Summary: The resale of liquidated farmland, which has been "warehoused" by agricultural lenders, is a once-in-a-generation chance for efficient family-size farmers to buy farmland at affordable prices and begin rebuilding family farm agriculture. The criticial policy question for this rebuilding stage is: which farmers are going to be able to obtain financing to participate in this rebuiding? The federal government's long-standing, bipartisan policy in agricultural credit has always been to provide modest assistance to efficient family-size operations which cannot get credit elsewhere. The proposed secondary market for farm mortgages stands this policy on its head. Instead of a policy of assisting efficient farmers who couldn't get credit elsewhere, the proposed secondary market implements a policy of assisting land buyers who can get it anywhere else.

Because of tight underwriting standards and the vunerability of a secondary market based on a single sector as volatile as agriculture, the proposed secondary market schemes necessarily focus lending on blue-chip land buyers. Well-established farmers and outside investors will get reduced interest rates and a competitive advantage over efficient familysize farmers who don't meet secondary market underwriting standards.

Ideas for the creation of a secondary market for farm mortgages have been circulating for over a year, and are now being actively studied for the Farm Credit System bailout package being considered by the agriculture committees in the House and Senate. Proponents have naturally focussed on the advantages of the secondary market. Analysis of disadvantages has been scant and superficial.

Advantages of a Secondary Market

For mortgage originators, the advantages of a secondary market include: -increased ability to make long-term agricultural real estate loans (through resale of loans on the secondary market)

-higher yields through more rapid turnover of portfolios

-increased profits through origination fees and servicing fees (recent
proposals provide a role for the FCS which then captures some of
these fees)

-better financial matching of bank assets (deposits) with loan terms

For farmer-borrowers, proponents claim the following advantages:
-increased availability of long-term, fixed-rate mortgages

--lower interest rates because of greater fund availability
--increase competition and better service because of increase in
number of sources for long-term agricultural credit.

Disadvantages of Secondary Market

There has been little analysis or questioning of the possible disadvantages of the secondary market approach in agriculture. We'd like to raise four basic concerns. First, which buyers would get the benefit of the

secondary market? It seems very clear that very strict underwriting standards will be needed to make a secondary mortgage market work in agriculture. One detailed report prepared by the American Council of Life Insurance (ACLI) uses underwriting standards that limit secondary market lending to the top 6-25% of farm real estate buyers, and there is nothing that prevents absentee owners and investors from gaining the benefits of the secondary market to farmers. In other words, the principle beneficiaries of the secondary market are likely to be blue chip borrowers made up primarily of outside investors and already well established farm operations.

Second, and more fundamental, what legitimate public purpose is served by using the powers of the federal government to give a competitive credit advantage to financially well-established land buyers. The secondary market proposals that we have seen have never addressed how the creation of a secondary market will changed the competitive positions of borrowers within agriculture. Even if there is some interest rate reduction that spills over into the traditional (non-secondary market), this rate reduction will be significantly less than that received by the direct secondary market

borrowers.

Using ACLI figures, we estimate that on a $100,000 land loan, the top land buyers will get an annual $750 interest rate reduction. Other borrowers who are eligible for commercial credit but not good enough for the secondary market underwriting standards may get a spillover interest rate reduction of only $87.14. All these buyers are competitors and the creation of the secondary market will artifically shift the competitive positions of farmers by giving the best-heeled buyers a larger interest rate advantage.

The secondary market will stand public policy on its head. Instead of serving borrowers who cannot get credit elsewhere, the federal government, through secondary market intervention, will be giving an interest break to top-ranked customers. Instead of the lender of last resort, the federal government will be "the guarantor of blue-chip land buyers".

Third, all the proposals we have seen are based primarily on the secondary market for housing. We think there are important differences between the housing industry and agriculture. First and foremost, the income sources of home buyers and their ability to repay their home loan is as diversified as the entire U. S. economy. By contrast, the ability of farmers to repay their farm loans is not diversified but based on the up's and down's of the farm economy. This is recreating one of the fundamental problems of the FCS--its fortunes are linked, and vulnerable, to the well-being of one sector. The government's risk, it seems, are far greater with a secondary market for agriculture than for housing. This vulnerability can be tempered in two ways: adopting strict underwriting standards and thus limiting the benefits to blue-chip borrowers or focussing loans towards land buyers whose incomes are not vulnerable to agriculture--outside investors. The kinds of measures needed to protect the secondary market from the risks of lending to a single, volatile sector like agriculture obviate any legitimate public purpose which could be served by the new device.

Fourth, creation of a secondary market is likely to create pressure for the standardization of state farm foreclosure laws. The current farm crisis has prompted a number of state legislatures to engage in a long-overdue review of antiquated farm foreclosure laws. The result has been more flexible and comprehensive foreclosure proceedings (including mediation) that reduce arbitrary liquidations or unnecessary dislocation of farm families. A secondary market in agriculture will need more unified security agreements and the practical political effect may very well be to reduce state foreclosure procedures to fast-track liquidation laws.

A number of FCS bailout proposals use the FCS inventory as an integral component of the bailout scheme. One of these approaches calls for the government purchase of FCS farmland inventory as a way to acheive a number of public policies:

(1) provide a cash infusion to distressed lenders (can include
banks as well as FCS institutions),

(2) stabilize agricultural land values through federally
sponsored, temporary warehousing and by providing land

purchase credit for a new set of buyers who would otherwise not
be in the market,

(3) provide land purchasing opportunities to family-size

operations which have the ability to become efficient family
farms,

(4) rejuvenate local, rural economies which are based on family
farms,

(5) provide a unique opportunity to develop appropriate

conservation practices on acquired farmland.

The farmland that has accumulated in lenders' inventories is a

rare public policy opportunity. The inventories can not only play a crucial role in any bailout scheme, but they can also serve as vehicle to implement a number of other critical policy objectives besides stabilizing distressed lenders.

Policy Need

While the farmland properties acquired by agricultural lenders are a valuable asset, in most cases, management of this farmland is a burden for which lenders are ill-equipped. In addition, bank examiners and auditors do not value inventory property highly, and the existence of inventoried farmland does little to improve a distressed lender's financial assessment. In most cases, this farmland can be used to stabilize a lender only by selling it and converting it from a "dead" asset to a usable asset-cash.

Until fairly recently, agricultural lenders had been voluntarily warehousing this inventory farmland because increased sales of farmland would have a depressing effect on the value of farmland which was serving as collateral for current loans. They are now under pressure to begin selling this land.

At the same time, it is clear from the recent sale of some FmHA inventory parcels, that many farm families are ready to begin building up their operations. Land prices have reached the point where the land can be paid for by farming it. With land falling to realistic prices, the critical policy question becomes--who will have access to the financing needed to buy this newly affordable farmland? Lenders who have recently begun to sell

acquired properties are requiring high downpayments and giving discounts for cash. Beginning or rebuilding family farms operations will simply not be able to compete for this inventory land.

"The Family Farm and Agricultural Lender Rebuilding Act"

There are two models for effecting a government facilitated purchase of distressed lenders' acquired property: (1) outright government purchase with targeted resale or (2) a government facilitated financing of individuals to purchase inventory farmland direct from distressed lenders. The second model could use a device similar to FmHA's direct farm ownership loan (FO) program to provide capital to give more farmers the ability to purchase inventory property. Under this model, the cash infusion to a distressed lender would be slower and less predictable, and there would be no mechanism for warehousing the farmland.

The Center for Rural Affairs has proposed an approach (which we call "the Family Farm and Agricultural Lender Rebuilding Act") based on three steps: (1) government purchase of distressed lender farmland; (2) temporary warehousing to prevent adverse impact on land sales, and (3) a two-step, targetted resale mechanism which is modelled after Congress' scheme for the resale of FmHA's inventory farmland.

This proposal recommends that FmHA be the implementing agency. While we share many reservations about FmHA's commitment to important congressionaly policies, it is probably, in the last analysis, the most logical and efficient choice. FmHA has long-standing experience in providing farm ownership financing to efficient family-size farms which cannot get credit elsewhere, and it has a county-level delivery system. Combining the FCS inventory with FmHA's will create some efficiencies since, FmHA is, itself, the second largest holder (after the FCS) of farmland inventory and will be implementing all of the warehousing and targeted resale steps for its own inventory. Finally, FmHA is a logical choice because there is a healthy tradition of monitoring FmHA's policy implementation by both Congress and many local organizations. If this inventory warehousing plan has merit, the only other realistic choice for implementation would be the creation of a new entity with untested authority, in which case, the monitoring capacity, which is so important to protecting the integrity of public policies, would be limited. The cost of the program would be roughly the value of current farmland inventories of qualified agricultural lenders.

The Resale Plan

If FCS and other distressed lenders' inventory property were combined with FmHA's inventory, the current FmHA resale scheme would be used to resale the FCS property. This includes a three-year phase for selling farmland to qualified family-sized farms with FmHA financing. After this three-year period, farmland can be sold to otherwise ineligible buyers. Highly erodible land is subject to conservation restrictions, and farmland cannot be sold at any time if it would have an adverse effect on land values. Once in the inventory, this farmland is owned by the federal government and since no private seller is involved, FmHA financing during the three-year period does not involve a loan of funds from the government, but rather a payment to the government. The government is in the position of a contract seller and no appropriation is necessary for financing this resale.

Congress has a long-standing plan for the sale of FmHA inventory property and refined this plan in the credit title of the 1985 farm bill. That plan regards FmHA inventory farmland as a public resource for rebuilding family farm agriculture. It is to be sold into private hands in a manner consistent with the historic purpose of FmHA's Farm Ownership program--to provide farming opportunities for efficient family-size operators who cannot get credit elsewhere. The farmland is to be held for three years with installment credit sales made to FmHA-eligible borrowers. If unsold after three years, the land is to be reclassified as "surplus property" and sold to the highest bidder regardless of FmHA eligibility.

Recent FmHA data and interviews with selected state and local FmHA officials show that FmHA is bypassing this congressional scheme by suddenly reclassifying massive amounts of inventory farmland as "surplus property" and selling it to ineligible or cash-paying buyers who are outside the scope of FmHA's programs. States vary widely in their treatment of inventory farmland, and FmHA's national office has not justified the reclassification. Many states (especially in the Midwest) have just begun to sell inventory farmland, but in most states the pattern of massive and unsupported reclassification of farmland as "surplus" is showing up.

71% of FmHA Farms Sold to Ineligible Buyers

By FmHA's most recent data (December 1986), 71% of current farmland inventory sales (100% in some important farm states) is being sold to buyers who are ineligible for FmHA loans and therefore outside the scope of the agency's mission. If this were to continue, and given projections for a doubling of FmHA's inventory, the sale of around 7000 farms (over 2 billion acres) would bypass the congressional scheme which envisions this inventory as an important public resource for rebuilding an efficient family farm agriculture. As can be seen from the chart on the next page, among the states with sold at least ten farms during the first quarter of FY1987 (October-December 1987), Tennessee had the worst record by selling 92% of its farms to ineligible buyers. Tennessee was followed by Missouri--86%, Florida--82%, Indiana--81%, and Kentucky--77%. FmHA inventory sales were under a moratorium in many key states (especially in the Midwest) because they would further depress land market values; as a result these states do not show up on the chart. This moratorium has now been lifted in almost all states, and we expect data for the second quarter of FY 1987 to show significant increases in those states.

At the core of this by-passing scheme is an administrative determination of whether inventory farmland is "suitable" for FmHA program purposes or "surplus" (i.e., "unsuitable" for FmHA program purposes). Suitable farmland must be reserved for sale to FmHA-eligible borrowers for three years. The disproportionate amount of farms classified as "surplus"