A financial time bomb has been ticking away in rural America for five years, and the hour of detonation is fast approaching. On Oct. 1, Iowa Gov. Terry Branstad declared an economic emergency in his state, triggering a law halting farm mortgage foreclosures under certain conditions for the first time since the depression. Newspaper headlines, congressional hearings, and US General Accounting Office reviews all point at impending disaster in the half-century-old Farm Credit System (FCS). How urg ent is the problem, what does it mean for rural and urban Americans, and what are its implications for productivity and structure of the nation's food system? The jury is still out on some of these questions, but one thing is certain; the problem is real and is likely to reach greatest urgency in 1986 or '87. The FCS began with federal funding in the 1930s when thousands of rural banks closed, land values tumbled, and sources of agricultural financing were drying up. By the 1970s, the system retired all federal funds and became one of the nation's largest financial institutions. Its 12 districts include 37 regional banks that provide short- and long-term loans to farmers as well as financing for agricultural marketing and supply cooperatives.
In total, the FCS system has over 800 farmer-owned lending units holding about one-third of US agriculture's estimated $210 billion debt. Since the system does not receive savings and checking deposits, its main source of funds is the sale of bonds in financial markets. FCS officials report that $11 billion of its $77 billion in outstanding loans may be uncollectible in the near future. Outside observers say even this estimate may be conservative.
What caused the FCS problems? It started in the 1970s, when farm commodity prices temporarily jumped above the inflation rate. The dollar devaluation, emergence of the Soviet Union and China as new markets, and growing demand led to excess optimism and a boom in farmland values. The boom was fed by low real interest rates, a strong dollar, and declining export demand. But the momentum of the 1970s kept the system from adjusting quickly. Heavily indebted farmers lacked cash flow to meet debt repayments, and this year's interest bill was added to next year's outstanding principal. When farmers attempted to sell land and machinery to pay debts, prices for these assets fell as much as 50 percent, compounding the problem. And the adjustment process has not yet run its course. For the US public, FCS problems raise two key questions. First, what will be the impact on the national economy if FCS does not receive federal assistance? Second, what will be the impact on productivity and structure of the US food sy stem? Along with these questions, an FCS collapse would severely hit already economically stressed rural communities and rural non-FCS lending institutions. Collapse of the FCS would negatively affect the US economy, through losses to many industries supplying agriculture. Financial repercussions are less clear. Potential FCS loan losses are larger than in financial failures such as Continental Illinois Bank and the Ohio and Maryland savings-and-loan crises. It is uncertain how widely FCS bonds are dispe rsed among portfolios of other lending institutions, and what secondary shocks might develop in the US financial system. In rural areas, a last-ditch effort by FCS to liquidate problem loans would push farm asset values lower, causing further adjustment problems for deeply indebted borrowers of rural commercial banks. In the process, many of these banks would likely fail, draining Federal Deposit Insurance Corporation resources.
Fortunately for consumers, US agriculture has excess production capacity. These adjustments are beginning to weed out some efficient farmers, and a FCS collapse would accelerate the process. But food production should be adequate for the short run. Partially offsetting this trend, declining asset values are reducing the capital required to begin farming and are helping young farmers get started in agriculture. Also, for the same reason some agricultural professionals are starting to return to the farm, and some insolvent farmers will return as tenants. But the success of these new entrants and reentrants, and long-term productivity growth in our food sector, hinge on the availability of stable financing.
In livestock, there is a trend toward concentration of cattle and hog feeding in fewer and larger units. Drying up of traditional credit sources might well accelerate this trend and encourage integration with feed manufacturing and meatpacking companies. That could affect the long-term competitiveness of meat pricing.
Thus, the FCS is in severe financial straits and will likely need outside aid to stay viable. Its demise would have negative impacts on the economy, the extent of which are not fully known. Its collapse could create crisis conditions for half a decade or more in agriculture and many rural areas, with a slowing of long-run farm productivity growth and possible decreased price competitiveness in meat. Thus, there are large risks in failing to extend a helping hand to the FCS.
Dr. Robert N. Wisner is an economics professor at Iowa State University.