Is the Farm Boom About to Bust?

Farmland prices have gone sky high even as crop prices are tumbling. Is a farm bubble about to pop?

This Sunday, Reuters published a frontline dispatch from the heart of America's latest real estate frenzy. Its dateline: Shelby County, Iowa, where signs of a farmland bubble are hard to miss.

These days, in Shelby and towns like it, there's about as much money trading hands as corn. Cropland prices in the plains states have risen a record 25% in the last year, as farmers have raced to outbid each other at auctions in town halls across the heartland. In Nebraska they've jumped 40%. Over the last decade, they're up nearly tenfold, driven by the globe's growing demand for food and investors' need for a safe bet in a tumultuous economy.

But as Reuters reports, those investors are beginning to balk at the high prices, even as actual farmers continue pushing them up. Auctioneers are shocked and worried by the buying frenzy. Meanwhile, crop values are slipping. Is the bubble about to pop?

To answer, let's first look at the behavior of land values over the past several of years. Reuters published this chart with its Sunday feature, which tells a pretty unambiguous story. Before the financial crisis, prices were soaring. The financial meltdown put an end to the party. But after the recession, agriculture has surged again like a runaway John Deere.

Now, let's compare that chart with the movements of the IMF's commodity food price index, courtesy of Index Mundi.

In a sense, these charts tell a fundamentally positive tale for farmers. Until very recently, food prices and land prices have been moving essentially in concert, up in the good times, down in the bad. Some of the the longterm forces driving up the value of American agricultural products, such as the rise of China, aren't going away.

But look closely: In the last few months, food prices have begun to slide. Last week, Bloomberg reported that wheat prices, already suffering their worst slump in three years, are set to fall even further, as bumper crops in countries such as Russia and Canada swell global supplies. Both wheat and soy beans are down more than 20% for the year. Corn prices have also dropped.

"Every country that can plant more corn and wheat has done so," one analyst told Bloomberg. "It's an incredible shift, and there's still spare farmland capacity that can be put into production."

In short, the rest of the world isn't content to rely on the United States as its wheat field, anymore. More farmers around the world are growing more food. That supply is putting downward pressure on prices. Cheaper food means fewer profits for Midwestern farmers -- the same Midwestern farmers who just spent top dollar buying up acreage.

In the 1980s, a similar situation led to a historic bust, as over-leveraged farmers defaulted on their bank loans. But industry watchers say this time may be different (ahem). As Reuters noted Sunday, farmers have largely been buying their land in cash. According to Farmdoc, a publication from the University of Illinois, grain farmers paid for just about 10% of their assets with borrowed money in 2009, a low figure by historical standards. Fewer risky loans means less risk of a catastrophic bust.

But the American farmer is far from debt free. According to an analysis by the Federal Reserve Bank of Kansas City, from 2004 to 2008, borrowing grew at a rate reminiscent of the leadup to the big crash of the 80s. The debt is also heavily concentrated among large farms. In 2008, nearly a third of it belonged the 5% of U.S. farms making more than $1 million a year.

That concentration of debt is a double edged sword. On the one hand, large farms are better able to survive a downturn. The Fed analysis found that an across the board 30% drop in farm incomes would only drive a relatively small number of mega-farms into financial distress.

On the other, one big farm collapse could be devastating. As Reuters wrote Sunday: "The consolidation of the farming industry means that the fall of one operator would likely have far deeper ripple effects in rural America -- not only in their immediate communities, but to the bankers, seed suppliers and other sectors that service their needs."

Have we entered the phase where farms are too big to fail? Doubtful. But we're beginning to see land prices veer away from the value of the crops they produce. There are danger signs in the heartland.