Guest opinion: What to think when they call farmland a bubble
November 19, 2010
In the late 1980s, foreign correspondents in Tokyo believed Japanese companies would rule the world forever, even as their editors in New York warned them that the Japanese stock market was a bubble waiting to burst.
In the late 1990s, those New York editors bungled bubble spotting in their own backyards. They failed to recognize the bubble in U.S. tech-related equities.
That’s the problem with financial bubbles. You don’t know for sure you’re in one until it bursts. And the more connected you are to the bubble, the more likely you are to be in denial, to think that “this time it’s different.”
What brings these musings to mind is the talk bubbling up that U.S. farmland could be the next bubble. The head of the Federal Deposit Insurance Corporation, Sheila Bair, warned last month that a “sharp decline in farmland prices similar to the early 1980s could have a severe impact on the nation’s 1,579 farm banks.”
Thomas Hoenig, chairman of the Kansas City Federal Reserve, chimed in this week that farmland prices “are rising above what the productive capacity of that land can support.”
What fun for farmland owners, to hear financial heavyweights like Bair and Hoenig declare their property overvalued.
Recommended Stories For You
OK, they didn’t go that far. Bair said farmland is a “candidate” to become a bubble. Hoenig said he doesn’t predict bubbles but knows when conditions are right for them. Neither is an expert on farm prices; they’re worried about the Fed’s loose monetary policy and scanning their radars for the bubbles they fear it might inflate.
Yet because the hardest bubbles to see are those we’re closest to, prudence suggests we not just dismiss the possibility of a farmland bubble without pondering it.
The argument for a bubble is straightforward. Farmland prices have soared – according to Bair, they’re 58 percent above 2000 levels, adjusted for inflation. And now people with no interest in farming are buying farmland as an investment. For example, the teachers’ pension fund TIAA-CREF has $2 billion allocated for equity in farmland, mostly in the U.S. and Australia. Investors flocking to a new “asset class” is a bubble early warning sign.
The counterarguments include farmers’ debt levels, which are low – just over 10 percent of the value of their assets – and falling. Ag commodity prices are strong. And while prices can tumble at any time, there are limits to how low they can go in a world adding two billion mouths to feed over the next 40 years.
It boils down to this: Have we reached the point where the price of farmland has lost connection with the land’s ability to produce income? That’s the hallmark of a bubble, the sign that speculation reigns – that the price is being set by folks who are only buying today in anticipation of selling to the “greater fool” tomorrow.
In the Japan of the late 1980s, the price-earnings ratios of Japanese company stocks were more than double their historical average. The New York editors correctly saw this as evidence of a bubble. The Tokyo correspondents, infatuated by the seeming invincibility of Toyota, Sony and other world-beating Japanese firms, thought “this time it’s different.”
The correspondents were wrong. So also, a decade later, were the New York editors, who failed to detect the tech bubble even though Internet startups with no profits and no immediate prospect of profits commanded soaring stock prices. No stronger evidence of price exceeding intrinsic value pops into the head than the invention during this frothy period of new measures for corporate performance because the old ones all assumed profits and therefore didn’t work.
Are farmland owners wrong today?
Probably not. Speculative investment money is influencing prices, but it isn’t stealing most of the deals. Despite Hoenig’s assertion that prices have surpassed land’s productive capacity, farmers keep shelling out cash for land. That suggests they think they can farm it profitably.
But if commodity prices tumble, they might earn less income than they projected from the land, so the situation does bear watching. And while farmers’ low debt levels mean they’re better positioned to survive a bubble’s burst, low debt doesn’t prove a bubble is fictitious. While excessive debt has fueled some bubbles – notably the U.S. residential real-estate bubble that led to the 2008 financial-market implosion – it wasn’t a big part of some others, like the tech-stock bubble.
The critical criterion isn’t debt but the relationship between an asset’s intrinsic value and its resale value. Hoenig may be wrong in saying the disconnect has already occurred, but he’s posing the right question. It’s the one farmers will ask themselves if they want to avoid the fate of those in the past who were blind to the bubbles right under their noses.