Thomas M Hoenig: Recent developments in US agriculture and its role in
the US economy
Statement by Mr Thomas M Hoenig, President of the Federal Reserve Bank of Kansas City,
before the Senate Committee on Agriculture, Nutrition and Forestry, Washington DC,
17 February 2011.
* * *
Thank you, Madam Chair. I appreciate the opportunity to discuss recent developments in
U.S. agriculture and its role in the U.S. economy. Agriculture remains a vital industry in the
expansive region that the Federal Reserve Bank of Kansas City serves and, accordingly, our
Bank has a long tradition of focusing significant attention on industry developments. Our
observations on agriculture, in turn, have given us useful insight into the U.S. and global
economies more broadly. In my remarks this morning, I'll describe recent developments in
the nation's farm economy and discuss some risks that have my attention.
Recent developments in U.S. agriculture
Agriculture - broadly defined as farm production and output from related industries -
accounts for almost one-sixth of U.S. jobs and economic activity. While the farm share of
economic output has declined as other parts of our economy have grown, increased activity
in broader agricultural industries - manufacturing, transportation, distribution and food
retailing - has opened new job opportunities in both rural and metro communities.
A robust agricultural sector cushioned the rural economy in our and other regions across the
nation during the recent recession, and the industry's strength is supporting further
improvement in the rural economy today. In 2010, strong demand and tight supplies for most
farm commodities contributed to a sharp rebound in farm profits, which then supported sales
in farm equipment and other farm-based industries. Strong profits from agriculture also
girded important elements of our rural financial system. Commercial banks with large
agricultural loan portfolios posted stronger returns than their peers over the past three years.
While more than 300 commercial banks failed during this time, only 22 were agricultural
banks.
Agriculture is also benefitting directly from the rebounding economic strength of China and
other emerging market economies, where rapid income growth is driving up food demand.
The United States remains a net exporter of agricultural products, shipping more than
40 percent of its wheat, cotton, soybeans and rice crops to foreign countries in 2010. United
States crop and meat exports are expected to rise to record highs in 2011. Looking out a little
further, economists expect global growth to exceed 4 percent well into 2012, with the
developing and emerging market economies remaining in the lead. Rapid income gains in
the developing world promise further increases in demand for higher-protein diets.
Developing risks in agriculture
Despite prospects of sustained farm income growth, U.S. producers must remain alert as
they face challenges related to their very success and tied to recent developments in
financial markets. Surging commodity prices and low interest rates have translated into
increasing farmland values, which have eclipsed their 1980s peaks. In our Bank's fourth
quarter 2010 Survey of Agricultural Credit Conditions, for example, cropland values in
Nebraska and Kansas were nearly 20 percent above year-ago levels and more than
75 percent higher than five years ago.
This run-up in farmland values has occurred, however, amid financial markets characterized
by high levels of liquidity and unusually low interest rates. History has taught us that it is
nearly impossible to determine how much of the farmland boom may be an unsustainable
bubble driven by financial markets and how much results from fundamental changes in
demand and supply conditions. Therefore, it will surprise no one when I say we are watching
the market closely, just as we are watching for imbalances emerging elsewhere in the
economy.
Of particular interest to me is how agriculture might adjust when financial markets return to
more-normal interest rate conditions. Rising interest rates often coincide with falling farm
revenues and higher capitalization rates, a depressing combination for farmland values.
Moreover, even if crop prices remain high but capitalization rates return to their historic
average, farmland values could fall by as much as a third, which most certainly would erode
the financial health of the farm sector.
Fortunately, the industry entered this period with a relatively strong balance sheet. Farm
leverage ratios are at historic lows, and agricultural banks are well capitalized. In addition,
farm operators and banks have strengthened their risk-management practices, using basic
hedging strategies and derivative markets to manage price and balance sheet risk, which
contributed to smaller increases in problem assets at agricultural banks than at their peers.
Nevertheless, I follow the basic lesson that bad loans are made in good times, and I remain
watchful.
In closing, I'll briefly highlight a symposium the Federal Reserve Bank of Kansas City hosted
last summer to consider agriculture's response to the extraordinary shifts occurring in market
conditions. There was a marked and, in my view, a very healthy consensus that the
industry's success will lie not in its ability to follow a single path, but in its ability to adapt
quickly to shifting economic landscapes and conditions. Still, my nagging concern remains
that current distortions in financial markets are increasing the risk that imbalances in asset
markets will catch agriculture - and the U.S. economy more generally - by surprise once
again.
Thank you Madam Chair.
Memorandum
January 14, 2011
To: Thomas Hoenig, Esther George, Diane Raley, Alan Barkema, Kevin Moore
From: Jason Henderson and Brian Briggeman
Subject: Farmland Values and Interest Rate Risk
Higher crop prices and lower interest rates have fueled a surge in farmland values, raising
concerns about a bubble in the agricultural real estate market. Since June, grain prices have
doubled, and futures markets suggest that prices could remain elevated through 2014. Still,
historically low interest rates and capitalization rates are needed to justify current farmland
values.
Over the past year, farmland values have posted double-digit gains, with additional gains
expected in 2011 (Map 1). By the beginning of 2010, U.S. farmland values had risen more
than 15 percent above 2005 levels, lifting the total value of U.S. farmland to almost $2 trillion
(Chart 1). While farmers own the majority of U.S. farmland, non-farm investors are buying
more land. According to a 2010 Iowa State University report, investors accounted for a
quarter of Iowa farmland sales.
Low interest rates, which have depressed capitalization rates, contributed to the recent spike
in farmland values. Capitalization rates on U.S. farmland have fluctuated over time, falling in
periods of negative real interest rates - 1970s and 2000s - and rising during periods of
higher real interest rates - 1980s. According to USDA data, Nebraska's capitalization rate on
cropland was 5.1 percent at the beginning of 2010, well below its historical average of
7.5 percent (Chart 2). Despite regional variation, capitalization rates on farmland values have
fallen to record lows across the nation, with rates below 5 percent in most states (Map 2).
Oklahoma and Texas have lower capitalization rates due to mineral rights inflating farmland
values.
Given low capitalization rates, farmland values face significant interest rate risk. For example,
irrigated cropland in eastern Nebraska is valued at $5,000 per acre. A historically low
capitalization rate of 5 percent is needed to rationalize this land value at current corn prices
and yields (Table 1). If interest rates would rise and lift capitalization rates to their historical
average of 7.5 percent, the capitalized value of irrigated farmland in eastern Nebraska could
fall by a third to $3,300 per acre (Chart 3). If capitalization rates would rise to 10 percent as
they did during the 1980s farm crisis, land values could drop by half. Additional analysis
suggests that other regions face similar interest rate risks.
Rising interest rates could also cut farmland values by reducing farm revenues. Higher
interest rates tend to raise exchange rates, which limits agricultural exports, in turn
depressing commodity prices and farm revenues. In 1981, the spike in real interest rates led
to higher exchange rates and contributed to lower agricultural exports. With falling exports,
commodity prices and farm revenues dropped, which pushed farmland values to their 1985
lows. If a similar event occurred today, farmland values could fall. For example, if
capitalization rates return to their historical average and corn prices drop to $4 per bushel,
their 2009 average, irrigated land values in eastern Nebraska could fall almost 50 percent to
$2,700 per acre (Chart 4). Other regions face similar risks. In sum, rising interest rates could
trigger a sharp decline in farmland values.

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