of our discussion--to reconceptualize the farm financial problem by concentrating on the basic issue of asset values rather than on the secondary matter of income and to follow the logic of that realignment of our thinking to develop a policy proposal which provides farmers with an institutional mechanism which holds out the promise of actually coping with the root financial problems.

A Brief Perspective on Adjustment Problems

Finding an appropriate solution for the present crisis is a difficult task--conceptually and practically. In part, the solution we derive will follow from our understanding of the problem. Since a significant aspect of the problem involves the farm sector's approach to adjusting to change, it is well to review briefly the characteristic patterns and assumptions which shape those adjustments.

In our view, farm sector adjustment entails: 1) ongoing growth and adjustment to technological development, and 2) immediate adjustment to major disruptions in price expectations. Each aspect keys on certain central issues and assumptions. The farm economy has responded to pressure to grow and adapt to new technology by substituting capital for labor and consolidating smaller farms into larger units--all in search of higher returns for management and entrepreneurial skill. The issues surrounding responses to major disruptions in price expectations include substantial transfers of wealth among individuals and misguided capital investments. The land transfers causing the most severe financial stress, ironically, involve typically the young, aggressively expanding farmers and those who seem to be progressive individuals with above average management skills.

overall, this view of the adjustment patterns allows us to accommodate a variety of causes and effects. The resulting conceptual richness provides for the incorporation of diverse events into a general understanding which has solid intuitive appeal and which creates a basis for an interesting framework for policy formation.

Each aspect of this has different roots and different effects on the structure and well being of the farm economy. Viewed in this manner, observations of different events in the sector, including the current situation, fit into a general understanding which has solid intuitive appeal and represents the beginning of a framework which will facilitate policy formulation. Brief introductory comments on both of these parts follow.

Ongoing Adjustment

People, affiliated with agriculture or not, often focus on the highly technical aspects of farming--crop production, machinery selection, operation, and maintenance. But farming is a business. Therefore, the equally technical factors of business operation, planning, and finance are profoundly important. We take the approach (suggested by Madden, 1984) that systematic variations in returns which are so strongly associated with size follow largely from management and entrepreneurial ability. Given that view it seems eminently reasonable that at any point in time, larger operations would tend to be operated by individuals possessing above average skills due to the selective mechanics of survival. We also view the farm firm as providing services, under the class of off-farm endeavor, in addition to agricultural product. This provides an explanation for the many smaller operations without resort to concepts of market imperfections and inefficiencies.

As the adjustment process unfolds, people substitute capital for labor, individuals leave the sector, and farms are consolidated under the control of fewer operators. Management skills seem to be available; the fact that in most years, farmers have competed strongly for land with which to expand their operations suggests an availability of management skills. Accumulated equity, in the hands of those with requisite management skills, has been an important constraint limiting more rapid expansion. Farm income is quite variable from year to year. For an individual farmer with a given preference for bearing risk, maintaining a desired probability of survival means limiting expansion to that directed by his accumulated equity. Our notion is that under "normal conditions" the market does a reasonable job of allocating residual returns between land, management skills, and other factors so as to regulate the structure of the sector under the ongoing process. We use the term "normal conditions" to mean that the general level of prices is relatively constant or changing in a manner consistent with expectations. But, normal conditions do not always hold, and this leads to the second issue.

Immediate Adjustments Associated with Major Disturbances in Price Expectations

The second aspect of adjustment which we highlight concerns the disruptive effects of substantial and unanticipated changes in returns to farm assets. Though often correlated with changes in current returns, changes in beliefs about future returns necessitate the largest adjustments. The problem is that the structural organization of the farm sector, particularly our system of ownership and financing, does not readily accomodate downward changes in beliefs of the magnitude which occur from time to time. Large downward changes in beliefs about future returns cause great losses of wealth between farmers and s...