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Are We Headed For a Repeat of the 1980s?

Are We Headed For a Repeat of the 1980s?

U of I economist explains the differences between today's market and the 1980s.

By Bruce Sherrick

Editor's note: This article is taken from the University of Illinois' FarmdocDaily website. For the full version, which includes additional graphs, click here. Sherrick is an ag econ professor at U of I.

There has been a recent increase in the number of inquiries asking about the current farmland market, and potential parallels to the early 1980s; and about precursor indicators of the farmland value declines in what is often termed the farmland crisis of the 1980s.

Are We Headed For a Repeat of the 1980s?

Among the most important differences between the period leading up to the farm crisis of the 1980s and today are the radically different interest rate and lending environments. In the 1980s, farm mortgage rates peaked at nearly 17.5% and have generally declined through time in concert with mid-term treasury rates to their present levels. The "spread over treasuries" provides one indicator of the perceived risk cost and spread over funding costs. In the data shown, the farm mortgage spreads averaged just over 2.25% for most of the period after the crisis of the 1980s, which is a higher level than during the pre-crisis era.

Less debt
Importantly, the level of indebtedness has also been reduced through time, rendering the sector as a whole less vulnerable to collateral revaluations. The ag sector has very low aggregate leverage (for context, NYSE traded companies in aggregate average around 65% debt). An implication is that there is more of a "buffer" built into the current holdings compared to that in the 1980s for asset re-valuations to trigger sell-off or liquidation responses from nearing zero equity.

In addition, typical mortgage loans in the 1980s included longer amortization periods (up to 40 years in some cases) and higher loan-to-value fractions than is typical today. Two important implications include that the principal reduction occurs more slowly in longer length loans, and that the fraction of the asset value in the form of current income required to service the debt was also much higher in the crisis period than is the case today.

Next, it is well-accepted that asset values reflect market participants' expectations regarding income levels and riskiness of income. In the case of farm real estate, there have been several recent years with higher than historic average income, and thus the attendant questions about the ability to continue to generate the same levels.

It is noted that these aggregate values may not represent individual farm cases well, but the point is that recent USDA forecasts of income have been reported in some cases as simply "reductions in income". While true relative to recent few years, it is also true that the reductions are to levels that are above the historical averages in constant 2014 dollars. Whether this level matches well with market participants' views of income is also debatable, but the general pattern of income through time remains important to appreciate, whatever the cause and potential effect.

Crop insurance culture
Another feature sometimes underappreciated in making comparisons to the 1980s is the dramatically different nature of crop insurance and the degree to which its use can reduce income variability and shortfalls in poor production years. Importantly, the modern crop insurance programs expanded to include revenue coverage later in the period - a product that did not exist in the 1980s when only rudimentary version of APH yield insurance existed, and only at low coverage levels. Another meaningful interpretation is that the modern insurance programs allow a producer to put a floor under losses, and also to very reliably address risks associated with cash rents of farmland (an analog of income to the asset).

In summary, there are substantial risks facing agriculture and the markets for assets used in agricultural production, as has always been the case. To understand these, it is also important to have a clear sense of the factors associated with the fundamental drivers in the market.

Income expectations remain reasonable and fairly stable, debt rates are low and interest rates are also historically low providing a buffer against potential asset revaluations, and crop insurance has fundamentally altered the riskiness of income as intended. There can still be important adjustments in any market as individuals refine and adjust their understanding of the factors influencing future income potential.
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