NC1177: Agricultural and Rural Finance Markets in Transition (NC1014, NC221, NCT-194)
Statement of Issues and Justification
Commodity prices and farmland values have surged recently. As a result, farmers and land owners have enjoyed an increase in their farm income, rate of return on assets, and wealth. Concern regarding the sustainability of these recent profits and the striking similarity of today's economic forces to the 1980s, have caused many individuals to wonder if U.S. agriculture is set up for another 1980s-type agricultural bust. Just as in the 1980s, government policies have contributed to the run up in commodity prices and land values (e.g. today's ethanol subsidies). In addition, commodity prices and land values are at historic highs. For example, USDA estimates show that the average value of land today (approximately $2,400 per acre) is higher than 1980s average land value as measured in 2008 dollars (approximately $2,000 per acre). Another similarity is the value of the dollar is at record lows, which has helped expand agricultural export markets. Furthermore, low interest rates along with recent profits have encouraged farmers to use debt and cash to invest in machinery, equipment, and land. The current financial market crisis warrants additional research into how U.S. agriculture will be affected by these events and the long-term impact they present.The modern agricultural production system is critically dependent upon the financial management of agricultural operations. Producers need cost-effective access to capital and sound government policy in order to continue to meet the food, fiber, and bio-energy demands of the United States. Agriculture has evolved into a very diverse and complex system which has exposed agriculture to many new risks. One such risk is evidenced by the subprime lending crisis. Not since the Great Depression have financial markets been in such turmoil and much of this turmoil is due to the increase in mortgage foreclosures, loan write-offs, and the deterioration of new financial instruments (e.g. credit default swaps). Bank foreclosures, bailouts, and mergers have occurred. The recent collapse and government take-over of the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac has called into question the role of GSEs in modern capital markets. Two important agricultural lenders, Farmer Mac and the Farm Credit System, have GSE status. Given the major involvement of the government with Fannie Mae and Freddie Mac efforts to restructure the entire GSE system are likely. Understanding the impact of the increase in systemic risk applies to not only capital suppliers and Wall Street but those that use capital, agriculture, and rural America.
The use of credit by farmers, rural businesses, and agribusinesses has a critical impact on their long-term sustainability and competitiveness. One aspect of credit use is determining when and how much credit the business should use. At the heart of this issue is determining the extent to which the firm should utilize its credit reserves or unused borrowing capacity. Borrowing capacity has a value to the firm because it can be called upon in times of financial distress and keeps options for future projects available. Determining the value of unused credit capacity, however, is a challenge complicated by the fact that the unused borrowing capacity tends to grow and shrink as the overall market conditions in agriculture fluctuate. When times are bad, unused credit reserves tend to shrink as lenders become more conservative. These unused credit reserves are typically larger for established farmers but many of these farmers are nearing retirement and may not want to take on additional debt. Young and beginning farmers, which are often small or have less than $250,000 gross farm sales, are now in position to move back to the farm or start a new or another career in production agriculture. While some of the wealth will be transferred from the older to the younger generation of farmers, which the transfer of wealth is another issue, many young farmers will need access to credit to start or grow their operations. Work is needed to determine how to value and manage credit reserves in agriculture as well the implications of a new generation of borrowers entering agriculture.
Firms in the food, fiber, and bio-energy industry are experiencing an increase in their financial risk largely due to the financial crisis. Their business risk is increasing as well. Output and input commodity markets have seen a significant increase in their volatility and these implications have been far reaching. Raising food prices worldwide resulting from bad crop years, possibly related to climate change, have reinforced the need to develop informed policies to promote economic development and expansion of agricultural markets in the developing world. Strengthening developing countries emerging markets is important because these countries are important trade partners. Broadening and deepening financial markets in rural areas is one effective way to promote strong emerging markets as recent microfinance and rural finance initiatives have demonstrated. Agricultural economists have lagged in their contribution to the knowledge of what programs bring about better financial development in rural areas in developing countries. The latest concentrated (and coordinated) research effort dates back to the 1980s and early 1990s. Nevertheless, agricultural economists have studied similar domestic problems and their accumulated knowledge can be used to evaluate what financial institutions and financial instruments are most effective in promoting growth in rural areas of the developing world.
Arguably, some of the increase in agricultural commodity and input prices is attributable to renewable energy. Ethanol production subsidies have led to growth of the renewable energy industry, which has resulted in over $3 billion of external capital flowing into agriculture and rural America. One source of funding is federal and state subsidization of the industry (e.g. tax credits, research grants), which has specific termination deadlines and sunset provisions. Moreover, the industry has a rapid investment pace as new technology is quickly emerging given the breadth of federal and state research programs. However, most renewable energy firms have financial sweeps embedded in their debt financing which makes financing new investment difficult. Lack of financing jeopardizes the long term competitiveness of renewable fuels if new technology is not adopted.
The members of NC-1014 play a critical role in educating future and current agricultural financial managers through teaching and extension. These efforts provide the industry with the knowledge necessary to manage financial aspects of farms and agribusinesses. However, work is needed to jointly develop an understanding of the key components of a state-of-the art financial management curriculum for undergraduate, graduate, and extension audiences. This project will seek to identify the key concepts and lessons that should be incorporated into each of these curricula. By improving the training of undergraduates, graduate, and practitioners the project will improve the financial management ability of members of the food system and increase the long-term sustainability of businesses operating in the food, fiber, and bio-energy system.
The track record of NC-1014 was excellent regarding the number of collaborations and outcomes that depended upon multi-state efforts. This current project will leverage those existing relationships. Each objective the new project specifically states how multi-state activity will occur and why it is needed. The scientists involved in the project have a wide variety of expertise in agricultural finance, social capital, and policy analysis. However, most institutions have only one scientist working in this area. Thus, a regional emphasis fosters synergy as resident experts can establish a critical mass necessary to attract national interest and leaders of regulatory agencies, financial institutions, and policy groups; more efficiently collect data of mutual interest; enhance peer review of each work produced; and collaborate on issues that exceed local interest. Extension members of the committee benefit from research that is not available locally. The past multi-state effort benefitted greatly from the rich participation of industry, public agency, and non-profit members.
Upon completion of the project, insights will be gained to ultimately improve the functioning of agricultural and rural financial markets. Producers, rural residents, and businesses should benefit through increased performance and reduced business risk. The lending sector will become more stable and better prepared to face future policy, portfolio and structure-related challenges. The value of this work to stakeholders is evidenced by the large number of non-station members who actively participate in annual meetings and desire to keep abreast of research results via listserve communication. The recent advent of eXtension will also afford new and unique opportunities to disseminate the results of the proposed research project to a larger audience.
There are no apparent barriers hindering the technical feasibility of the proposed research project.
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