By Terry Francl
American Farm Bureau Federation
The financial melt down in the U.S. that started with the sub-prime mortgage crisis has led to a bailout package proposed by the administration under the leadership of Treasury Secretary Paulson and currently under consideration by Congress.
As of Sept. 29, Congress is negotiating the details of the bailout proposal with the Administration and internally — basically the bi-partisan aspects of any agreement.
While the amount of the proposed bailout is high — $700 billion — it is unclear what the ultimate cost will be. To that end, a review of past government bailouts can be informative.
The Roosevelt Administration creates the Home Owners Loan Corporation and allocates $3 billion to purchase and refinance home mortgages to stem foreclosures. The government ultimately recorded a small gain when the corporation disbanded in 1951.
Congress guaranteed $250 million in bank loans to Lockheed Aircraft, then the nation’s largest defense contractor, to preclude the company from slipping into bankruptcy. Made a small profit.
Congress allocated $7 billion in operating subsidies to the Penn Central railroad. The resulting net loss was calculated to be approximately $3 billion.
1975 and 1978
First, a $2.3 billion short-term loan to New York City and second $1.65 billion in guaranteed bonds. No costs to the government other than the implicit value of the loans and guarantee.
A $1.5 billion loan guarantee to the Chrysler Corporation. Government made a $311 million profit from the sale of warrants.
Congress takes over Continental Illinois National Bank and Trust. The Federal Deposit Insurance Corporation injects $4.5 billion to purchase bad loans.
The Farm Credit System, at the time FLBs and PCAs, borrowed $1.26 billion in the form of government guaranteed loans. All principal and interest was repaid ahead of schedule.
Congress establishes the Resolution Trust Corporation to deal with the Savings and Loan crisis. The ultimate cost was estimated to be $150 billion.
The government brokered a $3.6 billion private bailout of the Long-term Capital Management hedge fund. No government funds were involved.
After the Sept. 11 attack on the World Trade Towers, Congress authorizes $5 billion in cash to shore up U.S. airlines and follows with $10 billion in loan guarantees. No estimate of the final cost to government.
Starting in 2008, the following government actions have been taken:
The Federal Reserve guarantees $28.8 billion of Bear Stearn assets in conjunction with the government sponsored sale to JP Morgan/Chase and Co.
Federal regulators seize the assets of IndyMac Bank and the FDIC injects $8.9 billion from its insurance fund.
The treasury provides up to $200 billion for Fannie Mae and Freddie Mac, $100 billion each, and sets up a temporary conservatorship.
The Federal Reserve provides insurer AIG a two-year secured loan of up to $85 billion.
Obviously, no one knows what the costs of the 2008 actions may ultimately total, nor is there any good way to estimate the actual costs of the $700 bailout.
A similar type of thing is happening with respect to the commodities that farmers sell to elevators and processors. In this case, the farmers are not being asked to provide more credit, but are being offered a lower price due to the higher basis — the difference between the futures price and the local cash price.
In these situations, the net impact of either the higher cost or lower prices is the same — less income. There are many factors other than just credit availability affecting the returns to U.S. agriculture, but the current financial instability simply serves to exacerbate the already volatile input/output price situation.
So the sooner action can be taken to stabilize the credit market, the better it will be for agriculture and the country as a whole.
The government sometimes recoups all or a portion of the commitments, but that knowledge only comes after the fact, sometimes many years later.
The U.S. agricultural sector is currently in a good financial condition at the farm level. Certainly individual producers have their own particular financial situation, but the overall agriculture balance sheet is very strong. Currently the USDA is projecting record high farm income in 2008.
Another measure is the debt-to-asset ratio, which is at a modern time low of 10 percent. However, the fallout from the general financial malaise is being felt worldwide, especially in countries that may be already facing slowing economies due to the high price of energy. This will most likely moderate the demand for agriculture products and ingredients, reduce the demand for U.S. agricultural exports and ultimately affect U.S. farm prices. Likewise, a slower domestic economy would also weigh on the demand for farm commodities and prices.
Within the U.S., the supply of credit is being impaired, which also affects the cost of credit. The gap between T-bill rates and the best commercial paper is near an all time high. This is already affecting some agri-business companies as reflected by recent developments in the fertilizer sector.
Fertilizer prices have basically doubled in the past two years and continue to rise. Farmers are currently being asked to make commitments for their 2009 fertilizer needs and to pay a substantial portion to that commitment, sometimes 100 percent, up front.
What is happening is that the credit function of these transactions is being shifted from the fertilizer producers and retail dealers to the farmers. The net result is that it increases the farmers cost.
This is not the first time that the government has been asked to step in and help out either companies or entire industries. While in a free-market system, government should be the source of last resort only when it becomes apparent that the repercussions and cost of failure go far beyond the individual companies or entities involved.
It is always a judgment call as to when to step in and how much support should be given. That is what the administration and Congress is currently doing in their discussion about the implementation of a bailout plan. Whatever their conclusion, it should be done with speed and clarity for the people of the U.S. and the world.
(Terry Francl is a senior economist with the American Farm Bureau Federation. Francl worked for Continental Illinois National Bank and Trust as an agricultural economist in 1984.)
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