Last December, the National Bureau of Economic Research made the official declaration that the U.S. economy was in a recession and that it actually began in December 2007. More news on the impact of the recession was delivered in early January when the Bureau of Labor Statistics reported that the level of unemployment in the U.S. had reached a 16 year high of 7.2 percent. Some fear that the U.S. unemployment rate could go higher. Growth in the economy for 2008 is expected to fall to 1.3 percent, compared to 2 percent in 2007 and 2.9 percent in 2006. In 2009, a continued contraction in the U.S. economy is expected with a GDP growth rate of negative 1.9 percent, according to the current USDA baseline projections.

 

Companies in the banking, home manufacture, auto and semi-conductor industries have sought government help to help tide them through what will likely be the worst economic downturn since 1946. But will farmers? Not necessarily.  

 

This news on the economic slowdown and rising unemployment follow one of the most volatile periods in commodity markets seen in many years. Beginning in 2007 commodity prices, primarily grains, oilseeds, and oil, began a rise to record levels in June of 2008. Then, beginning in July, prices of these commodities made the largest and fastest fall ever experienced. This fall was precipitated by softening global demand due to the recession and an appreciating dollar, which makes U.S. exports of agricultural commodities more expensive to foreign buyers.

 

Even with declining commodity prices throughout much of the fall, U.S. farm income is expected to rise slightly above the record level reached in 2007. Farm income in the U.S. is projected at $86.9 billion for 2008, compared to $86.8 billion in 2007, according to USDA reports. The growth in income was not enjoyed by all sectors. Grain and oilseed farmers benefited, especially those who marketed their 2007/08 crop at high late season prices, due to strong global demand for feed grains and feed stocks for bio-fuels. Meanwhile, livestock producers had to purchase these higher priced feed grains, resulting potentially in lower net farm income. Revenues were lower for producers of some fruits and tree nuts who faced lower prices in 2008 and lower production levels for some crops. Global demand for cotton products also fell, as did U.S. cotton production. The outlook for farm income in 2009 will depend on how much farm prices fall and how much the price of farm inputs (fertilizer, fuel, seed, etc.) also fall (see nearby sidebar story). Fuel and fertilizer prices have already seen significant drops during the fall. Though, energy prices are again inching upward.

 

The recession and the widely reported global financial crisis, precipitated by massive home mortgage defaults in the U.S., particularly by subprime borrowers, have led some to question whether the U.S. agricultural sector is facing another financial crisis reminiscent of the Willie Nelson Farm Aid era (mid-1980’s). The answer is that it is unlikely, as entirely different economic circumstances exist in the agricultural sector now and in the mid-1980s, as explained by Purdue University agricultural economists Mike Boehlje and Chris Hurt. However, there are some eerie similarities between the farm financial crisis of the mid-1980s and the subprime market fiasco of 2008.

 

During the late 1970’s and early 1980’s, farmers took on high levels of debt to invest in assets (primarily land) that were expected to increase in value at rates higher than the prevailing real interest rate. This practice was referred to as “inflation investing.” Furthermore, many lenders were willing to lend based more on asset value than on repayment capability (think subprime fiasco). As a result, farm debt to asset ratios rose to as high as 22.2 percent in 1985. Worse yet, many of these loans were made on variable interest rates.

 

Then came the perfect storm. Investing based on optimistic forecasts turned to crisis in the mid-1980’s when tighter credit policies and higher interest rates, combined with record-high debt levels resulted in soaring debt service costs. Just as short sales are undermining real estate markets in Las Vegas, Southern California, Phoenix and elsewhere, land prices collapsed as farmers dumped land holdings to generate revenue to pay off their debt. Higher debt payments would have been manageable had commodity prices rose as well, but prices, and farm incomes more generally, were falling due to the escalating trade subsidy war with the then-called European Community. 

In recent years, U.S. farmers have again enjoyed growth in asset values, primarily in the value of their land. Perhaps based on their experience from the 1980s, however, they have been much more prudent in the use of credit. Currently, the average debt to asset ratio among U.S. farmers is only about 9.0 percent, meaning that debt only accounts for $9 of every $100 dollars of assets. U.S. farmers are also in a much more liquid position than they were in the 1980s, meaning that they have assets that can be converted into cash relatively easily to handle unforeseen financial obligations or hardships. Current interest rates are also dramatically lower than those experienced in the mid 1980s, when short-term rates approached 20 percent.

 

Much has been reported lately on the availability of credit in U.S. markets. Indeed, some have described U.S. credit markets as being frozen, resulting in less available credit for businesses and consumers, principally home buyers. This has raised questions on the availability of credit in the agricultural sector, particularly for short-term operating loans. Most agricultural lenders report that they are well positioned with available funds. Agricultural lenders typically rely on traditional sources of funds, including bank deposits, discount notes, and bonds. Few agricultural lenders use any of the exotic derivative instruments associated with home mortgage markets. Bonds tied to agricultural loans continue to be very safe investments for creditors due to the conservative lending practices of agricultural bankers, recent strong earnings in the agricultural sector, and the low rate of defaults in the agricultural sector. During the first quarter of 2008, over five percent of commercial real estate loans were in default, compared with less than 2 percent of agricultural loans, according to the Federal Reserve Bank. In fact, in 1987 agricultural loans had the highest delinquency rates of any loan-type, while by 2008 they had the lowest (see figure). Under the current circumstances, agricultural lenders are expected to be a little more demanding with their customers, asking for updated financial statements and marketing plans. Agriculturalists would do well to consider their lenders as business partners and to work closely with them.

 

The recession will, however, have an impact on the agricultural sector. As evidenced by the drop in commodity futures prices during the fall, farm prices are expected to be lower. The decline in agricultural prices reflects the decreased earnings of consumers around the world and, hence, the decrease in demand for food and a decrease in demand for U.S. products, reflecting the stronger dollar. (Cotton prices have, however, shown some glint of strengthening during the past month). Past recessionary periods in the U.S. have resulted in decreases in farm income, often after a short lag, given the longer production processes associated with most agricultural enterprises.

 

However, people still have to eat. Consumers will seek opportunities to economize on their food purchases; private label products are expected to make a comeback and value-added products (e.g. bagged salads, baby carrots) are expected to see a decline in sales. We have already seen declines in consumer food expenditures away from home, particularly at upscale restaurants, but retail food sales remain strong. Wal-Mart and Kroger, the two largest food retailers in the U.S., reported strong sales growth in the last quarter of 2008, largely driven by sales of value-oriented food items. More food consumption at home could prove beneficial for produce sales, as at-home servings of fruits and vegetables tend to be larger. However, in an effort to economize on food purchases, sales of organic products and luxury goods (e.g. imported beer) are expected to fall. These changes in consumer purchasing patterns may require producers to reconsider their marketing partners and portfolio of enterprises.

 

Managing to avoid failure, however, is hardly a recipe for business success. There are many plausible scenarios for a strong turn-around in farm-commodity markets. Unprecedented federal budget deficits will mean a reversal in the recent strength of the dollar, while aggressive stimulus packages, both in the U.S. and abroad – most notably China – stand a good chance of reviving the long-term uptrend in commodity demand. Many farmers are well-positioned to take advantage of the next recovery by controlling costs, renegotiating rents and loans, increasing throughput in utilizing assets to generate more income, and seeking diverse income streams.

 

Although markets for corn-based ethanol have been drawn down by the fall in crude oil prices, the long-term demand for alternative energy sources such as wind, solar, and cellulosic ethanol provide agricultural producers and landholders of all types an opportunity to benefit from more fundamental changes in the global economy. Reduced competition from non-agricultural buyers has also generated buying opportunities in many agricultural asset classes. As in past economic downturns, smart decisions taken now by those with the wherewithal to do so will be rewarded.