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Driven by rising global demand for corn, wheat, soybeans and other
crops, U.S. farm net income in 2007 reached record levels, and 2008 is
shaping up to be just as profitable. Net farm income in 2008 is
forecast by the U.S. Department of Agriculture to hit $92.3 billion, up
4.1% from farm earnings last year and 51% above the 10-year average of
$61.1 billion. (See related story: Feeding at the trough) A combination of factors is driving the run-up in the agricultural economy. Besides rising food consumption in rapidly developing economies such as China and India, prices of crops are being driven by U.S. demand for corn-based ethanol and soybean-derived biofuels. Meanwhile, the weak dollar makes agricultural exports more competitive overseas. Sombke would like nothing better than to have his sons become the fifth generation to farm their family's 2,500-acre homestead in Conde, S.D. In fact, he'd like to see a lot more young South Dakotans choose a life in farming. The average farmer in the state is in his mid-50s, and Sombke has wondered who will work the land in 10 to 15 years. Until recently, there wasn't much to lure young people. Farming offered a lifetime of break-even money as the paltry reward for physically demanding work, long hours, huge financial risks and few vacations. Today's ag boom gives Sombke, president of the South Dakota Farmers Union, hope that more kids will follow their parents into the farming business. Nevertheless, he can't shake a sense of foreboding. Farmers, their distributors and their bankers have seen booms before, and they all know the good times often end with a crash. The go-go farm economy could be the next financial bubble. "This is a very volatile situation," Sombke says. "We've moved into territory we're not used to being in." High commodity prices "are great for the farm economy now," but he worries that too little is being done to prepare for the day when prices reverse, setting up a reprise of the farm collapse of the mid-1980s that caused thousands of farmers to lose their land. Right now, it's hard for anyone outside the business to see anything that could halt the whirring combine of American agriculture from reaping bountiful financial harvests for years to come. But agriculture experts also believe that today's booming farm economy is built upon a fragile confluence of factors that could upend the sector suddenly. Demand for corn could plummet if it loses political favor as a feedstock for ethanol, leading the government to cut subsidies that make ethanol plants profitable. Oil prices could significantly outpace crop prices, which would slash farmers' profits by increasing the cost of fuel, fertilizer and other inputs. A collapse of farm profits could also hit banks in American farm states, particularly the Midwest. Emboldened by the record profits, many farmers are expanding their land holdings -- and paying record prices to increase their acreage. According to the USDA, farm real estate values, which include all land and buildings on farms, averaged $2,160 per acre at the beginning of 2007, up 14% from the previous year. Aside from the strong farm economy, prices are also being driven up, says the USDA, by outside investors, low interest rates, attractive tax incentives, nonfarm development and even competition from recreational users such as hunters. "We've seen double-digit percent annual increases in farmland prices in the last several years," says Tom Gronstal, Iowa superintendent of banking. "We're at exceptionally high land values as a result of increases in prices of corn and soybeans. Land prices seem sustainable as long as commodity prices stay where they are. But we know that commodity prices tend to go in more than one direction. "If lenders and investors become convinced these prices are going to continually increase and have too much loaned against ground purchases, when commodity prices fall, we will have set ourselves up for another mess just like in real estate." According to the USDA, farm mortgage debt has risen 30% in the past five years and will stand at $121 billion by the end of 2008. Gronstal warned the Senate Banking Committee in March that lending for agricultural land was a potential trouble spot on the horizon. Roger Novotny, director of the South Dakota division of banking, says the same dynamic is occurring in his state. "We do see rapid inflation in crop land value and commodity values, combined with rapid escalation in the cost of inputs. "Put together, it works OK right now. But if one thing springs in the wrong direction, the agricultural area could be faced with negative economic times." Although land prices have steadily climbed since the last ag land bubble burst in the mid-1980s, he says increases in the past few years have been especially dramatic. Although higher capital requirements have positioned banks to better weather a financial storm, Gronstal worries that the farm belt as a whole is less able to absorb a major shock this time. Two decades ago, the crash in land prices led to many foreclosures of family farms and was brought to the public's consciousness by events such as Farm Aid, which was organized to assist troubled farmers by country balladeer Willie Nelson. Back then, however, the region still had a strong industrial base that helped small towns remain afloat and provided new employment for some of the farmers who lost their land. "We've seen a continuing disappearance of those jobs, and there are not very many alternatives if they have to give up the farm or seek alternate employment to help them sustain their livelihoods," Gronstal says. Neither regulator sees a crisis in the immediate future, but a continued run-up would worry them. "If land prices start to come down in the next 18 to 24 months, it probably wouldn't be a disaster. But the longer we have a continued high trend, the more likely it is people will forget what can happen," Gronstal says. His examiners are admonishing bankers to hold more capital in reserve for long-term loans and require farmers to make bigger down payments. In South Dakota, Novotny says bankers are wisely disregarding recent sales when valuing land for new loans. "When lending money, they may discount the land to previous values or hold steady to surrounding land values," he says. In the 1980s, the mistaken belief that land prices would never come down led many farmers to mortgage their original holdings to round out their acreage. "Practices like that can get someone mortgaged to a pretty high degree," Gronstal says. "If everything goes to pieces, they lose not only what they expanded to but what they had to start with as well." It wouldn't take much to send land or crop values downward. A big worry is that the run-up is caused by investment in corn-fed ethanol, which could well have a short life as a preferred alternative fuel. The only permanent factor in its favor is that it is domestically produced. But it isn't that much less a pollutant than oil-derived fuels and there is debate over whether it requires more energy to refine than it creates. "There are many arguments against corn ethanol, which requires significant government subsidies to be profitable for producers," Gronstal says. "At some point, public sentiment in favor of ethanol might change, causing the government to remove the subsidies." If that happened, the price of corn would plunge. Another wild card is political fallout from escalating food prices. Riots over spiking food costs and shortages have broken out in developing countries from Egypt to Haiti. Oil is also a worry. It is necessary not only to run equipment, heat livestock quarters and transport harvests and livestock to market but to manufacture fertilizer. "We're afraid input costs will overwhelm the industry," says Tim Ahartz, South Dakota's deputy banking director. The flush farm economy has attracted Wall Street firms looking for the next source of double-digit returns. Firms such as Morgan Stanley, BlackRock Inc. and Barclays Capital have bought into the farm boom and are taking large stakes in crop futures and land here and around the globe. Sombke, using data available on agriculture news service Data Transmission Network Corp., estimates that investment funds now control one-third of the major crops grown in South Dakota. Ag experts see investment funds' participation as a double-edged sword. On the positive side, they provide liquidity, but they also tend to move in the same direction, which exaggerates price swings. Sombke worries that the funds could exit overnight, yanking the bottom out of the market. Regulators so far are playing down both the impact of the funds on today's prices and the risks posed by a quick exit. "During such turbulent times, it's tempting to shoot first and ask questions later," Walt Lukken, acting chairman of the Commodity Futures Trading Commission, said as he opened an April 22 CFTC roundtable on today's ag markets. Despite the potential for volatility over the next few years, Jeffrey Conrad, president of Hancock Agricultural Investment Group, predicts investors will profit handsomely if they have a 10- to 15-year horizon. "Values have trended up aggressively in the last few years," he says. "Will the trend up continue at current rates? I doubt it. But we think the long-term fundamentals will remain in place." He agrees corn is likely to be replaced as the preferred feedstock for biofuel, but corn ethanol's likely replacement, cellulosic biofuel, needs land, too, for the grasses that make up its base ingredient. Other drivers of land values are not likely to change either, he says. The developing middle classes in Asian economies will continue to grow, and expansion of urban areas into nearby farmland isn't likely to reverse. Conrad discounts talk of a financial disaster for farmers. They are nowhere near as leveraged on a debt-to-asset basis as they were in the 1970s. "The situation then was not sustainable," he says, noting that the Farm Credit Administration's variable pricing policies at that time compounded farmers' woes when interest rates shot up. Ed Egilinsky, managing director of alternative strategies for Rydex Investments in Rockville, Md., agrees that long term there's every reason to be bullish on the sector, even if downward moves occur periodically. "Commodities can go through several downward declines and still be in an upward trend for the foreseeable future," he says. But there's no indication that developing Asian economies are going to stop increasing their food purchases or that biofuels won't play some role in the world's energy future. Rydex's commodities funds are structured to profit anytime there is a change in market prices, so Egilinsky's clients will make money regardless of whether prices climb or fall. He concedes, however, that the large size of commodities funds today and increasing speculation will exacerbate swings in prices. Even in a strong farm economy, rising prices are inflicting a toll. As in the rest of the economy, credit is tightening. The combination of spiking commodities and dear credit is complicating hedging techniques farmers use to lock in profits. Typically, farmers enter futures contracts with grain elevators to protect themselves in case prices fall between planting and harvest. The elevators, which store their crops and then sell them to upstream processors, pass the risk on by selling another contract on a futures exchange. If crop prices keep rising, the elevator must make a margin call to keep an account current. In the past, an elevator would turn to a bank to put up the money for margin calls. But banks are increasingly nervous about the escalating amounts required to meet the calls and the risk that prices could fall hard. CoBank ACB in Omaha, for instance, has stopped financing any new 2009 and 2010 grain purchases. Some smaller elevators have been forced to merge in order to have enough cash and credit to meet the calls. Larger elevators owned by ag conglomerates such as Archer-Daniels-Midland Co. are increasingly requiring farmers to cover margin calls themselves. ADM, Cargill Inc. and Bunge Ltd., ag sources say, are buying grain only 60 days out, and other large competitors are likely to follow their example. "If a farmer can't meet the obligation, he will have to go on the open market," Ahartz observes. State bank regulators and utility commissions, which typically oversee grain elevators, are concerned that farmers will increasingly use brokers or open their own hedging accounts on the Chicago Board of Trade to lock in today's high prices. The notion that farmers will take on more risk worries officials, but so far they're only monitoring the situation. For farmers who get caught up in a major correction, the notion that
prices will come back would be little solace, Sombke says. The wise
ones will make sure they haven't stuck their necks out too far. "We
know our land is not an entitlement. We don't assume it's something we
can't lose." - Bill McConnell See related story: Feeding at the trough CategoriesComments Deal Video
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Doug Sombke would have scoffed if you'd told him a few years ago that his three sons might one day take over the family farm. But these are heady times in America's agricultural business. Amid the hottest farm economy in nearly 30 years, Bryce and Bryan, both sophomores at Northern State University, and older brother Brett, now out of school, aim to do just that. 
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do you know the Conde, SD farm family mentioned? Also the article references our Omaha office not lending on 09 and 10 contracts.