Feeding the fad: The Federal Land Banks, land market efficiency, and the farm credit crisis

This dissertation describes a case in which government interference which is relatively benign when an asset market is efficient can cause credit crises when it is not. Despite recent evidence against the efficient markets hypothesis, many analyses of asset and credit markets are conducted only under an assumption of efficiency. Here the implications of deviations from efficiency are considered. The dissertation also offers a new explanation of the recent U.S. farm credit crisis.; Statistical tests and other evidence are presented in support of an assertion that farm land prices rose well above fundamental values during the 1970s and then fell back in the 1980s. When land prices fell, many farmers found themselves with land worth less than the amount of mortgage principal still to be repaid. Default was often the rational choice for these farmers.; The land market is vulnerable to deviations. Because land is in fixed supply and is difficult to sell short, the price of land always reflects the opinions of those most optimistic about land's value, regardless of the wisdom of those opinions. A simple model illustrates this vulnerability.; The deviation was financed mainly by the Federal Land Banks (FLB), which are part of the Farm Credit System (FCS). By using the market price of an acre when determining its value as collateral, the FLB took excessive risks. If land had been assessed at its fundamental value, the FLB would have loaned less to each borrower, and the borrowers' equity would still have been positive after the collapse of prices. The volume of loan defaults would have been much smaller. The size of the deviation would also have been smaller.; The cooperative structure of the FCS imparts a propensity to take deviation-induced excessive risks. Both its owners and the controlling body of its regulator were selected from those most optimistic about land's value. Optimists will tend not to notice that a deviation is in progress and thus will not act to restrain lending. FCS liabilities are implicitly guaranteed by the government, removing the last check on risk taking.; This defect is not obvious when the land market is assumed to be efficient. The general point is that it would be wise for policymakers to be sure that the institutions they create are reliable both when asset markets are efficient and when they are not.