Tax-advantaged status no longer relevant

Northwestern Financial Review, Dec 15-Dec 31, 2004 by Monson, Roger

Farm Credit System

For almost 90 years the Farm Credit System has occupied a unique and enviable place in American agricultural finance. It is extremely profitable, has a mountain of capital, and has a portfolio of high volume, low- risk credits. In short, the Farm Credit System has everything a well run financial institution should desire.

The Farm Credit System is a special purpose, tax advantaged, retail lending, government sponsored entity that is limited to specific areas of the financial services market. Some system managers want to offer more products to a wider range of customers over a wider area of the country. This summer and fall, one FCS institution considered selling to a non-FCS institution, recognizing that the answer for system institutions that wish to expand into new areas of the financial services market is to cut their ties to the federal government.

For those that wish to remain part of the special purpose, tax advantaged, retail lending, government sponsored Farm Credit System, they must recognize that with the advantages Congress has bestowed upon them, there are limits and responsibilities. There is no economic or public policy argument that can be made to justify expanding the charter of the System.

The announcement that one FCS association intended to sell itself to a non-system lender illustrates this point. Its elected board of directors recognized the limitations of the special system charter and decided that it was time to seek broader opportunities outside the confines of government sponsorship. Even though this transaction was not consummated, it was a step in the right direction. System institutions that wish to offer a broader array of products and services must seek those opportunities outside the system.

The Farm Credit System, America's first Government Sponsored Enterprise, was created in 1916 when Congress chartered 12 cooperative regional farm credit banks in order to increase farmers' ability to finance the purchase of farms and ranches. In 1933, Congress responded to the banking crisis by creating cooperative Production Credit Associations to lend money directly to farmers and ranchers. To this day, the FCS remains the only GSE that has direct, retail lending authorities.

Over the years the FCS has received additional authorities, most notably in 1971 when lending to farm businesses was authorized. Significant changes to FCS lending practices were also authorized by the 1971 legislation, including a major liberalization of its real estate lending limit.

The FCS was a major player in the agricultural credit market of the 1970s and 1980s, when farm and ranch lending quadrupled, rising from $13.2 billion in 1971 to $53 billion by the end of 1980. By 1982 the FCS had more than $64.5 billion in loans outstanding to American farmers and ranchers, 34 percent of the total agricultural credit market. Farmers and ranchers took advantage of low real interest rates and borrowed heavily from all lenders. When interest rates jumped in the early 1980s, farm real estate values crashed and the FCS found itself burdened by a high number of non-performing loans and an interest cost structure that could not be sustained.

Congress responded by authorizing a $4 billion line of credit rescue package for the FCS. Specifically, the FCS was authorized to sell up to $4 billion in taxpayer-backed bonds to assist troubled FCS institutions. During the period of restructuring following the federal bailout, the FCS shrank its farm loans by nearly $30 billion over nine years. The organization has, since 1987, contracted rapidly with 13 banks for cooperatives consolidating into one and 12 farm credit banks consolidating into four. At the retail lending level there has been massive consolidation as well, with 895 associations in 1983 consolidating to less than 100 in 2004.

As of June 30, the Farm Credit System had approximately $119 billion in assets, $94.3 billion in loans, $19.7 billion in capital (a 16.5 percent capital ratio), a loan loss reserve of $2 billion (2.1 times non-performing assets), and had net income of $939 million. In 2003, the System made a $1.825 billion net profit.

The Farm Credit System today, from a business perspective, is a large, sophisticated, and highly profitable financial services institution that happens to be organized as a cooperative. Other than its cooperative business organization, there is nothing to distinguish the Farm Credit System from any other large commercial enterprise.

From a public policy perspective, the justification for why the system continues to enjoy such extraordinary governmental support is tenuous. The recently announced plan by one system association to put itself on the auction block underscores the tenuousness ofthat continued government support. The Farm Credit System is the only Government Sponsored Enterprise that competes directly with the private sector by doing direct, retail lending in competition with taxpaying private enterprises.

The reasons that made sense in 1916 for Congress to create a taxpayer-subsidized, retail lending, Government Sponsored Enterprise focused on making small loans to farmers and ranchers no longer exists. The system, which got its start with the capital investment of the American taxpayer, and got bailed out by taxpayers following a decade of spectacularly poor lending practices, is now a highly profitable, highly sophisticated financial services provider which has no apparent public policy mission to fulfill in the American economy. Why should taxpayers continue to subsidize its activities and to be at risk for future blunders?