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Ag Recovery? Don't Bet On It, Says Economist

While a brighter mood on Wall Street has some investors breathing easier these days, the farm economy may still face turbulent waters in coming months, according to a well-known Extension economist.

Danny Klinefelter, ag economist with Texas A&M, said the outlook for the farm economy depends on three factors: net farm income, land prices and interest rates.

USDA forecasts net farm income will drop from $87 billion last year to an estimated $54 billion in 2009. "If net farm income is going to stay below $60 billion there will be problems," Klinefelter said. "If it drops below $50 billion, we're going to have some real problems."

Similarly, a drop in land prices of 10% would be "manageable," while a 20% decline would cause "real problems. But if they drop 30% we've got big problems," because land is still the collateral backing most farm loans. Real estate accounts for 87% of farm assets. "Land is the key," Klinefelter told an audience at the CME Group in Chicago Monday.

The good news for land prices is that some buyers see it as a hedge against inflation, which could keep attracting capital to the market.

As for interest rates, Klinefelter doesn't see a quick increase in 2010. But after that, a rebounding economy could pit the private sector against the government, which needs to borrow to finance deficits, driving rates higher. In addition, new regulations requiring lenders to have more reserve capital, along with higher insurance fees, could add another 1% to 2% to effective interest rates.

Some analysts looking at the U.S. farm balance believe it's in fairly good shape to handle a downturn because debt-to-asset ratios are historically low. But that measure is a lagging indicator, according to Klinefelter, who instead looks at the debt to income ratio, a leading indicator that is beginning to rise.

Klinefelter believes failures and foreclosures will increase over the winter, as stressed livestock operations run out of money. Many of these operations are large, and could have a ripple effect: "A hog integrator that goes out of business could take his entire supply chain with him," he said. The industry could face another 18 months to two years of stress.

Steve Meyer, of Paragon Economics, who introduced Klinefelter, noted the pork industry has been through periods of extreme losses before. But those downturns were caused by low hog prices. This year's debacle was compounded by high costs of feed and other inputs. "At least before it didn't cost us more money to lose that money," Meyer said.

Crop farmers appear to be in better shape, but could also confront a "cleansing" period lasting three years, followed by a "hangover" of another two years, Klinefelter predicted.

In preparation for a downturn, Klinefelter recommended restructuring loans, extending terms to match the time it will take an asset to generate funds pay back the debt. Banks, on the other hand, may want to keep terms shorter to lower their risk of rising rates if they can find investors willing to provide capital for longer periods.