In The U.S. Midwest, A Farmland Bubble May Be Growing

Sales of everything from compact tractors to combines have jumped at Jim Lichtenberg’s Nebraska store this year as farmers try to make the most of a boom in corn and soybean prices.

“Yields were good this year and crop prices are real good right now, so guys have been spending some money,” said Lichtenberg, who has worked as a salesman for Johnson Farm Equipment in Fremont for 10 years. He estimates sales have risen by as much as 40 per cent this year.

Surging grain prices and growing investor interest are lifting farmland prices in the Midwest, and bank regulators fear that another U.S. bubble may be inflating.

Farmland prices are 58 per cent above their 2000 levels in inflation-adjusted terms, according to the Federal Deposit Insurance Corp. That’s about how much residential real estate prices rose in the United States from 2000 through 2004.

Those soaring land values reflect the largely unsung prosperity of U.S. states that shrugged off the downturn.

That’s good news, but many analysts wonder what would happen to the lenders who finance farmland operations and purchases if prices fall.

“If commodity prices plunge from the current levels and you think they’re in a bubble, which I tend to think they are, there is risk” for agricultural banks, said Rochdale Securities analyst Richard Bove.

Investors like farmland because they see it as a safe asset that generates income. They also benefit from the Federal Reserve’s low interest rates, which are prompting investors to seek high yields in commodities.

These factors may not last, Bove said.

FEDS WATCHING

The Federal Deposit Insurance Corp. is monitoring credit to U.S. farmland, said Sheila Bair, chairman of the Federal Deposit Insurance Corp., last month in Baltimore,

The loan market does not seem frothy now, but there is still risk there, Bair said.

“A sharp decline in farmland prices similar to the early 1980s could have a severe adverse impact on the nation’s 1,579 farm banks,” Bair said in October.

The $245 billion farm loan market is small compared to the $11.5 trillion U.S. home loan market and the nation’s $2 trillion of farmland assets.

But a downturn in rural land values could hit Midwestern states hard, and some smaller banks could end up hobbled. As the U.S. government deals with a financial crisis that has already ruined more than 300 banks, a farmland bubble could add to the taxpayers’ cleanup bill.

As land prices rise, bank exposure grows. In 2004, banks had about $95.7 billion of farm mortgages. In the middle of 2010, that figure was closer to $132 billion.

“Every bank is working hard to find creditworthy customers. When you see a sector like agriculture that’s doing well, suddenly they like to swing towards it, whether they have the expertise and understanding to deal with it or not,” said Wells Fargo agricultural economist Michael Swanson.

For over a year, some Midwestern state regulators have been eyeing potential weaknesses, and national bank regulators are starting to join them.

Prices and yields of crops in South Dakota have been “extremely strong” in the absence of drought and large-scale flooding, said Tim Ahartz, deputy director at the South Dakota Department of Banking.

For the past year, Ahartz has asked banks to be more specific about what types of agricultural loans are on their books, to ensure that lenders better understand the risks of those portfolios.

“Our fear is if drought, for example, were to reoccur, or if input costs of farming continue to rise and the yields of the crop can’t keep up, where is the cash flow going to come from?” Ahartz said.

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