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FUNDAMENTAL REAPPRAISAL OF THE DISCOUNT MECHANISM

CAPITAL AND CREDIT
REQUIREMENTS OF AGRICULTURE,
AND PROPOSALS TO INCREASE
AVAILABILITY OF BANK CREDIT
EMANUELMELICHAR
RAYMOND J. DOLL
Prepared for the Steering Committee for the Fundamental Reappraisal ofthe
Discount Mechanism Appointed by
the Board of Governors of the Federal Reserve System




The following paper is one of a series prepared by the research staffs of the Board of Governors
of the Federal Reserve System and of the Federal Reserve Banks and by academic economists
in connection with the Fundamental Reappraisal of the Discount Mechanism.
The analyses and conclusions set forth are those of the author and do not necessarily indicate
concurrence by other members of the research staffs, by the Board of Governors, or by the Federal
Reserve Banks.




November 6, 1969

FUNDAMENTAL REAPPRAISAL OF THE DISCOUNT MECHANISM

Project #24

CAPITAL AND CREDIT REQUIREMENTS OF AGRICULTURE, AND PROPOSALS
TO INCREASE AVAILABILITY OF BANK CREDIT




by
EMANUEL MELICHAR
Board of Governors of the
Federal Reserve System

and
RAYMOND J. DOLL
Federal Reserve Bank of
Kansas City




CAPITAL AND CREDIT REQUIREMENTS OF AGRICULTURE, AND PROPOSALS TO
INCREASE AVAILABILITY OF BANK CREDIT

!•
II.

INTRODUCTION

1

SUMMARY OF FINDINGS AND PROPOSALS

2

PART A.

III.

CAPITAL AND CREDIT REQUIREMENTS OF AGRICULTURE

10

CAPITAL REQUIREMENTS, 1950-1979

13

The capital stock of agriculture, 1950-1980

IV.

INTRODUCTION

14

Composition and trends.
Real versus price changes
Projected capital stocks in 1980
Capital requirements by asset group, 1950-1979
Vehicles, machinery, and equipment.
Buildings and land imprbvements
Livestock inventory
Inventory of stored crops
Financial assets
Real estate purchases

• . .16
17
21
24
25
.28
32
.33
34
35

Total capital flows, 1950-1979
V.

42

CREDIT REQUIREMENTS, 1950-1979

48

How have capital requirements been financed?

48

Financing from cash flow
. .48
Relative reliance on credit, 1950-1968
51
Current factors affecting credit use
52
Projected credit requirements, 1970-1979
57
Internal financing in the 1970 fs
57
Projected debt expansion under alternative capital models . .62




VI.

SOURCES OF CREDIT, 1950-1979

65

Sources of outstanding credit, 1950-1968

66

Holders of outstanding debt

67

Sources of additions to debt

70

Relative role of banks, 1950-1968

70

Share of outstanding debt

73

Share of additions to debt

75

Projected credit expansion by major lenders, 1970-1979
Credit from sellers of farms

75
75

Projected loan demands on banks

•

Supply of funds at rural banks

78
,82

Farmers1 deposits
82
Total deposit growth, 1950-1968
84
Deposit and farm loan growth compared, 1950-1968
84
Projected deposit growth, 1970-1979
86
Projected deposit and farm loan growth compared, 1970-1979. .90
VII.

SEASONAL PRODUCTION CREDIT

94

Seasonal capital requirements

• .

95

Seasonal credit extensions

.98

Institutional sources of seasonal credit. . . .
102
PART B. PROPOSALS TO INCREASE AVAILABILITY OF BANK CREDIT
VIII.
IX.

INTRODUCTION

105

CORRESPONDENT AND BRANCH BANKING

109

Correspondent banking




.

Correspondent credit services . . . . . .
Extent of the overline loan problem
Responsiveness to rural credit needs
Cost of correspondent credit services . . .
A proposal to minimize drains on rural funds

ii

109
110
Ill
. 113
115
121

Branch banking
FEDERAL RESERVE CREDIT

127

Seasonal discount credit

X.

123

128

An example of seasonal fund flows at rural banks
130
Community consequences of large seasonal flows
133
Prevalence of large relative seasonal outflows
134
Potential impact of specific seasonal discount proposals . . . 136
Impact of bank liquidity on potential borrowing
140
Latent seasonal demands
142
Supplemental adjustment credit
143
Longer-term credit*

144

XI . UNIFIED MARKETS TO SERVE RURAL BANKS

148

Organization

149

A secondary market for rural bank loans

149

Trading in loan paper
Sale of debentures
Insurance mechanisms
Education

150
150
151
153

Other services of unified markets

153

Federal funds
Certificates of deposit
Bond services
XII.

153
155
157

CONCLUDING COMMENTS




158

iii

CAPITAL AND CREDIT REQUIREMENTS OF AGRICULTURE, AND PROPOSALS
TO INCREASE AVAILABILITY OF BANK CREDIT
I.

INTRODUCTION

A large proportion of the nation's banks is located in rural
areas where agriculture is the primary economic base.

Deposit trends

at these banks, and loan demands made on them, derive mainly from developments in the agricultural economy.

Thus many aspects of the well-known

"revolution" in the structure of the agricultural production and related
rural business have had major impact on rural banks and promise to continue to
exert similar influence for some time to come.

This study gives special

attention to those problems of rural banks that arise from the peculiar
nature of and changes in their agricultural environment.

It seeks to determine

how the Federal Reserve discount mechanism might be made more helpful in
their specific situation.
The examination of past and projected agricultural and rural banking
trends, however, suggested that maintenance of the present leading role of
banks in rural lending will likely require institutional changes beyond
those that appear feasible in discount administration and other Federal
Reserve policies.

Thus after documenting the growing capital requirements

of the agricultural sector and the increasing inability of rural banks to
finance their usual share of the resulting credit demands, this report
outlines a broad program designed to increase materially the flow of
funds from national captial and money markets into rural areas via
the banking system.




- 2 -

II . SUMMARY OF FINDINGS AND PROPOSALS

Capital used in agriculture has been increasing rapidly.
Since 1950, for example, the value of farm assets of a primarily
productive nature has risen by 131 per cent.

This growth is traced

mainly to technological developments that have prompted enlargement
of individual firms and substitution of purchased inputs for labor
and farm-produced inputs . Some of the capital growth occurred as
farmers added to physical stocks of machinery, livestock, and other
assets.

Another part can be ascribed to growth and price inflation

in the nonfarm economy, which brought higher prices for some purchased inputs and added to demand for land.

And a substantial por-

tion resulted from land price increases to which farm enlargement,
land improvement programs, and other technologically-induced pressures
contributed.

In addition, as agriculture purchased more production

inputs, capital requirements of related rural businesses also rose.
Several agricultural economists have recently studied farm
capital growth.

Each concluded that the value of capital stocks will

rise further, though they differed on the rate of growth and on which
assets will lead the advance.

Mainly from these studies, three al-

ternative capital models are developed in this paper.

In the lowest

of these estimates, the value of farm assets projected for 1980 is
28 per cent above that of 1969, while the highest estimate indicates
a gain of 74 per cent.
From the projected capital stocks, estimates are made of
the implied yearly capital flows--the capital requirements that must




- 3 -

be financed in some manner.

As the capital assets of agriculture in-

crease, larger annual flows of capital are generally required to make
real additions to stocks, replace equipment as it depreciates, and
transfer assets from one farmer to the next.

Annual capital flows

for these purposes are estimated to have averaged $7 billion during
the 1950 f s, and to have been fairly stable during the late 1950fs and
early 1960 f s.
per year.

By 1965-68, however, the annual flow averaged $11 billion

And, under the three alternative capital models formulated

herein, capital flows are projected at from $13 to $19 billion in 1975-79,
Annual capital flows are either financed internally from
cash flow —depreciation allowances and net income—or externally by
expanded use of credit.

Upon comparing estimated capital flows,

known expansion of credit, and estimated cash flows, it appears that the
proportion of cash flow allocated by farmers to capital needs declined
during the 1950 f s.

Consequently, the share of capital spending financed

by debt rose from 13 per cent in the early 1950fs to 31 per cent in the
early 1960 f s.

Then, the proportion of income allocated to capital

apparently stabilized, but because capital spending rose more sharply
than income, the share financed by debt reached 37 per cent during
1965-68.
These findings provide a framework within which future farm
credit demands may be projected.

For the estimates made herein, capital

flow requirements and depreciation allowances were taken as projected
by the three alternative capital models, net farm and nonfarm income
was projected on the basis of recent trends, and the proportion of cash
flow that farmers would allocate to capital spending was projected at




- 4the level that prevailed in the 1960 f s.

Outstanding farm debt, which

rose from $10.7 billion in 1950 to $23.6 billion in 1960 and $52.0
billion in 1969, in the lowest projection increases to $91 billion by
1980 and in the highest to $137 billion.

The lower projection implies

that debt will increase by about 5 per cent annually, a significant
slowdown from recent growth rates averaging 9 per cent, but a rate that
nevertheless calls for $3 to $4 billion of net additions to outstanding
debt annually between now and 1980.

The higher projection calls for

debt to rise by $79 billion during the next decade, which would require
annual rates of increase similar to those of the 1960 ! s.
Increased credit to agriculture has been supplied in three
important ways.

First, more sellers of farms have been taking mortgages

or using land contracts.

Mainly in this way, individuals have been pro-

viding about one-fifth of the additions to outstanding farm debt.
Second, money and capital market funds have been channeled into agriculture through the lending operations of life insurance companies,
Federal land banks, production credit associations, and national farm
supply corporations . Such funds have provided about one-half of the
growth in farm credit.

Third, commercial banks have been supplying

about one-fourth of the additional credit.

Some of these loans have been

made by large money-market banks, either directly or through correspondent
relationships with rural banks.

Much of the loan expansion, however, has

occurred at smaller country banks.




- 5 Rural banks have increased loans at a much faster pace
than their deposits have grown, a divergence made possible by the
low ratio of loans to deposits found at most banks when World War II
ended.

Through lending supported by the past accumulation of deposits,

bank credit to farmers has almost kept pace with the total expansion
of farm credit, even though deposits, being dependent on gains in
aggregate farm incomes and savings, rose at a much slower rate.
However, expansion of bank lending by a relative shift
from security investments to loans obviously could not be sustained
forever.

Individual rural banks began to reach a "tight11 position

during the 1950's, and presently a large proportion have reached
the point at which further reductions in liquidity do not appear
feasible, given present institutional arrangements.

As these banks

include most of the larger institutions and those that have been
most active in meeting the credit demands of their areas, much of
the nation's farm loan volume is affected.
In the last few years, loan demands would have pressed
harder against rural banking resources had not time deposits grown
at an extremely rapid pace.

Unfortunately, a lower rate of deposit

expansion may realistically be expected over the next decade.

When

the alternative farm credit demands projected to 1980 are compared
with the projected deposit expansion, a majority indicate that banks
as a whole will find it difficult to supply from their own resources
the same share of farm credit growth that they have provided since 1950.




- 6 -

If rural banks are to maintain their relative role in farm lending,
this analysis indicates that they must draw increasing proportions of
their loan funds from sources other than local deposits.
Several existing arrangements permit fund flows between urban
and rural areas via banks.

In unit banking states, city bank participa-

tions in farm loans channel urban funds into farm lending.

A thorough

examination of this mechanism, however, leads to serious doubts that
it can develop sufficiently to fill the credit gap.

Its present use is

largely restricted to dealing with overlines rather than with general
credit deficits at country banks; in fact, since the usual "payment" for
the service consists of deposits maintained at the urban correspondent,
the net flow of funds in most cases appears to be to the city rather
than the rural bank.

For those rural banks that are short of loanable

funds, correspondent credit would be more helpful if it could be paid
for by fees rather than balances, and development of this practice is
advised.

However, it seems that the generally tight liquidity positions

of city banks will hardly lead them to favor this change or to increase
significantly the supply of correspondent credit if it were adopted.
In states with large branch bank systems, funds can flow internally from urban offices to rural branches where loan demand exceeds
deposit inflow.

Studies of branch systems show that such flows do occur,

and that at particular branches the funds so obtained are often relatively greater than a unit bank would have been likely to obtain through
the correspondent banking system.

Thus in states that have well-developed

statewide branch systems and also urban areas sufficiently large either
to provide surplus funds or to support a bank large enough to tap national




- 7 -

money markets, the supply of bank funds to farm lending appears more
likely to remain adequate provided that the managers of the branch
systems maintain both interest and competence in farm lending.

But

even if the latter condition were met, it seems doubtful that expansion of branch banking to rural areas of present unit banking
states will provide an adequate near-term solution to maintenance
of banking's role in farm lending.

If laws restricting branching are

liberalized at all, initial changes are likely to permit only limited
branching arrangements.

Furthermore, in some rural states with limited ur-

ban development, even statewide branch banking might not have a sufficient
urban base to increase materially the flow of funds into the rural areas .
New approaches are therefore recommended.

To maintain farm

lending operations of commercial banks in a fully viable condition-in fact, to improve them at banks that are already experiencing the
difficulties cited--two broad proposals for channeling funds to rural
banks are made herein.

First, greater amounts of Reserve Bank credit

should be provided directly to rural banks through changes in the nature
and administration of the discount mechanism.

Second, new institutional

arrangements should be established to permit greatly increased rural
bank participation in national capital and money markets«
Small rural member banks have made limited use of System discount facilities in recent decades . The window may have been avoided
partly because of the manner in which it was administered—the "reluctance
to borrow11 may have developed into a considerably larger deterrent against
borrowing by the smaller banks.




In addition, temporary fund needs at

- 8 -

rural banks are usually for relatively lengthy periods such as a
crop production season, and borrowing arrangements at most Reserve
banks

have been ill adapted to handling such needs.

In fact, a

strict interpretation of the regulation held that botrowing for
normally expected seasonal fund outflows was inappropriate.
Thus administration of the discount window that removes
any previous stigma associated with borrowings for small short-term
adjustments, and that permits borrowing for lengthy seasonal periods
under equally clear guidelines, should encourage rural bank use of
the discount window.

Seasonal borrowing privileges, in particular,

would benefit the significant number of small rural banks, and the
communities they serve, whose farm customers have a large relative
seasonal fund demand.

By borrowing from the Federal Reserve to meet

such seasonal outflows, these banks could employ for other community
loan needs the funds that now must be set aside for the seasonal demands
and which therefore either remain idle, or are temporarily invested
outside the community, for up to half the year.
A seasonal borrowing privilege appears able to provide prompt
and significant assistance to rural member banks facing relatively large
seasonal demands, but could not be employed by the many rural nonmember
banks and would likely be relatively insignificant to rural member banks
in areas of balanced crop and livestock production, in which farm credit
demands occur throughout the year.

A complementary and more general

approach—one that would benefit all rural banks--would aim to reduce
the capital market imperfections that now largely prevent small and rural
banks from using these national markets as a source of funds *




- 9 -

To this end, a second set of proposals is set forth under
the general title of the "unified markets ."

These markets would be

designed to place small and rural banks on a more nearly equal competitive footing with other participants in the national capital and
money markets by minimizing the disadvantages that result from the
small size and isolated location of these banks.

The major objective

of unified markets is seen as facilitating sale of a wide variety of
bank assets and liabilities, thereby encouraging national money market
funds to flow into rural areas through the banking system much as they
presently can through the cooperative credit system.

Unified markets

could provide rural banks with information and arrangements for
effective trading in Federal funds, government securities, and certificates of deposit issued by these banks, in.addition to a secondary
market for loans.

In each of these endeavors, they would strive to

overcome the market imperfections that now place small and rural banks
at a relative disadvantage, and would thereby secure more equitable

allocation of money market funds among sectors of the economy

and regions of the nation.




- 10 PART A. CAPITAL AND CREDIT REQUIREMENTS OF AGRICULTURE
III. INTRODUCTION

Farmers' use of credit increased almost five times in
the aggregate and nine times on a per farm basis between January 1,
1950, and January 1, 1969.

Total debt (exclusive of CCC debt) rose from

$11 billion to $52 billion; debt per farm increased from $1,900 to
$17,000.

Several factors combined to bring about this large expansion:

new technology spurred upward trends in total farm capital stocks and
production expenses; technology also permitted enlargement of individual
farms, with associated capital demands; prices of some capital goods-particularly real estate and machinery--advanced considerably; and finally,
farmers

financed an increasing proportion of their capital requirements

by borrowing.

Farm debt as a percentage of selected production assets

rose from 8.8 per cent in 1950 to 18.5 per cent in 1969.
Since the major forces responsible for the rapid growth of
farm debt from its low point of 1946 continue to prevail, there is
widespread expectation of further credit expansion.

Few studies, however,

have attempted to quantify these expectations in a reasonably rigorous
and comprehensive fashion.

One study that did cover all farm debt was

generally assumed to have reached a bullish--perhaps even alarming-conclusion by projecting outstanding farm debt of $100 billion in 1980.
In fact, however, this projection implied a substantial slowdown in the
rate of credit expansion, which followed as a consequence of the much
reduced rates of future capital spending and land price inflation that
were assumed in the study.

Other analyses of investment and land prices

appear to support much higher expectations, but their authors stopped at




- 11 -

projection of stocks rather than also examining the implied capital flows
and credit demands.
This paper therefore attempts first to ascertain and analyze
postwar capital flows in agriculture, and to remedy the paucity of
projections of such flows.

In Chapter IV, the nature and magnitude of

past and future capital requirements are explored.

Uses of capital are

identified, and the flow of capital into each use is estimated,

projections

of capital flows for 1970-79 are then cferived for each of three projections
of farm capital stocks in 1980 that have been published by other analysts.
Chapter V then attempts to determine likely future credit
demands, given the projected capital flows.

To provide a basis for

such credit projections, financial data for 1950-68 are examined to
ascertain trends in the manner that capital flows required in this period
were financed--whether internally from depreciation allowances and net
income or externally through increase in debt.

Then, with the aid of

specific assumptions about future income and financial behavior of farmers,
probable additions to debt are projected.

(With additional time and resources,

development of a model in which capital, income, and savings flows are
jointly determined would be a preferable procedure, and perhaps will be
inspired by these preliminary efforts.)
After projection of total credit demands, attention turns to
the various lenders that may supply these funds.

Again, though appre-

hensions have often been expressed about the continued ability of
certain farm lenders—particularly commercial banks—to continue rapid
expansion of farm credit, no previous study has pitted specific alternative projections of credit demands against projections of bank




- 12 -

lending resources, in order to determine the situations in which those
fears might be justified.
Chapter VI.

This analysis is attempted in

First, sources of additions to farm debt during 1950-68

are examined, in order to ascertain the share of credit provided byeach lender group.

Then, for each of the alternative credit projections

derived in the preceding chapter, estimates are made of the amount by which
banks would have to expand their farm lending in order to maintain their
relative role in this market.

The various required rates of expansion

in loans are compared with the projected rate of growth in deposits, to
determine the conditions in which banks are likely to experience future
difficulty in meeting farm loan demands from their own resources.
Credit extensions to meet seasonal capital requirements are
treated separately in Chapter VII.

Because neither seasonal expenses

nor total seasonal loans are measured directly, little quantitative
analysis of these flows has been attempted at the national level.
However, in Chapter VII an attempt is made to provide indicators of
the trend in seasonal capital needs and in seasonal credit provided
by banks and production credit associations.

The relative extent

to which these two lenders have met the increased seasonal needs is
then estimated.




- 13 IV.

CAPITAL REQUIREMENTS, 1950-1979

Measurement, analysis, and projection of capital used in agriculture
has primarily dealt with stocks of assets and with past and expected future
changes in those stocks.

The U. S. Department of Agriculture (USDA) annually

publishes the value of several categories of farm assets such as real
estate, machinery, and livestock.

Analytical studies have related observed

changes in these series to changes in various farm and nonfarm factors.
On the basis of these observed relationships together with estimates of
future trends in the causal factors, several recent studies have projected
values of major farm assets to 1980.
This chapter begins with a brief review of past developments and
of three selected projections of capital stocks.

These data alone, however,

prove inadequate as indicators of the actual flow of capital into agriculture, both past and future.

The annual capital flows, though related

to changes in the value of stocks, are not equivalent thereto.

In particular,

large amounts of capital are required annually to replace machinery that
has worn out or become obsolete and to finance transfers of real estate.
Thus in a given year the value of stocks could remain unchanged because
of stable prices and no net real investment, but several billion dollars
of capital would be required by replacement and transfer transactions.
Conversely, although price increases of machinery or land that cause assets
to be revalued upward would have the same proportional effect on replacement and transfer transactions, the dollar increase in the latter would
be only a small fraction of that in stocks, because only a portion of the
stocks is replaced or transferred in any given year.
A significant analytical contribution of this chapter, therefore, is calculation of past annual capital flows and of flows implied
by the stocks projected for 1980.



Data on most kinds of capital

- 14 -

spending were available from the USDA, but one very important
category—real estate transfers prior to 1965--had to be estimated.
Capital spending and transfers implied by each projection of stocks were
also estimated, with attention to whether an increase in stocks was
expected to result from price rises or from real additions.

Each type of

asset is discussed separately, to consider the factors that probably
caused past changes in the annual capital flow that it required, and
hopefully to establish a basis for projection of probable future change.
The projected components are then summed to obtain three alternative
projections of farm capital flows during the 1970 ! s.

The capital stock of agriculture, 1950-1980
The stock of various types of farm capital, valued at current
market prices, is estimated annually by the USDA.

Table 1 shows that

selected assets of a primarily productive nature totaled $281.1 billion
as of January 1, 1969.

These assets—machinery, livestock, stored crops,

working capital, and real estate—constitute the capital analyzed in this
study.

The account includes some nonproductive assets such as dwellings,

personal cars, and some forms of personal savings.

It excludes the two other

personal assets included in the USDA's Balance Sheet of Agriculture—household
equipment and investments in cooperatives—as well as other personal
assets owned by farmers, such as nonfarm investments and the cash value of
life insurance policies, that are not included in the Balance Sheet.
As in the Balance Sheet, all farm assets of the selected types are included
in the totals, whether owned by farmers, nonfarm landlords, or other
persons or institutions.




- 15 Table 1
Value of Selected Assets Used in Agriculture
1950

1955

18.6
11.6
9.6
6.9
7.5
98.2
.52.0

B.
Vehicles, machinery & equipment.
Livestock
Stored crops
Demand deposits & currency . . .
Time deposits & savings bonds . .
Real estate
Total selected assets. . . .

Source:




10
11
6
6
6
62
100

1965

1969

Billions of dollars

A.
Vehicles, machinery & equipment.
12.2
Livestock
12.9
Stored crops
7.6
Demand deposits 6 currency . . .
c
7.0
Time deposits & savings bonds. .
6.8
Real estate
75 .3
Total selected assets. . . . 121.8

1960

12

7
6
5
5
65
100

22.2
15.2

7.7
6.2

7.6
130.2
189.1

25.5
14.5
9.2
5.9
7.9
160.9
223.9

32.6
20.1
10.5
6.3
9.0
202 .6
281 .1

Per cent of total
12
8

11
6

4

4

3

3

4

4

69
100

72
100

12

7
4
2
3
72
100

The Balance Sheet of Agriculture, 1968, U. S. Department of
Agriculture, January 1969, pp. 10 and 26-27. Data are shown as of
January 1 of each year.




- 16 -

Composition and trends.

The selected agricultural assets

increased in value in every postwar year except 1950 and 1954, for a
total gain of $159.3 billion since the beginning of 1950.

Annual increases

during the 1950's averaged 4.5 per cent, fell to 3.4 per cent during
1960-64, but then accelerated to 5.9 per cent in 1965-68.

- 17 -

Real estate remains the most important farm asset, and indeed
its relative value rose from 62 per cent of total assets in 1950 to 72
per cent in 1969.

Of the real estate value, perhaps a fifth is contributed

by farm dwellings and service buildings, and the remainder by land and
land improvements.
In second place among asset groups, the machine stock—vehicles,
machinery, and equipment--comprised 12 per cent of assets in 1969 and has
roughly maintained this proportion since 1950.
1969, at 7 per cent of the total.

Livestock ranked third in

Stored crops and financial working

balances each represented about 5 per cent and have been declining in
relative importance.
Changes in asset values over five-year intervals since 1950
are shown more explicitly in Table 2 (dollar changes occurring during
1965-68 were multiplied hy 1.25 to express them as a five-year rate
comparable to the previous periods).

Among the prominent features,

(1) increases in real estate values accounted for a largp proportion—
an average of 80 per cent—of the gain in total assets; (2) growth in value
of machinery and livestock involved considerable sums in some years, but
varied considerably over the period; and (3) asset growth in 1965-68 proceeded
at an extraordinarily rapid rate, as growth in machinery, livestock, and real
estate values each accelerated.
Real versus price changes. In contrast to the changes in "current"
value discussed above, the total farm physical plant, often referred to as
"real11 assets, was expanded rather slowly since 1950 (Panel C, Table 2 ) .




- 18 -

Table 2
Changes in Value of Selected Assets Used in Agriculture
1950-54
A.
Vehicles, machinery 6 equipment
c
Livestock
Stored crops
Demand deposits 6 currency
c
Time deposits & savings bonds
Real estate
Total selected assets

1960-64

1965-69*

Five-year total (billions of dollars)

6.4
-1.7
2.0
- .1
.7
22.9
30.2
B.

Vehicles, machinery 6 equipment.
c
Livestock
Stored crops
Demand deposits & savings bonds
Time deposits & savings bonds
Real estate
Total selected assets

1955-59

52
-13
26
- 1
10
_30
25

3.6
4.0
-1.9
- .7
.1
32.0
37.1

3.3
- .7
1.5
- .3
.3
30.7
34.8

8.9
7.0
1.6
.5
1.4
52.1
71.5

Percentage change in current value
19
36
-20
-10
1
_33
24

15
- 5
19
- 5
4
_24
18

35
48
18
8
17
_32
32

C. Percentage change in real assets
Vehicles, machinery 6 equipment
c
Livestock........
Stored crops
Demand deposits 6 currency
c
•••••
Time deposits 6 savings bonds.
c
Real estate
Total selected assets
D.
Vehicles, machinery 6 equipment
c
Livestock
Stored crops
Demand deposits 6 currency
c
Time deposits 6 savings bonds
c
Real estate
Total selected assets

Vehicles, machinery 6 equipment......
c
Livestock
Stored crops. •••••..
Demand deposits 6 currency
c
Time deposits 6 savings bonds
c
Real estate
*..*..
Total selected assets



37
11
11
-10
- 1
_4
8

- 3
0
3
-16
- 6
2
0

4
7
- 2
-12
- 3
2
2

18
2
40
-3
2
2
6

Average annual percentage change in current value
8.8
-2.7
4.8
- .3
2.0
5.5
4.5
E.

3.6
6.3
-4.3
-2.2
.3
5.8
4.5

2.8
-0.9
3.6
-1.0
.8
4.3
3.4

6.3
8.5
3.4
1.6
3.3
5.9
5.9

Average annual percentage change in real assets

6.5
2.2
2.1
-2.2
- .3
.8.
1.4

- .7
.0
.6
-3.5
-1.3
«f.
/c
«0

.8
1.3
- .4
-2.4
- .7
A
.3

3.4
.5
7.1
- .6
.4
£
1»3

- 19 Table 2 (continued)

*Data shown for 1965-69 are actual values for 1965-68 multiplied by 1.25 to
facilitate comparison with previous five-year periods.
Source:
Note:

Table 1, and additional data from the U.S. Department of Agriculture.

Users of the data on real assets are referred to p. 20 for a discussion
of a probable bias in these estimates.




- 20 -

According to USDA estimates, the selected farm assets, when valued at
constant prices, rose by only 15 per cent in 1950-68.

As the current

value of these assets increased by 131 per cent, by implication the
total price rise during the period was estimated as 101 per cent.
The separation of capital growth into its real and price
components is important to analysis and projection of capital flows,
simply because these flows over time differ for varying mixes




of real and price increases in stock.

Efforts to allocate changes in

stock values to real and price components are greatly handicapped,
however, by the fact that capital goods change over time as technology
advances.

The tractor and land of today are not the same products as

in 1950, and so one cannot be sure how much of the increase in their
current price represents price inflation and how much is due to gains
in quality or productivity of the assets. As the latter gains often
occur in subtle ways that defy measurement, the USDA estimates_of real
assets may understate the progress that has occurred, and the price
increase may therefore be overstated.
Nevertheless, it appears that real estate and machinery prices
rose rather steadily during 1950-68, with very significant impact on
total asset values.

On the other hand, prices of livestock moved in a

direction opposite to livestock numbers, so that when the real livestock inventory increased, its current value tended to decrease, as in
1950-54 and 1960-64.

- 21 -

The rate at which physical additions were made to stocks
of machinery, livestock, and crops varied substantially from one period
to the next.

Machinery stocks were easily the most volatile component,

with especially rapid increases in the early 1950fs and again in 1963-67.
Projected capital stocks in 1980.

Three widely-circulated

projections of 1980 stocks constitute the point of departure for
estimation of capital flows in the intervening period.

The stocks projected

for 1980 in current (1980) dollars are summarized in Table 3.

To

facilitate comparison with current values, Model NC (for "no change")
shows the value of stocks (and later also of flows) if neither price
nor real changes occurred after January 1, 196 9.
The first set of projected stocks, Model HT, is based primarily
on projections for 1960-79 published by Heady and Tweeten in 1963 after
extensive econometric analysis of the determinants of demand for various
farm capital goods.i'

The Heady-Tweeten projections were made in real

terms only, but the machinery, financial asset, and real estate values
shown in Table 3 are altered to reflect moderate price advances.

For

real estate, the current dollar projection employs a Heady-Tweeten
price equation that is relatively successful in explaining the
postwar course of farm land values.
Hie second projection, Model B, is based on current dollar
projections of 1980 stocks published by Brake in 1966, with the real
1/




Earl 0. Heady and Luther G. Tweeten, Resource Demand and Structure
of the Agricultural Industry. Iowa State University Press, Ames,
Iowa, 1963, 515 pp.

- 22 Table 3
Alternative Projections of Selected Farm Assets in 1980
Model

NC

Model

HT

Model

B

Model

HM

A. Billions of dollars
32.6
20.1
10.5
15.3
202.6
281.1

Vehicles, machinery & equipment. .
Livestock
Stored crops
Deposits, currency & savings bonds
Real estate. . . . .
Total selected assets

40.5
21.4
10.0
25.2
392.9
490.1

36.4
23.2
11.4
15.7
272.2
358.9

64.2
21.9
10.0
25.2
288.4
409.7

B. Per cent of total

12
7

Vehicles, machinery & equipment
Livestock
Stored crops
Deposits, currency & savings bonds
Real estate
Total selected assets

8

4

5

2
5

72
100

80
100

4

16
5
2
6
70

10
6
3

4
76
100

100

C. Change during 1970's3 (billions of dollars)
Vehicles, machinery & equipment, .
Livestock
Stored crops
Deposits, currency 6 savings bonds
c
Real estate
Total selected assets

0
0

7.3
1.2

0
0

- .5

0
0

177.8
195.0

9.2

3.5

29.6

2.8
.8

- .5

1.6

.
4
64.1
71.5

9.2
79.2
119.1

D. Percentage change during 1970's
Vehicles, machinery & equipment
Livestock
Stored crops
Deposits, currency & savings bonds
Real estate
Total selected assets . . .

0
0
0

0
0
0

22

10

6

14
8
2
31
25

-4
57
83
66

85

8

-4
57
38

41

E. Average annual percentage change during 1970's
Vehicles, machinery & equipment
Livestock. . . .
Stored crops
Deposits, currency & savings bonds
Real estate
Total selected assets. . .



0

2.0

0

.
6
-.4
4.6

0
0

0

6.2
5.2

1.0
1.3
.
7
.2

6.4
.
8
-.4
4.6

2.7

3.3

2.2

3.5

- 23 estate estimate as updated by Brake in 1968 .£/
The final projection, Model HM, is based primarily on one
of several projections of real stocks of machinery and livestock and
of price changes of real estate published by Heady and Mayer in 1967,
in a project executed for the National Advisory Commission on Food and
Fiber.2-' The estimates used herein assumed that land retirement programs
of the present "feed-grain11 type are continued for wheat and feed grains
and are also applied to cotton production, and that exports increase
in accordance with 1950-65 trends•

As with Model HT, the machinery

and real estate projections were modified to reflect trends in
machinery prices and in the general price level, respectively.

In

addition, because Heady and Mayer did not project values of stored crops
or of financial assets, these items were projected at the same levels
as in Model HT.
The three projections agree in one important respect: that
the total value of farm assets will increase considerably during the
next decade.

Beyond this, there are differences that appear likely

to have considerable impact on capital and credit demands:

(1) the

projected total increase in value varies from $71.5 billion under Model
B to $195.0 billion under Model H T — a n average difference of $12 billion
per year over the decade, and (2) growth projected for major
asset components differs greatly.

Model HT projects a relatively rapid

2/

John R. Brake, "Impact of Structural Changes on Capital and Credit
Needs," Journal of Farm Economics% December 1966, pp. 1536-1545.
Also, "Dimensions of the Credit Door," unpublished speech at
Blacksburg, Virginia, August 5, 1968.

3/
.

Earl 0. Heady and Leo V. Mayer, Food Needs and U. S. Agriculture in
1980. Technical Papers--Volume I, National Advisory Commission on
Food and Fiber, Washington, D. C , August, 1967, 116 pp.




- 24 -

rise in real estate values, but only moderate gains in the machine
stock.

The reverse is true of Model HM, while Model B anticipates

relatively moderate growth in all components, but with rising real
estate values dominant.
In the next section, the bases for these stock projections
are briefly noted, and the capital flow requirement that appears
implied by each model is calculated.

The framework for the analysis

both here and in the next chapter draws heavily on the pioneering
capital study by Tostlebe, which is also the source of many insights
into long-term trends .4/ A comprehensive and more recent capital and
credit study by Johnson was also very useful.5.1

Capital requirements by asset group, 1950-1979
Farm capital flows and credit demands arise in three
important ways.

First, they originate from expenditures to maintain

or expand the capital plant.

In this category one finds spending

for replacements and additions to the stock of vehicles, machinery,
equipment, buildings, and land improvements; additions to inventories
of livestock and of crops stored for feed and seed; and additions to
financial working balances.

Second, capital flows and credit demands

arise when the capital plant-- especially real estate—is transferred
from one owner to the next by means other than gift or inheritance.
Estimates for 1950-68 of the various capital flow requirements of these two
k_l Alvin S. Tostlebe, Capital In Agriculture: Its Formation and
Financing since 1870, Princeton University Press, Princeton,
1957, 232 pp.
1/ D. Gale Johnson, "Agricultural Credit, Capital and Credit Policy




in the United States,11 Federal Credit Programs, Commission on
Money and Credit, Prentice-Hall, 1963, pp. 355-423,

- 25 -

types are summarized in Table 4.

Third, seasonal credit demands

occur when additional working capital is needed to finance seasonal
production processes for which the level of cash assets normally
maintained does not fully provide.

Consideration of these demands

is deferred to Chapter VII.
Vehicles, machinery, and equipment.

Improved vehicles,

machinery, and equipment (subsequently all grouped under "machinery")
constitute a readily visible example of the impact of technological
change on the capital goods of agriculture.

And, in addition to all

the new equipment purchased for production on farms (with which this
study is concerned), there has been considerable nonfarm investment
in such allied industries as hatcheries and feed mills, which perform
work that formerly tended to be done on farms.
Expenditures for machinery now constitute a significant
capital requirement, over two-fifths of the total flow.
these expenditures are of two types:

Analytically,

to replace stock that has worn

out or become obsolete, and to expand the total stock in order to
increase output or reduce labor requirements.

Expenditures arising

from either need are affected by the course of machinery prices.
To maintain the machine stock at a given real level requires
an annual expenditure equal to about 14 per cent of the value of the
stock, according to recent depreciation allowances estimated by the
USDA.£/ With the stock valued at $32.6 billion in 1969, annual replacement requirements are thus around $4.6 billion.

6 / Farm Income Situation, U.S. Department of Agriculture, July 1969,
.
p. 61.




- 26 -

Table 4
Capital Flows, 1950-69
(billions of dollars)

1950-54

1955-59

1960-64

1965-69

A. Five-year total*
Gross capital expenditures:
Vehicles, machinery 6 equipment
c
Buildings and land improvements

15.4
7.7

14.0

16.0

23.6

6.9

6.4

6.4

2.4

.5
.8

1.3

.2
1.4
.5
1.4

To increase:
Livestock inventory
Stored crop inventory
Demand deposits & currency . .
Time deposits 6 savings bonds.
c

- .1
.7

- .7

.1

- .2
- .3
.3

Required by real estate purchases.

11.0

13.5

16.0

20.7

37.4

35.1

39.4

54.2

Total capital flow

.
4

. . , • . .

B. Annual average
Gross capital expenditures:
Vehicles, machinery 6 equipment
c
Buildings and land improvements

3.1

To increase:
Livestock inventory
Stored crop inventory
Demand deposits 6 currency . .
c
Time deposits 6 savings bonds .
c

.5
.1
.0

Required by real estate purchases.
Total capital flow

2.8
1.4

3.2
1.3

4.7

.1

.3

.0

.1

.2
- .1
.0

.0
- .1
.1

.3
.1
.3

(

2.2

2.7

3.2

4.2

,

7.5

7.0

7.9

10.8

1.5

1.3

*Data shown for 1965-69 are estimates for 1965-68 multiplied by 1.25 to facilitate comparison with previous five-year periods.
Source:




Machinery and building expenditures from Farm Income Situation, U.S.
Department of Agriculture, July 1969, p. 60; increase in livestock
and crop inventories are unpublished data from the U.S. Department
of Agriculture ( livestock and crop total is published in Farm
Income Situation, July 1969, p. 53); increase in financial assets
from The Balance Sheet of Agriculture, 1968, U.S. Department of
Agriculture, January 1969, p. 10; capital flows required by real
estate purchases are estimated by Emanuel Melichar.

- 27 -

Machinery prices, however, appear likely to increase over
time.

Prices set by manufacturers are likely to reflect the general

upward course of unit costs in the capital goods sector of the nonfarm
economy.

The implicit price deflator for the total farm machine stock

rose at annual rates of 4.4 per cent in 1955-59, 2.0 per cent in 1960-64,
and 2.8 per cent in 1965-68.

If, in view of this record, cine projects

annual machinery price increases averaging 2.5 per cent in 1969-79, and no
real growth, the value of the stock would still rise to $42.8 billion by
1980.

Annual replacement requirements would by then average $6.1 billion.
Any physical additions to the total stock constitute a capital

flow requirement superimposed on the replacement expenditures.

In this

century, periods of rapid real expansion have alternated with extended
periods of little or no growth.

A spending boom that nearly tripled

the real stock between 1945 and 1954 was succeeded by ten years of little
growth or of small declines.

Renewed rapid expansion beginning in 1963

lifted real stocks by another 23 per cent before 1969.
Some projections of machinery requirements emphasize the spur
from continued technical innovation, combined with desires and incentives
(higher wage rates) to reduce labor requirements.

Such projections, as

in Model HM, indicate substantial real increases in future machine
stocks.
Other analysts have been more impressed with the substantial
upgrading of stocks that can occur in the course of the large replacement
expenditures.

For instance, structural analysis by Heady and Tweeten

suggested "a 'mature1 agricultural economy in terms of machinery.




- 28 -

A large amount of new machinery will continue to be purchased not only
to replace worn-out machines but also to substitute for machines which
are inadequate for large holdings. This will offer sizeable opportunities
for machinery to replace labor, despite the rather small increment in
machinery assets11—

This view is represented in Models HT and B.

The historical record since World War II taxes analysts
seeking to determine the more appropriate view, as the growth rates
shown in Table 5 demonstrate.

Heady and Mayer analyzed the record of

1949-64 and found a strong upward trend over these years.

The large

expenditures shown for Model HM in Table 6 are based mainly on assumed
continuation of this trend.
$9.6 billion.

In 1975-79? annual expenditures would average

But Heady and Tweeten, writing in the early 1960 f s, thought

the relative stability of 1952-60 to be more representative of the future,
and thus projected little real expansion.

Brake, though writing in

1966 after expenditures had again accelerated, also expected relatively
slow future growth.

Models H T and B both project average annual expend-

itures of about $5 billion in 1975-79, or little higher than those at
the peak of the recent boom.
Buildings and land improvements.

Construction of farm dwellings,

service buildings, and various other structures and land improvements
such as fences, wells, ponds, terraces, and tile lines comprises a substantial

continuing capital expenditure, currently about 12 per cent of total

capital flow.

In some regions, construction of items such as irrigation

systems and commercial feed lots has been expanding.

Nationally, however,

expenditures have been declining absolutely as well as relative to other
capital uses.

T_l



Heady and Tweeten, op. cit.« p. 492.

- 29 Table 5
Past and Projected R a tes of Change in Machine Stocks and Prices, 1946-79
Average annual rate of change (per cent)
Total
Real
Price

1946 - 48
1949 - 51
1952 - 55

+23.2
+18.2
+ 3.7

+18.4
+14.5
+ 2.7

+4.0
+3.2
+1.0

1956 - 60
1961 - 62

+ 2.5
+ 2.1

- 1.3
- 0.8

+3.9
+2.9

1963 - 64
1965 - 67

+ 6.0
+ 6.7

+ 4.0
+ 3.8
+ 1.8

+1.9
+2.8
+2.8

1968

+4.5

- 0 .5
1 0 .3
-

+2 .5
•K) .6
+2 .5

1970 - 79
Model HT
Model B
Model HM

+ 2.0
+0.9
+ 6.2

+• 3 .6

Source:

Past annual rates of change in total stock was computed from
data in The Balance Sheet of Agriculture, 1968, U. S. Department
of Agriculture, January 1969, pp. 26-27 • Estimates of past
real stocks were supplied by the U.S. Department of Agriculture.
Price changes shown are for the implicit price deflator for
the total machine stock, as computed from these two series.

Note:

Users of the data on prices and real stocks are referred to
p. 20 for a discussion of a probable bias in these estimates.




30
Table 6
Alternative Projected Expenditures for Machinery
(Billions of dollars)

1950-54

1955-59

1960-64

1970-74

1975-79

Model NC

23.1

23.1

Model HT

24.3

26.8

Model B

24.4

25.5

Model HM

35.6

48.2

Model NC

4.6

4.6

Model HT

4.9

5.4

Model B

4.9

5.1

Model HM

7.1

9.6

A,
Actual

15.4

14.0

1965-69

Five-vear total
16.0

23.6*

B. Annual average
Actual

3.1

2.8

3.2

^Expenditures for 1965-68 multiplied by 1.25.




4.7

- 31 The downward drift in construction followed large gains in the
years immediately after World War II.

Expenditures for farm operators1

dwellings reached a peak of $702 million in 1948, buit by 1968 were
reduced to $493 million.

Construction of other buildings and land improve-

ments topped at $949 million in 1952, and was down to $812 million in 1968.
One factor reducing new farm construction is the rapidly declining
number of farm units and families.

From 1950 to 1968, the number of farms

fell by 46 per cent, or by about 2.6 million units.

Each farmstead that

was abandoned or became a rural residence for a nonfarm family tended
to reduce future farm building needs.
In addition, expenditures for new service buildings have been
negatively affected by various technological developments.

Greater

efficiency in livestock production--more milk per cow, faster growth
of hogs and broilers--enabled farmers to increase output without proportional increases in animal housing space.

Greater use of purchased

mixed feeds and virtual elimination of horses and mules tended to reduce
farm feed storage requirements.

Less costly types of buildings, such as

those employing pole-type construction, were increasingly adopted.
Projected construction expenditures used in Models HT, B, and
HM are based on a recent study by Scott and Heady. JL/

They project an

average annual real decrease of 0.9 per cent and assume that prices of
building materials will continue to rise at the 2 per cent annual average
experienced from 1947 to 1963.

Thus yearly current-dollar spending would

average $1.4 billion during 1970-74, and $1.5 billion in 1975-79.

8/




John T. Scott, Jr., and Earl 0. Heady, Aggregate Investment Demand
for Farm Buildings: A National. Regional and State Time-Series
Analysis % Research Bulletin 545, Agricultural and Home Economics
Experiment Station, Iowa State University, Ames, Iowa, July 1966.
pp. 704-736.

- 32 -

Livestock inventory.

Additions to the quantity of live-

stock on farms entail a capital flow equal to the value of the
physical quantities added.

There is general agreement that expanding

domestic population and rising per capita income will continue to raise
aggregate demand for livestock products, and that the greater output
will require larger livestock inventories on farms.
are not likely to rise as fast as output.

However, inventories

As Tostlebe noted after

study of 1890-1950, "the most significant technological advances in
agriculture. . .have quite consistently been connected with the production
of livestock and of livestock products. . . .improvements in the breeds
of livestock and in livestock feed and management have been sufficient
to permit animal products to become increasingly important in the farmproduct mix, while the investment in productive livestock per dollar
of total farm product declined greatly.".2/ This effect remains important.
Excluding horses and mules, the number of animal units of breeding livestock
on farms in 1967 was the same as in 1919, and somewhat below levels of
the 1940!s and 1950's.

However, production per breeding unit was 116

per cent larger than in 1919, 38 per cent above that of 1950, and up
13 per cent since 1960.1£/

The larger numbers of feeder livestock

and poultry have since 1950 required capital flows that varied
greatly from year to year, but averaged only $228 million annually (Table 4 ) .
As with the machinery projections, analysts again apparently
differ as to relative future impact on inventories of the divergent

£/
10/




Tostlebe, op. cit., p. 126.
Changes in Farm Production and Efficiency, U.S. Department of Agriculture, June 1955, p. 23, and June 1968, p. 10.

" 33 "

influences of greater consumer demand and increased production efficiency.
Heady and Tweeten projected an average annual gain of only 0.75 per cent in
the real livestock inventory, which would require yearly expenditures of
about $120 million during the next decade.

But Heady and Mayer specifically

assumed no further improvement in the inventory-output ratio and thus
projected an average real gain of 2.8 per cent annually over 1965-79.
Even if livestock prices receded to 1965 levels by 1980, this growth would
require expenditures of over $700 million annually during the 1970 f s.
Brake also projected similar real growth, along with 1980 prices 14 per cent
over those of 1965.

Annual expenditures of $600 million would be required

to achieve this projection.
Though the projections vary considerably, even a relatively
faulty livestock forecast does not introduce a large relative error in
projected total capital flows.

Projected livestock expenditures

have the greatest relative importance in Model B, but even there they
account for only 5 per cent of total capital flows anticipated.
Inventory of stored crops.

The value of net physical additions

to farmers1 holdings of stored crops constitute a volatile but minor
capital flow that averaged $144 million annually in 1950-68.
Diverse influences appear to be operating on the long-term trend.
Larger livestock production leads to growth in feed inventories, but the
rise is moderated by upward trends in the animal output obtained from a
given quantity of feed and in the proportion of total feed purchased
from commercial mixers.

To the extent that feed inventories are held

by feed companies and dealers, the associated capital requirement has
been transferred to the nonfarm economy.




• 34 "

Each capital model projects
real stocks.

a continued small upward trend in

However, because 1969 inventories represent a considerable

bulge over the long-term trend (one of several sizable fluctuations
exhibited over the postwar period), these projections translate into a
small amount of disinvestment between 1969 and 1980.
Financial assets.

Farmers must hold money balances to carry

on their business transactions, primarily involving payment for current
operating and family living expenses.

Historically, these balances

have risen both absolutely and as a proportion of total assets, reflecti*^
the growth of cash operating expenses as each farm unit has
become less self-sufficient and more dependent on purchases from other
farms or from the nonfarm sector.
During 1950-65, however, growth in money holdings was at least
temporarily interrupted as farmers reduced their demand deposits and
currency by $1.1 billion, or 16 per cent.

The upward trend in operating

expenses continued during these years, but offsetting influences on money
stocks were apparently more powerful.

The decline in the number of farms

and in the farm population must be numbered among the latter.

In addition,

an upward movement in interest rates put an increasing opportunity cost on
cash balances.

Ready availability of seasonal production credit may

also have enabled farmers to reduce the relative amount of cash assets
held on January 1, the day on which these stocks are estimated for the
Balance Sheet.
In response to higher interest rates paid on time and savings
deposits and perhaps also as a result of improved farm financial management, farmers may have been more likely to hold seasonally-idle working




- 35 "

capital in these forms rather than as demand deposits.

Thus the change

in these assets, which tended to increase during the postwar period, has
been included among capital requirements.

At the same time, farmers

have reduced their holdings of a roughly equivalent asset, U.S. savings
bonds, which has also been included among the financial assets here
enumerated.
Projection of financial balances must contend with these
diverse influences.

Heady and Tweeten projected a 23 per cent total

real gain in "cash for operating expenses11 between 1960 and 1980.
To achieve this real growth as prices paid by farmers rise by an assumed
2 per cent yearly, farmers would have to add $917 million per year to
their holdings of the financial assets listed herein.
is used in Models HT and HM.
dollars.

This estimate

But Brake projected a slow rise, in current

Farmers would have to add only $36 million annually to

financial assets to fulfill his projection, which is used in Model B.
Real estate purchases.

Most farm real estate is owned by

individuals and is transferred from one owner to the next by sale
rather than inheritance.

Of the total number of transfers in the year

ending March 1, 1969, for example, only 13 per cent were inheritance or
gift transfers.

Voluntary sales by retiring or retired farmers and others

and by executors of estates averaged $5.5 billion annually over the
four years ending on March 1, 1969. -^

Thus annual land purchases are

somewhat larger than expenditures for vehicles and machinery.

11/




Farm Real Estate Market Developments, U.S. Department of Agriculture,
August 1969, p.22; March 1969, p. 11; April 1968, p. 14;
June 1967, p. 13.

- 36 -

Capital flows required by land transfers are lower than
the value of sales, however.

The total capital flow required equals

the money removed from the agricultural production sector by sellers
who are retiring or retired farmers, nonfarmer heirs, or nonfarmer
investors withdrawing from farmland ownership.

To calculate the

capital flow, therefore, the value of sales must be adjusted for
the amount of outstanding debt on the property, which is either
assumed by the purchaser or is repaid as a result of the sale, and
also for the proceeds of land sales that are used to buy other farm
land.
There is little data on which to estimate these adjustments
and so derive required capital flows from value of sales.

One

indication of the amount of outstanding debt is provided by a 1967
survey showing that assumption of outstanding property mortgages
accounted for 9 per cent of credit involved in land transfers, which
puts assumptions at about 5 per cent of transfer value.

A 1964 survey

indicated that about 10 per cent of total voluntary sales were made
by farmers who continued in farming after the sale, and who therefore
may have bought other tracts with the proceeds .JL2/

No data seem

available on debt repayments or on the subsequent activity of nonfarmer sellers.
For our capital flow estimates, land sales were adjusted
downward by 25 per cent to obtain the capital flow required. In
1965-68, capital flows associated with real estate transfers were
therefore estimated to average $4.2 billion per year, or 38 per cent
of total farm capital flows.
12/ Farm Real Estate Market Developments, U.S. Department of Agriculture,
December 1968, p. 23; August 1965, p. 31.




- 37 -

For years prior to 1965, estimates are made still more
difficult by lack of data on the value of real estate sales.

For

these years, only transfer rates and total real estate values are
provided by the USDA#

Since in 1965-68 the value of sales averaged

78 per cent of the figure obtained by multiplying the transfer
rate by total Value, this relationship was used to estimate capital
flows required in 1950-64, as shown in Table 7.

The estimates

indicate a steady upward trend that about doubled the required flow
between 1950 and 1968, as the effect of higher land prices easily
overwhelmed the effect of lower transfer rates.
The same relationships were used in projecting future capital flows.

With a continued small decline in the transfer rate,

required annual capital flows would average about 2.2 per cent of
any projected value of the real estate stock.

Thus if the value of

land and buildings were to stabilize at the 1969 level, as in Model
NC, required transfer capital would be $4.5 billion per year.

In the

other models, the capital flows depend on the projected course of
real estate prices.




- 38 Table 7
Alternative Projected Capital Flows Required by Real Estate Purchases
(Billions of dollars)

1950-54

1955-59

1960-64

1965-69

1970-74

1975-79

Model NC

22.7

22.6

Model HT

28.1

37.3

Model B

24.9

28.0

Model HM

25.4

29.3

Model NC

4.5

4.5

Model HT

5.6

7.5

Model B

5.0

5.6

Model HM

5.1

5.9

A. Five-year total
Estimated actual

11.0

13.5

16.0

20.7*

B. Annual average
Estimated actual

2.2

2.7

3.2

^Estimated flows in 1965-68 multiplied by 1.25.




4.2

- 39 -

An econometric study by Tweeten and Nelson that attempted
to measure the relative strength of pressures on farm land prices in
1950-63 ascribed 52 per cent to farm enlargement (of which an unspecified
portion was thought due to government programs), 20 per ceftt to demand
for non-farm uses, 17 per cent to the expectation of further capital
13/
gains, and most of the remainder to reduction in quantity of land.—
Since the land price index was deflated by the wholesale price index
prior to analysis, participation by farm land in a general price uptrend
was additionally assumed.

Because of the many alternative ways in which

a land price model could be specified and estimated, this one study
is not definitive.

But perhaps it serves to indicate the principal

forces bearing on land prices, and through them exerting a major influence
on capital and credit requirements.
In this view, the basic factor behind land price increases
is technological change.
tivity of land.

First, innovations have increased the produc-

Higher crop yields resulting from new technology and

better management have tended, ceteris paribusT to lower unit production
costs and increase net returns.

Second, other new technology—prin-

cipally larger tractors and machines—has permitted a farmer to operate
a larger land area, and thereby also lower unit overhead costs.14:/ This
incentive to enlarge farm units has created an active demand for land.

13/

Luther G. Tweeten and Ted R. Nelson, Sources and Repercussions
of Changing U, S. Farm Real Estate Values. Technical Bulletin
T-120, Oklahoma State University Experiment Station, April 1966,
p. 18.

14/

Tweeten and Nelson, op. cit., pp. 45-47.




- 40 -

Competitive bidding among the more successful farmers--those able to
achieve above-average net returns from each added tract--has led to
increased prices; in effect, the higher net returns have been capitalized
into land prices .JL5/ Also, as this experience prevails over many years,
the upward course of land prices is probably further reinforced as buyers
discount expected future advances in technology and therefore in net
returns—or, what is equivalent if less sophisticated, discount capital
gains from an expected future upward trend in land prices .-i^.'
Much of the same new technology that reduced unit costs,
however, also tended to increase total farm output.1Z/

Output gains

could occur both through improvement in inputs and farming practices
and as farm consolidation placed more of the total resources into the
hands of the more efficient and specialized operators.

Government output

control programs kept the potential output increase from being fully
achieved, but the gain has been sufficiently large relative to
the slower expansion of demand to exert a depressing influence on output
prices.

The latter effect tended to offset the favorable impact of

unit cost reductions on net returns, and would have been more pronounced
in the absence of the government programs .JL^/
15/

Albert A. Montgomery and Joseph R. Tarbet, "Land Returns and Real
Estate Values," Agricultural Economics Research% January 1968,
pp. 5-16.
William H. Scofield, "Land Prices and Farm Earnings," Farm Real
Estate Market Developments, U. S. Department of Agriculture,
October 1964, pp. 39-42.

16/

Tweeten and Nelson, op, cit.« pp. 19-22.

17/

Gene L. Swackhamer, "Agriculture and Technology^" Monthly Review*
Federal Reserve Bank of Kansas City, May-June 1967, pp. 5-6.

18/




Tweeten and Nelson, op. cit.« pp. 23-25.

- 41 -

In these circumstances the commodity programs, by restricting
total production and either maintaining output prices or supplementing
net incomes, have allowed a higher portion of the benefits of cost-reducing
technology to accrue to farmers rather than consumers.

To the extent

that government programs have thus preserved the technologically-induced
gains in net returns that have in turn been capitalized into land prices,
they may be considered a contributor to the rise in the latter.11/

The

effect has been particularly obvious in cases where benefits of an effective
program have been tied to specific parcels of land; for instance,
land with a tobacco allotment has been valued at several times the price
of similar land that lacked an allotment .-2^'
Insofar as the future course of real estate values depends
on technological advances and the extent to which these foster further
farm enlargement, their direction in the relatively near future does
not seem in doubt.

Numerous studies continue to indicate that optimum

family farm sizes, given known technology, are far above present averages.
It is reasonable that price projections to 1980, as made in the three
models, be based mainly on the upward thrust from this source, but with
realization that prices can be materially affected within that time
by changes in the nature and extent of government programs and in export
levels, general price trends, and the degree to which expected land
price increases are discounted.

Over a longer period, changes in the

rate and nature of technological advances—particularly in the extent
to which they would continue to foster enlargement of the land area of

19/

Ibid., pp. 15-18, p. 47.

20/

William H. Scofield, "Land Returns and Farm Income,11 Farm Real
Estate Market Developments? U. S. Department of Agriculture,
August 1965, p. 51.




- 42 -

individual farms--become a greater source of uncertainty.-^'
in population growth and in the nature of urban appetites

Changes

for resi-

dential and recreational lands also become larger considerations.
Of the projected real estate values, that of Model HT represents most closely an extension of the past historical relationship
between land prices and farm enlargement.

Prices are projected to rise

by 6.2 per cent annually, causing required transfer capital flow to rise
rapidly to an annual average of $7.5 billion in 1975-79 (Table 7 ) .
In Model HM, on the other hand, an average yearly price increase of
3.3 per cent is derived by assuming that land values will reflect
projected increases in the economic rent to cropland as well as general price
inflation averaging 2 per cent yearly.

Annual capital flows required by

this model attain an average level of only $5.9 billion in 1975-79.
Model B reflects Brake's assumption that land prices will rise by an
average of 3 per cent yearly, with implied capital flows therefore similar to those of Model HM.
Total capital flows, 1950-79
Total capital flows--past, present, and projected-are summarized in Table 8.
In the 1950*s, total flows averaged $7.3 billion
annually.

Real estate purchases rose throughout the decade, but in

the second half machinery expenditures and additions to livestock inventory slackened sufficiently to stabilize the total.

In 1960-64,

additions to machinery and livestock holdings were resumed and together
with increasing real estate purchases raised total flows to
21/




Bruce B. Johnson, "An Active Land Market in Perspective,f! Farm Real
Estate Market Developments. U.S. Department of Agriculture9
December 1968, pp. 34-35.

" 43 "
Table 8
Alternative Projected Total Capital Flows
(Billions of dollars)

1950-54

1955-59

1960-64

1965-69

1970-74

1975-79

Model NC

56.2

56.8

Model HT

63.7

76.8

Model B

59.0

64.0

Model HM

75.9

94.4

Model NC

11.2

11.4

Model HT

12.7

15.4

Model B

11.8

12.8

Model HM

15.2

18.9

A. Five-year total
Estimated actual

37.4

35.1

39.4

54.2*

B. Annual average
Estimated actual

7.5

7.0

7.9

^Estimated flows for 1965-68 multiplied by 1.25.




10.8

- 44 an average of $7.9 billion per year.

Then in 1965-68, a sharp increase

in machinery expenditures and a steady rise in land prices combined
to raise capital flows to an annual average of $10.8 billion.
If the capital stock were to be stabilized at the level
existing at the beginning of 1969, both in real terms and in current
dollars as Model NC assumes, future capital flows would average
$11,3 billion per year.

About two-fifths of this sum would arise from

real estate transfers, a similar share from expenditures required to
maintain the stock of vehicles and machinery, and the remaining one-fifth
from maintenance of the stock of buildings and land improvements.
It is evident, therefore, that any further increases in prices
of capital goods and any further additions to the physical plant would
raise total capital flows above the present level.

Each of the

other three models envision some price and real increases during the next
decade and therefore project higher capital requirements.

They differ

only in the magnitude of the increases expected.
Model B, which projects moderate land price increases and
small gains in machinery expenditures, envisions only a moderate gain
in the required capital flow.

By the second half of the next decade,

annual flows would average $12.8 billion.

Real estate transfers

would rise somewhat in relative importance, to 44 per cent of the total,
from 38 per cent in 1965-68.
Model HT projects only moderate gains in machinery expenditures
and very small additions to livestock inventories, but strong increases
in farm land prices.

By 1975-79, required capital flows would

consequently average $15.4 billion per year, with real estate transfers




- 45 contributing 49 per cent of this total.
Model HM, on the other hand, projects moderate increases in
land prices, but very large real additions to machinery stocks.

Because

of the latter, the capital flows projected are the largest of
the three models, averaging $18.9 billion annually during the late
1970 f s.

Of this total, 52 per cent would consist of machinery expen-

ditures and only 31 per cent would stem from real estate purchases.
The projections differ considerably. But to emphasize the
differences, and the unknowns that they reflect, would be to lose the
principal message the estimates convey.

Recall that over the past ten years

annual capital flows rose by $4 billion; in relative terms, by
54 per cent.

The projections for the next decade show annual require-

ments rising by $2 to $8 billion; in relative terms, by 19 to 75 per
cent.

The message is clear: capital demands will rise further from

the high level of the last few years; in number of additional dollars,
the gain could easily exceed that of the last 10 years; relative to
the new high level of current requirements, the additional demands may
represent a somewhat slower advance, but under some conditions might
equal or exceed the recent sharp rise.
The unanimous projection of a significant further increase
in capital flows appears well grounded.

The two primary sources of

future capital flows--machinery purchases and farm enlargement—have
a common root in technological advance.
knowledge now available

The fund of technological

but not yet applied

and the high likelihood

of additional discoveries indicate that growth in total investment and




- 46 investment per farm will continue for some time,22./

The National

Advisory Commission on Food and Fiber recently summarized these
expectations as follows:
There is little doubt that farming will continue
to use more capital in the future.
First, science and technology are continually
advancing not only in application to farming but
throughout the economy.
Second, reflecting increased productivity, the
relative cost of capital keeps declining. Capital
becomes continually cheaper, compared with labor
and land, so farmers will continue to use more
capital.
These changes not only make it possible for the
individual farmer to increase his volume of operations-- they make it necessary for him to do so.
He must expand his investment and then spread costs
over more units of product to remain competitive.2A/
Thus even though agriculture is already one of the more
capital-intensive sectors of the American economy, further rise in the
capital-output ratio (in current prices) seems certain.

The ratio of

the value of farm productive assets to the gross national product produced
in agriculture has been estimated as at least 6:1 in the 1950's compared
with a ratio of about 1.5:1 in the nonfarm economy.2h.l
the ratio in agriculture averaged 8:1.

By 1964-66,

These data hint that the annual

capital demands of farming place a relatively severe and rising strain
on the income flows from which they are either initially or ultimately

22/

Federal Reserve Bank of Kansas City, "Financial Requirements of
Agriculture/1 Monthly Review. September-October 1964, pp. 5-7.

23/

National Advisory Commission on Food and Fiber, Food and Fiber
for the Future. July 1967, p. 240.

24/

D. Gale Johnson, op. cit.« p. 355.




- 47 -

financed.

These relationships are next examined--first as they have

evolved since 1950, and then as they might develop under each of the
alternative capital projections.




- 48 -

V.

CREDIT REQUIREMENTS, 1950-1979

Given the prospect of substantial capital flow requirements,
the task of this chapter is to project the share that will be financed
from cash flow-depreciation allowances and net income—as opposed
to the share financed by expanded use of credit.

Thus one pre-

liminary task is to project depreciation and net income, and the
other is to project the share of these amounts that may be allocated
toward meeting capital needs.

After examination of the postwar

history of these series, such projections of internal financing are
made here.

They are then compared with the projected capital flows

to secure estimates of future credit demands and farm debt expansion.

How have capital requirements been financed?
It is analytically useful to view capital flows required by
the farm production sector (including nonfarm landlords) as being
met either (1) from a cash flow consisting of income remaining after
operating expenses are paid or (2) by borrowing .25./
Financing from cash flow.

Cash flow is herein estimated as

the sum of net farm income of operators and landlords, plus the capital consumption allowances that were included in estimated production
expenses (estimated depreciation of buildings, land improvements,
vehicles, machinery, and equipment, as well as accidental damage to
these capital goods), plus nonfarm income of the farm population.
Nonfarm income is included in cash flow because most farm families
apparently continue to pool farm and nonfarm income prior to meeting

25/




Tostlebe, op, cit.. p. 132.

- 49 -

living and capital investment needs . Nonfarm income of farm landlords is not included as it seems likely that such investment is
expected to pay its own way from farm income and land price appreciation .
Of total annual cash flow averaging $32 .5 billion in
1965-68, net farm income represented 50 per cent, capital consumption
allowances 17 per cent, and nonfarm income 33 per cent (Table 9) .
Though the principal component remains net farm income, its relative
importance has been declining.

Fifteen years earlier it contributed

61 per cent, while capital consumption allowances represented 13 per
cent and nonfarm income only 26 per cent.
Cash flow averaged $24.4 billion annually in the first
five years of the 1950 ! s, declined slightly when farm income dropped in
the next five year period, more than made up this loss during the first
half of the 1960!s and then jumped to an annual rate of $32.5 billion
in 1965-68.

In this last period, however, the relative gains in cash

flow did not keep up with those in required capital flows.

Whereas capital

flow averaged 30 per cent of cash flow in the 1950!s and early
1960 f s, this ratio increased to 33 per cent in 1965-68 (Table 9 ) . Thus
the burden posed by capital requirements, viewed in relation to the
cash flow from which they might be financed, has recently increased.
Over the 1950 ! s, when the relative capital burden was
running at about 30 per cent of cash flow, farmers progressively reduced the proportion of cash flow they devoted to meeting capital requirements . In the first half of the 1950 f s, 27 per cent of cash
flow was used for capital purposes, and this met the bulk of capital




- 50 Table 9
Financing of Capital Flows, 1950-69

1950-54

1955-59

1960-64

1965-69

A. Five-year total (billions of dollars)*
Sources of capital financing
Increase in debt
From cash flow
Total capital flow . . . .

4.7
32.7
37.4

8.2
27.0
35.1

12.4
27.0
39.4

20.0
34.3
54.2

Sources of cash flow
Capital consumption allowances
Net farm income
. . . . . . .
Nonfarm income
Total cash flow

16.2
73.9
31.9
122.0

19.6
63.3
33.1
116.0

22.0
68.3
40.7
131.0

27.7
80.9
54.0
162.5

B. Annual average (billions of dollars)
Sources of capital financing
Increase in debt
From cash flow
Total capital flow. . . .
Sources of cash flow
Capital consumption allowances
Net farm income
Nonfarm income
Total cash flow

.9
6.5
7.5

1.6
5.4
7.0

2.5
5.4
7.9

4.0
6.9
10.8

3.2
14.8
6.4
24.4

3.9
12.7
6.6
23.2

4.4
13.7
8.1
26.2

5.5
16.2
10.8
32.5

C. Per cent
Analytical ratios
Capital flow/Cash flow
Proportion of cash flow used for capital .

31
27

30
23

30
21

33
21

Average annual growth rate during period:
Selected assets (Table 2)
Debt

4.5
7.6

4.5
8.9

3.4
8.8

5.9
9.6

10.2

12.5

16.1

Debt/Assets, end of period

18.5**

* Data shown for 1965-69 are estimates for 1965-68 multiplied by 1.25 to facilitate
comparison with previous five-year periods .
*«As of January 1, 1968.
Source:



Capital flows from Table 4, debt from Table 14, assets from Table 2,
cash flow components from Farm Income Situation, U.S. Department of
Agriculture, July 1969, pp. 48, 52, 57, and 61.

- 51 -

requirements.

By the early 1960!s however, only 21 per cent of

cash flow was being used for capital purchases, and the same share
was so used in 1965-68 in spite of the relatively greater capital
spending that then occurred.
Relative reliance on credit, 1950-1968.

Credit thus

became increasingly important as a source of funds for capital expenditures . In the early 1950 f s, only 13 per cent of capital
flows were met by an increase in debt.

Ten years later this

ratio had risen to 32 per cent, and by 1965-68 it averaged 37 per
cent .
One must go back 50 years to find a similar degree of
reliance on credit.

Writing in the 1950's, Tostlebe noted:

To a remarkable degree, farmers have
financed the increase in farm capital with their
own incomes and savings • A comparison of the
volume of new capital that was financed by loans
and book credits with that which was financed with
funds derived from gross farm income and savings
shows that in every decade for which we have information, save the one immediately preceding 1920,
farmers supplied by far the greater part of the
funds that financed the capital acquisitions .26/
A few years later, Johnson was still able to state:
. . .even when it is assumed that all increases in
loans and credit were used to increase agricultural assets, their contribution has generally
been less important over the past two decades
[1940-59] than either depreciation or net income
as a source of financing .27/

2j6/ Ibid., p. 19.
27/ D. Gale Johnson, op. cit., p. 377.




- 52 -

According to our estimates, however, in 1958 credit became a more
important source of capital than net income.

In fact, in-

creases in debt have recently rivaled depreciation allowances for
the lead in supplying capital, whereas ten years before they were
only one-third as large.
Thus in projecting credit demands it is not enough to cite
the capital flows anticipated.

It appears equally important to project

the cash flow and also the proportion of that flow which farmers will
be willing or forced to apply to satisfaction of the projected capital
needs.

In so doing, additional uncertainties are obvious.

change in net income probable?

Is a major

Has the postwar trend toward less

internal financing reached its lowest point?

How probable is a higher

savings rate in the near future?
Current factors affecting credit use.

In the last period of

markedly increased participation of creditors in the financing of
agriculture, that of 1900-1920, Tostlebe found two primary factors
in operation.

One was the pressure of financing farm transfers at the

28/
newly-inflated prices.—Physical farm enlargement was not a major factor,
but average dollar value of assets per farm rose by 79 per cent between
29/
1900 and 1910, and by 91 per cent between 1910 and 1 9 2 0 . — Tostlebe also
speculates that family living offered stiff competition for available
funds:
First, and most important, inflated expenditures
for family living probably made heavy inroads on the incomes of many farmers. The rise in prices of that period
made necessary much greater outlays to maintain the prewar
level of living. But more than that, the prosperity of
the times encouraged farmers to spend freely, so that the
level of living for many farmers was substantially higher
during this period than before .30/
J28/ Tostlebe, op. cit., pp. 140, 145-147.
10/ Ibid., p. 145.



29

Ibid., p. 85.

- 53 -

These elements appear in the current situation, though they
do not seem to dominate it.

Typical farms are now so large that an

average person seeking to enter farming through purchase necessarily
has to borrow a large portion of the funds required.

Also, family

farms approaching optimum size increasingly represent a quantity of
assets that a typical farmer is not expected to save during a lifetime,
so farmers are more likely to remain indebted throughout their career.
On the other hand, in these circumstances, alternatives to the use of
credit—leasing of land and equipment from nonfarm investors, vertical
integration, corporate ownership--are spreading and lessening the credit demands made directly by farmers, though probably increasing credit demands
of these other entities of the farm production sector.
The desire to raise family living levels may also be a powerful factor in current borrowing.

National television networks have

exposed farmers to consumer amenities.

Among land owners, income after

depreciation and expansion allowances might not permit a significant
rise in living conditions, but paper capital gains may have imparted
a sense of financial prosperity reflected in spending.

Several authors

have noted that short of selling their land, farmers can tap these
gains only by offering them as collateral for increased debt.
process has probably occurred in subtle ways.

This

Perhaps depreciation

allowances, which after all look just like net income, are consumed
in current living, and the tractors that were purchased for cash ten
years ago are today replaced on the instalment plan.

Or, instead of

saving toward a down-payment on the adjacent 80, a farmer simply plans
to use his inflated equity in his present holdings to effect a completely







- 54 -

debt-financed purchase.
The attitudes of farmers and lenders toward the future
of farming and toward what constitutes appropriate uses and terms
of farm credit are obviously important determinants of the proportion of capital needs financed by debt.

Farmers must be

willing to borrow and lenders to lend if outstanding credit is
to increase—and both were obviously willing over the last 20
years . The outlook for product and land prices must be important
in the determination of these attitudes.

In recent years, lenders

that identify their interests most closely with those of agriculture—retiring farmers and the cooperative credit system—
have provided a larger share of credit, and other lenders have
employed more agriculturally-trained loan officers . Thus it is
not surprising that the outlook and attitudes of borrowers and
lenders have apparently tended to coincide.
The question of attitudes leads into the dominant
feature of the present situation—farm enlargement--that was
largely absent in the previous period.

According to Tostlebe,

average physical assets per farm nationally remained virtually
unchanged between 1870 and 1940, though their composition was
31/
altered.— A slow decline in the size of southern farms concealed
a slow increase in the size of midwest and western enterprises,
but nowhere did expansion match that which started in the 1940 ! s.
Since

tihen the benefits of, or competitive necessity for, en-

largement became more obvious to farm lenders.

31/lbid., p. 85.

In fact, numerous




- 55 -

educational efforts attempted not only to instruct lenders in these
matters, but also to advise them to tell farmers about the need to
expand in order to raise income, and how credit could assist this
endeavor.

Greater appreciation of the leverage that could be

attained through credit was instilled in lender and farmer alike.
The importance of these considerations emerged in the
1960 Sample Survey of Agriculture, in which a large national
sample of farmers was for the first time asked to enumerate debts
owed to various sources . About 58 per cent of all farmers were
indebted to varying degrees . When Garlock compared indebted
operators to those without debt, he found that:
Regardless of whether the farmers
were classified by age, years on the farm,
tenure, or type of farm they operated, the
indebted farmers, on the average, conducted
larger-scale operations than the debt-free
farmers . The value of the land and buildings
they operated was greater, they leased more
land, and they owned more land. Also they
sold products of greater value, earned more
net cash income from farming, and had larger
off-farm incomes and more net income from
all sources than did the debt-free farmers.
Although credit was indispensable
to indebted farmers in building up and
operating large farm businesses, it is
questionable whether use of credit was fundamentally responsible for their larger, more
profitable operations . What the data probably
mean is that the farmers who used credit were
more energetic and aggressive, more willing to
take risks, and less willing to work only with
the assets they owned outright than were the
debt-free farmers. This is indicated by their
more extensive use of leased land as well as
by their use of credit.

- 56 -

These expansionist characteristics of
the credit users—particularly the heavy credit
users--are pointed up more sharply when farmers
are classified according to the extent of their
indebtedness. ...Despite their small equities,
the most heavily indebted farmers owned farms
of nearly as high value as those owned by the
debt-free farmers. But the most significant
point is the extent to which the indebted farmers
used their equities as a fulcrum for developing
larger operations than their own financial
resources would support. The most heavily indebted farmers owned 3-1/2 times as much land,
and operated 6 times as much land, as they
could have owned or operated without borrowing
and leasing. By using these methods of expanding
operations, they raised their net cash farm
incomes to levels approximating those of the
other groups whose equities were much greater .32/
In times past, these expansionary desires, grounded in the
economics cited by Garlock, might have been financed in larger part
by saving.

But given that many farmers have come to regard credit as

an appropriate tool for achieving these ends, that lenders encourage
this use of credit, and that both young farmers and the holders of paper
gains are probably disinclined to postpone attainment of family living
goals, a continued high or perhaps even increased use of credit relative
to required capital flow seemsprobable as long as the factors
forcing farm enlargement continue operative.

These have been found

rooted in technological innovation, and seem in no danger of expiring
before 1980.

They have already been found responsible for higher

capital requirements, and now are also found reponsible for greater
relative use of credit in meeting these requirements, given the farm
income situation since 1950.

Barring a drastic rise in net farm

32/ Fred L. Garlock, Farmers and Their Debts .. .The role of credit in
the farm economy, Agricultural Economic Report No. 93, U. S.
Department of Agriculture, June 1966, pp. 8-9.



- 57 -

income, it seems reasonable to expect a savings rate no higher than that of
the 1960 ! s.

On the other hand, if real net income per farm rises at a

reasonable pace, neither would there be great pressure to reduce the savings
rate.

The credit projections that follow incorporate this reasoning.

Projected credit requirements. 1970-1979
The analytical framework outlined above and exemplified by
Table 9 can be used to project credit requirements to 1980 under the
various capital models that have been developed.

For each

past period shown in Table 9, capital flow, capital consumption,
net income, and increase in debt were all "known," and thus the amount
of cash flow that was used to meet capital requirements could be
obtained by subtraction.

For the projections, however, only the

capital flows and the capital consumption allowances that are
consistent with these flows are initially given.

But if

the course of net farm and nonfarm income is projected, the total cash
flow becomes known.

Then, if a further projection is made about how

much of cash flow farmers will devote to meeting capital requirements,
the amount of increase in borrowing--the credit requirement—can be
solved for as the residual.
Internal financing in the 1970 f s.

To project internal

financing, the course of net farm income, nonfarm income of farmers,
and the savings rate must first be estimated.
Instinctively, one wants to project total net farm income by
projecting gross farm income and production expenses and calculating
the difference.




But a different approach is taken here, based on the




- 58 -

belief that over a period of years (1)

advances in real per farm

income will parallel gains in per capita incotae achieved in the nonfarm
economy; (2)

technological advances will cause farm numbers to decline

independently of the course of farm income; and (3)

the general price

level will tend to rise.
These trends have been in evidence over the postwar period.
Between 1958 and 1968, for example, operators1 real net farm income per
farm (income adjusted for changes in the index of prices paid by farmers)
rose by 3.3 per cent annually, while national per capita real personal
income rose at a yearly rate of 3.4 per cent.

However, the number of

farms decreased by 3.2 per cent annually, and so total real operators1
net farm income was unchanged.

But prices paid by farmers rose at

an average annual rate of 1.6 per cent, and so total net farm income in
current dollars increased at the same rate.
For the 1970fs the National Planning Association projects
an annual advance of 3.25 per cent in national per capita real personal
33/
income.—-

In the longer run, the interplay of competitive and

political forces will tend to ensure that farmers participate to roughly
the same extent in this advance in the national level of living.

At the

same time, as farm enlargement continues and farm numbers therefore
decline, this rate of gain in real income per farm may be achieved by
a merely stable total real net income.

However, if prices paid by

farmers tend to rise by an average of 2 per cent annually, as is

33/

Ahmad Al-Samarrie, Morris Cobern, and Takeshi Hari, National
Economic Projections to 1978/79, National Planning
Association, Washington, January 1969, p. 117.

- 59 -

projected in Models HT and HM, total net farm income would
also have to rise by 2 per cent annually to yield the projected real
gains.
Note that this projection of net farm income implicitly
requires that gross income rise sufficiently to provide not only the
increase in net income, but also to cover any rise in production
expenses (including interest payments on projected increases in
debt) and in projected depreciation allowances.
Total nonfarm income of the farm population has been rising
rapidly and the trend is expected to continue as nonfarm employment and
investment opportunities become increasingly available to rural residents.
Between 1958 and 1968, nonfarm income rose at an annual rate of 5.8 per
cent in spite of an average yearly drop of 4.8 per cent in the farm
population.

For the 1970 ! s, we project total nonfarm income to increase

by 5 per cent annually, with two-fifths of the gain reflecting projected
price inflation.
To summarize the cash flow projections, net farm income is
projected to increase from $16.1 billion in 1968 to an annual average
of $17.4 billion in 1970-74 and $19.3 billion in 1975-79.

Annual

nonfarm income is projected to rise from $11.8 billion in 1968 to
an average of $14.3 billion in 1970-74 and $18.3 billion in 1975-79.
Capital consumption allowances, which vary among the capital models
according to the growth of the machine stock foreseen, are projected
at annual levels of $7 to $8 billion in 1970-74 and $7 to $10 billion
in 1975-79.

Total cash flow, which was $34 billion in 1968, is therefore

projected to rise to about $39 billion per year in 1970-74, and about
$45 billion in 1975-79, with some variation among models as shown in Tables
10 and 11.



- 60 Table 10
Projected Financing of Alternative Capital Flows
1970-74
Model
NC
A,
Sources of capital financing
From cash flow (21% of cash flow)
Increase in debt
Total capital flow

Model
HM

Five-year total (billions of dollars)
40.4
15.8
56.2

40.5
18.5
59.0

35.5
87.1
71.7
194.3

Sources of cash flow
Capital consumption allowances
Net farm income
Nonfarm income
Total cash flow

40,8
22.9
63.7

34.3
87.1
71.7
193.1

41.5
34.4
75.9

B. Annual average (billions of dollars)
Sources of capital financing
From cash flow (21% of cash flow). . . .
Increase in debt
Total capital flow

8.1
3.2
11.2

8.2
4.6
12.7

8.1
3.7
11.8

8.3
6.9
15.2

Sources of cash flow
Capital consumption allowances
Net farm income
Nonfarm income
Total cash flow

6.7
17.4
14.3
38.5

7.1
17.4
14.3
38.9

6.9
17.4
14.3
38.6

7.8
17.4
14.3
39.5

C.
Selected assets
Outstanding debt

End of period (billions of dollars)
281.1
71.5

378.6
78.9

320.5
74.3

344.2
92.3

D. Per cent
Analytical ratios
Capital flow/Cash flow
Increase in debt/Capital flow
Average annual change during period:
Selected assets
Outstanding debt
Debt/Assets, end of period




29
28

33
36

31
31

38
45

0
5.1

5.1
7.1

2.2
5.9

3.4
9.8

25.4

20.8

23.2

26.8

- 61 Table 11
Projected Financing of Alternative Capital Flows
1975-79

Model
B
Five year total (billions of dollars)
Sources of capital financing
From cash flow (217O of cash flow)
Increase in debt
Total capital flow

49-9
44,5
94.4

Sources of cash flow
Capital consumption allowances •
Net farm income. . . . . . . . .
Nonfarm income
• • • •
Total cash flow

34.5
96.5
91.5
222.5
B.

49-6
96.5
91.5
237.6

Annual average (billions of dollars)

Sources of capital financing
From cash flow (21% of cash flow). . . .
Increase in debt
Total capital flow ,

9.3
2.0
11.4

9.5
5.9
15.4

9.4
3.4
12.8

10.0
8.9
18.9

Sources of cash flow
Capital consumption allowances
Net farm income
Nonfarm income
Total cash flow

6.9
19.3
18.3
44.5

7.7
19.3
18.3
45.3

7.2
19.3
18.3
44.8

9.9
19.3
18.3
47.5

C.
Selected assets
Outstanding debt

End of period (billions of dollars)
281.1
81.6

490.1
108.1

D.
Analytical ratios
Capital flow/Cash flow . . .
. . .«
Increase in debt/Capital flow . . .
Average annual change during period:
Selected assets
,
Outstanding debt

Debt/Assets, end of period




26
18

358.9
91.3

409.7
136.8

Per cent

34
38

29
27

40
47

0
2.7

5 .3
6 .5

4.2

3 .5
8 .2

29.0

22.1

25.4

33.4

2 .3

- 62 Of this cash flow, 21 per cent is projected to be allocated
to meeting capital requirements, the same proportion as was so
allocated on average during 1960-68.

Internal financing of capital

flow is thus expected to average about $8 billion per year
in 1970-74 and $9 to $10 billion in 1975-79, up from the average of
$6.9 billion in 1965-68.
Projected debt expansion under alternative capital models.
For each capital model, the projected increase in outstanding farm
debt consists of the difference between the capital flow and
the internal financing projected by that model.

These calculations

are shown in Tables 10 and 11, and the resulting debt projections
are summarized in Table 12,
Under Model NC, in which farm assets remain unchanged in
value, substantial but decreasing annual additions to debt would still
be required, and outstanding debt would reach $81.6 billion in 1980,
up from $52.0 billion in 1969.

Thus it appears that farmers would for

some time tend to incur sizable amounts of new debt simply in the

course

of replacement and transfer of todayfs capital plant at today's prices.
In Model B, in which capital flows advance moderately,
outstanding farm debt would reach $91.3 billion in 1980.

The rate of

debt expansion would fall to an annual rate of about 4 per cent by
1980, compared to the actual rate of 9.6 per cent in 1965-68.

However,

debt would grow more than twice as rapidly as assets and in 1980
would constitute 25 per cent of assets, compared to 19 per cent in 1968.
The relatively greater land price increases projected in
Model HT lead to an outstanding farm debt of $108.1 billion in 1980.




Annual gains in debt would average about 7 per cent; in dollars, the
annual increase during 1975-79 would average $5.9 billion.

However,

- 63 Table 12
Alternative Projected Credit Requirements

1950-54
A.
Actual
Model NC
Model HT
Model B
Model HM

4.7

1970-74

8.2

9

12.4

20.0*

1.6

2.5

2.0
5.9
3.4
8.9

Outstanding debt at end of period (billions of dollars)

15.4

23.6

36.0

56.0*
71.5
78.9
74.3
92.3

D.

10.0
29.3
17.0
44.5

4.0*
3.2
4.6
3.7
6.9

Actual
Model NC
Model HT
Model B
Model HM

1975-79

Average annual increase in debt (billions of dollars)

C.

81.6
108.1
91.3
136.8

Annual growth rate of outstanding debt during period (per cent)
7.6

8.9

8.8

9.2*
5.1
7.1
5.9
9.8

E.
10

2.7
6.5
4.2
8.2

Debt/Asset ratio at.end of period (per cent)
12

*Estimate based on data in Table 9.
**As of January 1, 1968.




1965-69

15.8
22.9
18.5
34.4

Actual
Model NC
Model HT
Model B
Model HM

Actual
Model NC
Model HT
Model B
Model HM

1960-64

Increase in debt during period (billions of dollars)

B.

Actual
Model NC
Model HT
Model B
Model HM

1955-59

16

19**

25
21
23
27

29
22
25
33

- 64 -

because of the large rise in farm real estate values projected by this
model, the ratio of debt to assets would rise only slowly, to perhaps
22 per cent in 1980.
Model HM represents the greatest increase in capital
flows, resulting mainly from large real additions to farm machine
stocks.

Outstanding debt would continue to grow almost as fast as in

recent years, and would reach $136.8 billion in 1980.
annual additions to debt would average $8.9 billion.

In 1975-79,
The rise in debt

would far outpace growth in the value of farm assets, so that the
debt-asset ratio would rise to 33 per cent by 1980.
In comparison with the experience of recent years, these
projected credit demands represent somewhat slower rates of expansion
in debt.

However, no model represents continuation of the combination

of capital growth that has actually prevailed in 1963-68--significant real
additions to machine stocks plus
values.

relatively rapid increases in land

If similar experience were to continue through all the years

to 1980, credit demands would probably prove larger than any of these
projected.

But the historical perspective on capital flows provided in

Chapter IV indicates this to be a somewhat extreme expectation.
Sizable increases in debt and in the debt-asset ratio are
projected by each model.

The levels reached in each by 1980 are not

so large as to be impossible, but neither can the process continue
indefinitely, especially at the rate represented by Model HM.

At some

point, capital flows may recede and/or farmers' savings may increase.
Or nonfarmers may supply significantly more of the capital needed.

A

watch should be maintained for the occurence of such structural changes
on a significant scale, as these events would alter credit demands,




- 65 -

VI-

SOURCES OF CREDIT, 1950-1979

From 1950 through 1968, $41.3 billion of additional credit
was supplied to farmers by a great many individual and institutional
lenders.

As will be shown below, the share supplied by some lender

groups increased over this period, while other groups became less
important sources.

Commercial banks, however, maintained about the

same relative role over the entire period.
In the preceding chapter, further sizable increases in total
farm debt were projected for the 1970 f s.

To continue to provide

their recent historical share of such expansion, banks would have to
continue to expand their farm lending substantially.

The amount of

increase necessary to achieve this target varies among models, as it
depends on the projected size of total credit requirements and also
on how much of the credit is incurred to support non-real-estate
rather than real estate spending.

These projections of required bank

credit growth are made here for each of three alternative models that
have been presented—Models HT, B, and HM.
Attention then turns to the supply of funds at rural banks,
to examine how banks have been able to increase farm lending rapidly
since 1950, and whether they will be able to continue the pace*

Future

deposit growth is projected and then compared with the various projections
of future farm loan demands, to provide an indication of the degree to
which internal growth of rural banks is or is not likely to be adequate
to meet farm credit demands arising in a variety of possible future
farm capital situations.




- 66 Sources of outstanding debt, 1950-1968
Credit to farmers is provided by a large number of individuals,
dealers, and institutions.

Estimates of the amount outstanding from

each of several classes of lenders are published annually by the U.S.
Department of Agriculture.

For the major institutional lenders, these

estimates are based on lender reports submitted at least annually.
Commercial banks hold the largest outstanding farm loan total among
these reporting lenders.

Other institutions in this group are insurance

companies, the Farmers Home Administration, and the agencies (Federal
Land Banks, Federal Intermediate Credit Banks, and production credit
associations) that comprise the cooperative credit system supervised
by the Farm Credit Administration.
Many other lending institutions make small amounts of
loans to farmers, but in general they do not report their volume of
farm loans.

In the USDA estimates of farm lending, their loans are

grouped with credit provided by individuals.
Taken together, individuals, dealers, and these non-reporting
institutions are the most important source of farm credit.

Retiring

farmers and other sellers of farms, in particular, provide large amounts
of credit to the purchasers by taking mortgages or land contracts.
Merchants, dealers, and individuals such as farm landlords also supply
large amounts of non-real-estate credit to finance purchases of production
inputs, machinery, and livestock.

In this group, national farm supply

and machinery corporations have emerged as a major source of financing.
In general, these creditors do not report their loan volume annually, and
so USDA estimates of the debt they hold may contain relatively large errors,
This is particularly true of recent yearly changes, es census surveys of




- 67 farm debt made in 1960 and 1965 have permitted improved evaluation
of the relative longer-term role of these lenders.
Holders of outstanding debt.

Outstanding farm debt on January 1,

1969 totaled $52.0 billion, up from $23.6 billion at the start of the
decade and $10.7 billion in 1950 (Table 13). Individuals, dealers, and
non-reporting institutions held about two-fifths of the outstanding
debt throughout this period.

Among the major lending institutions,

commercial banks ranked first with $13.6 billion in 1969, about onefourth of the total farm debt.

Outstanding loans at banks had also

increased markedly from $6.5 billion in 1960 and $3.0 billion in 1950.
The cooperative credit system held nearly one-fifth of outstanding
farm debt in 1969.

Its volume of $10.1 billion represented a rapid rise

from $3.8 billion in 1960 and $1.4 billion in 1950.

Life insurance

companies held $5.8 billion of farm mortgage loans in 1969, representing
11 per cent of total farm debt.

Finally, the Farmers Home Administration

held 3 per cent of the total debt.
Farm debt has been rising by about 9 per cent yearly since the
mid-1950fs (Table 14). During 1965-68, total debt rose at an annual rate
of 9.6 per cent, paced by annual gains of 13.5 per cent in outstandings
held by the cooperative credit system and assisted by rapid expansion of
farm loans at each of the other principal lenders.

Expansion at banks

averaged 8.9 per cent annually during 1965-68 and 8.4 per cent during
1960-64, in each case only slightly below the growth rate of total
farm debt.




- 68 Table 13
Outstanding Farm Debt by Lender Groups, 1950-69
(excluding CCC)
1950

1955

1960

1965

1969

A. Billions of dollars
Banks

3.0

4.1

6.5

9.7

13.6

Cooperative credit system
Life insurance companies
Dealers & individuals (non-real-estate)* . . . .

1.4
1.2
2.3

1.9
2.1
3.2

3.8
2.8
4.9

6.1
4.3
7.1

10-1
5.8
10.3

Individuals (real estate)*

2.3

3.4

4.9

7.6

10.9

5

.7

.8

1.3

1.3

10.7

15.4

23.6

36.0

52.0

Farmers Home Administration
Total

B. Per cent of total
Banks

28

27

27

27

26

Cooperative credit system
Life insurance companies
Dealers & individuals (non-real-estate)* . . . .

13
11
22

12
13
21

16
12
21

17
12
20

19
11
20

Individuals (real estate)*

22

22

21

21

21

5

5

4

4

3

100

100

100

100

100

Farmers Home Administration
Total

*Includes other non-reporting lenders .
Source: Agricultural Finance Review, U. S. Department of Agriculture, April, 1969,
pp. 2 and 22-23.
The Balance Sheet of Agriculture, 1968, U. S. Department of
Agriculture, January 1969, pp. 13 and 15. Data are as of January 1 of each year.




- 69 -

Table 14
Average Annual Growth Rate of Outstanding
Farm Debt, by Lender Groups (excluding CCC), 1950-68
(per cent)

1950-54

1955-59

1960-64

1965-68

6.8

9.2

8.4

8.9

6.4
11.8
6.6

14.6
6.6
8.7

10.0
8.7
7.9

13.5
7.7
9.8

Individuals (real estate)*

8.1

7.3

9.5

9.4

Farmers Home Administration

5.5

3.5

8.6

1.0

7.6

8.9

8.8

9.6

Banks
Cooperative credit system
Life insurance companies
Dealers & individuals (non-real-estate)*

Total

^Includes other non-reporting lenders.
Source:

Table 13.




- 70 -

Sources of additions to debt.

Another perspective on farm

credit is provided by examination of the sources of net additions to outstanding debt, which are shown in Table 15 for five-year intervals
since 1950.

In each five-year period,

dealers and individuals provided

about two-fifths of the increase, while banks provided about one-fourth.
The increase at the cooperative credit system was low in 1950-54, when
real estate lending by the Federal Land Banks was restrained by appraisal
methods that proved outmoded.

More recently, the cooperative credit

system has been supplying around 20 to 25 per cent of the additions to
farm credit.

In 1965-68, banks and the cooperative credit system each

supplied 25 per cent of the total increase.

After providing 19 per cent

of the gain in farm credit in 1950-54, the share of life insurance
companies dropped to about 10 per cent in subsequent periods.

Relative role of banks. 1950-1968.
New insights into the relative role of various lenders, as
well as a better basis for projection of future roles, may be secured by
further aggregation of lenders into groups with key common characteristics,
Thus we find it useful to group three lender classes — the cooperative
credit system, life insurance companies, and the non-reporting creditors
who supply non-real-estate credit—into one category we call "money market
lenders" because the supply and the real or opportunity cost of the credit
provided by each is influenced by conditions in the national money market.
The cooperative credit system obtains its funds by selling money market
instruments.




Such instruments also comprise a major alternative

investment for funds of life insurance companies.

And, the non-real-

estate lending volume of non-reporting creditors is dominated by national

- 71 -

Table 15
Sources of Additions to Farm Debt, 1950-69
(excluding CCC)
1950-54

1955-59

1960-64

1965-69*

A. Five-year total (billions of dollars)
Banks

1.2

2.3

3.2

4.9

Cooperative credit system
Life insurance companies

.5
.9

1.9
.8

2.3
1.5

5.0
1.8

Dealers 6 individuals (non-real-estate)**.
c

.9

1.7

2.2

4.0

Individuals (real estate)**

1.1

1.4

2.8

4.1

Farmers Home Administration

.2

.1

.4

.1

4.7

8.2

12.4

20.0

Total

B. Annual average (billions of dollars)
Banks

.2

.5

.6

1.0

Cooperative credit system
Life insurance companies

.1
.2

.4
.2

.5
.3

1.0
.4

Dealers 6 individuals (non-real-estate)**.
c

.2

.3

.5

.8

Individuals (real estate)**

.2

.3

.6

.8

Farmers Home Administration

0

0

.1

0

.9

1.6

2.5

4.0

Total

C . Per cent of total
Banks

25

28

26

25

Cooperative credit system
Life insurance companies

11
19

23
9

19
12

25
9

Dealers 6 individuals (non-real-estate)**.
c

19

20

18

20

Individuals (real estate)**

24

18

22

21

Farmers Home Administration
Total

3
100

2
100

3
100

0
100

*Data shown for 1965-69 are actual values for 1965-68 multiplied by 1.25 to
facilitate comparison with previous five-year periods.
**Includes other non-reporting lenders.



Source:

Table 13.

- 72 corporations that supply production inputs to farmers, and such concerns
are likely to have obtained funds for tthese loans in the money market
or by borrowing from money market banks.

Local merchant credit remains

in this category as separate data are not available, but the amount of
this misclassification is relatively small.
After this consolidation, four groups of farm lenders remain.
In addition to (1)

the money-market lenders, there are (2)

who hold real estate debt, (3)

banks, and (4)

individuals

the Farmers Home

Administration.
Individual holders of real estate debt are sellers of farms
who took mortgages or sold by land contract for tax reasons, to make the
sale, to obtain a higher price, or because they were attracted to a
continuing investment in their farm.

Their volume of lending depends

on the strength of these considerations and on prices and activity in
the farm real estate market.
Banks are set apart as a third major lender group because
their farm lending is significantly affected by factors different from
either sellers of farms or the money-market lenders.

Loans for real

estate purchases constitute only 15 per cent of their farm lending, and
so land market considerations are less important in determining loan
volume than in the case of sellers of farms.

Also, the bulk of banks

active in farm lending find it difficult to participate effectively in
national money markets under present conditions and so are dependent
on local sources of funds.

Thus, whereas money market participants

active in farm lending face a very elastic supply function, in that
their demands on the money market constitute only a small portion of
total national demands for funds, most rural banks face




a relatively

- 73 inelastic supply.

In seeking to enhance the growth of their lending

resources, they are limited both by legal ceilings on interest rates
they can offer on deposits and by the overall economic growth being
achieved by their community•

In the long run, therefore, constraints

are thereby placed on growth of farm lending at most rural banks,
given present institutional arrangements that exclude such banks from
effective participation in the money market.
The Farmers Home Administration completes our list of four
lender groups.

In its direct farm lending program, this agency makes

supervised loans to farmers unable to obtain credit from the other
lenders.

The outstanding volume of these loans failed to increase

during 1965-68 and consequently declined to 3 per cent of total outstanding farm debt.

In the projections that follow, it is assumed that the

volume of farm lending by the Farmers Home Administration will remain
unchanged over the next decade.
Share of outstanding debt.

As outstanding farm debt rose

from $10.7 billion in 1950 to $52.0 billion in 1969, the share consisting
of real estate debt held by individuals fluctuated narrowly between
20 and 22 per cent of the total.

The share held by banks declined

slowly from 30 per cent in 1952 to 26 per cent in 1969.

Conversely,

the portion held by money market lenders rose from 46 per cent in 1950
to 50 per cent in 1969 (Table 16).
Of the total debt held only by banks and money market
lenders, the share held by banks declined from 39 per cent in 1952 to
34 per cent by 1969.

In eight of the years from 1950 to 1968, bank

credit grew faster than credit from money market lenders, but on average




- 74 Table 16
Outstanding Farm Debt, by Major Lender Groups
(excluding CCC), 1950-69

1950

1955
A,

Banks
Money market lenders # . . . . .
Individuals (real estate).** . .
Farmers Home Administration. . •
Total

1960

15.4

1969

Billions of dollars

4.1
7.2
3.4
.
7

3.0
4.9
2.3
,5
10,7

1965

6.5

9.7

11.5

17.5

4.9
.3

7.6
1.3

23.6

36.0

13.6
26.2
10.9

1.3
52.0

B. Per cent of total
Banks
Money market lenders *
Individuals (real estate).** . .
Farmers Home Administration. . .
Total

27
46
22
5
100

23
46
22
5
100
C.

Banks
Money market lenders *
Total

*

**

38
62
100

27
49
21

27
49
21

4

4

100

100

26
50
21
3
100

Per cent of bank and money
market total

37
63
100

36

64
100

36
64
100

34
66
100

Includes debt held by the cooperative credit system and life insurance
companies, and non-real-estate debt held by farm supply corporations,
dealers, individuals, and other non-reporting lenders.
Also includes real estate debt held by other non-reporting lenders.
Source:




Table 13.

- 75 -

the latter tended to expand more rapidly throughout the period.

In

the last four years, 1965-68, debt at banks rose by 8.9 per cent
annually, while debt held by money market lenders grew at a rate of
10.6 per cent.

(Table 1 7 ) .

Share of additions to debt.

While the share of outstanding

debt held by banks eroded slowly over the entire period since 1950,
banks1 share of additions to farm credit showed no downward trend
during 1950-64.

Though year-to-year fluctuations were large, banks

on average provided slightly over one-fourth of the total increase
in farm credit and slightly over one-third of the total gain at banks
and money market lenders.

These shares of new credit were slightly

below the shares of outstanding credit with which banks entered the
period, which accounts for the erosion in the latter statistics.
In 1965-68, banks 1 share of additions to credit dropped to
25 per cent of the grand total and to 31 per cent of the sum provided
by banks and money market lenders . The share provided by money market lenders increased (Table 18) .

Projected credit expansion by major lenders, 1970-1979
The preceding chapter presented three alternative projections
of increases in farm debt to 1980, based on three different capital
models and a single farm income and savings rate projection.
Given these projected additions to total farm credit, estimates are
here made of the corresponding increases in farm lending by banks that
would be necessary for banks to maintain their recent historical share-about one-third--of the total credit expansion projected for banks and
money market lenders together .
Credit from sellers of farms.

As a preliminary step, it is

necessary to estimate the amount of additional real estate credit



- 76 Table 17
Average Annual Growth Rate of Outstanding Farm Debt,
by Major Lender Groups (excluding CCC) , 1950-68
(per cent)

1950-54
Banks
Money market lenders *
Individuals (real estate)**
Farmers Home Administration
Total

1955-59

1960-64

6.8
8.0
8.1
5.5
7.6

9.3
9.8
7.3

8.4
8.8
9.5
8.6
8.8

8.9

1965-68
8.9
10.6

Includes debt held by the cooperative credit system and life insuance
companies, and non-real-estate debt held by farm supply corporations,
dealers, individuals, and other non-reporting lenders.
Also includes real estate debt held by other non-reporting lenders.
Source:




Ta^le 16

9.4
1.0
9.6

- 77 Table 18
Sources of Additions to Farm Debt, by Major
Lender Groups (excluding CCC) , 1950-69

1950-54
A.

1955-59

B.

2.3
4.3
1.4
._L
8.2

.5
.9
.3
J3
1.6
C.

25
48
23
3
100
D.

Banks
Money market lenders**
Total

3.2
6.0
2.8
A_
12.4

4.9
10.9
4.1
._X
20.0

Annual average (billions of dollars)
2
7
2
JD
9

Banks
Money-market lenders**
Individuals (real estate)***
Farmers Home Administration
Total

1965-69*

Five-year total (billions of dollars)

Banks
1.2
Money-market lenders-*
,2.3
Individuals (real estate)***
1.1
Farmers Home Administration. . . . . . . . .
J2
Total
4.7

Banks
Money-market lenders-*
Individuals (real estate)***
Farmers Home Administration
Total

1960-64

.6
1.2
.6
A.
2.5

1.0
2.2
.8
J)
4.0

Per cent of total
28
52
18
2
100

26
48
22
3
100

25
54
21
0
100

Per cent of bank and money market total
34
66
100

35
65
100

35
65
100

31
69
100

Data shown for 1965-69 are actual values for 1965-68 multiplied by 1.25 to
facilitate comparison with previous five-year periods.
Includes debt held by the cooperative credit system and life insurance
companies, and non-real-estate debt held by farm supply corporations,
dealers, individuals, and other non-reporting lenders.
Also includes real estate debt held by other non-reporting lenders.
Source:

Table 16




- 78 that may be provided by individuals, particularly sellers of farms.
Credit from this source is virtually certain to be related to the value
of farms transferred by sale; thus more would be expected if land prices
rise rapidly, as projected by Model HT, than if they rise more moderately
as projected by Models B and HM.

In addition, credit provided by sellers

has recently been increasing relative to the value of transfers.

We

estimate that such credit may have equalled 18 per cent of the value of
real estate sales in 1955, 22 per cent in 1960, 24 per cent in 1965, and
29 per cent in 1968.

Several factors have contributed to this increase,

chief among them substantial capital gains tax advantages to sellers
who provide credit under a land contract and the ability of
sellers to offer lower downpayments than most institutional lenders.
Again, the future trend of this ratio saems likely., to be positively related to the rate of gain in real estate values .
With these considerations in mind, past increases in real
estate credit provided by individuals were related to estimated capital
flows required by real estate transfers. This ratio was estimated
at 11 per cent in 1955-59, 17 per cent in 1960-64, and 20 per cent in
1965-67.

For Models B and HM, the ratio was projected to average 22 per

cent in 1970-74 and 24 per cent in 1975-79.

For Model HT, in view of

its more rapid rise in land prices, the ratio was projected at 25 and
29 per cent, respectively.

These relationships were applied to the

value of real estate capital flows projected by these models
(Table 7) to obtain the estimated amounts of additional real estate
credit that may be supplied by individuals and other non-reporting
lenders.

The estimates are shown in the second column of Table 19.
Projected loan demands on banks.

Subtraction of the projected

seller-supplied credit from the total credit requirements shown in the



- 79 Table 19
Alternative Projected Farm Loan Expansion at Major
Lender Groups, 1970-79
(billions of dollars)

Total

Individuals
(real estate)

A,

Banks and
At banks
money market to maintain
lenders
relative share

Five-year total

Model HT
1970-74
1975-79

22.9
29.3

11.0

15.9
18.3

5.4
6.3

Model B
1970-74
1975-79

18.5
17.0

5.5
6.7

13.0
10.3

4.4

Model HM
1970-74
1975-79

34.4
44.5

5.6
7.0

28.8
37.5

7.0

3.5
9.8
12.8

B. Annual average
Model HT
1970-74
1975-79

4.6
5.9

1.4
2.2

3.2
3.7

1.1
1.3

Model B
1970-74
1975-79

3.7
3.4

1.1
1.3

2.6
2.1

.9

Model HM
1970-74
1975-79

6.9
8.9

1.1
1.4

5.8
7.5

2.0
2.6




.7

- 80 first column of Table 19 (copied from Tables 10 and 11) yields projections
of the amounts to be supplied by banks and money market lenders together.
If banks are to supply one-third of the latter totals, they would have
to increase their farm loans by the amounts shown in the last column of
Table 19.
In Table 20, the required additions to farm lending by banks
are shown in a more familiar context, as the sum that outstanding
farm loans would reach in 1975 and 1980 (Panel C) and as the average
annual rate of increase in outstandings in each five-year interval
(Panel D ) . Outstanding loan volume required in 1980 ranges from
$22.5 billion (Model B) to $37.9 billion (Model H M ) .

These sums may

be compared to outstanding volume of $13.6 billion in 1969.

The

projections show that credit demands on banks would be very large if the
high rate of machinery investment projected by Model HM should materialize.
Rapidly rising land prices, as represented by Model HT, would have more
moderate effect on credit demands on banks, because the projected
increase in seller-financing of real estate transfers meets a significant
portion of credit demands arising from that source.
Under the moderately greater capital flows of Models B and HT,
and given the projected internal financing, annual rates of farm loan
expansion averaging 6 per cent would suffice to maintain the relative
role of banks in farm lending during 1970-74.

This pace would be

significantly below actual rates of farm loan expansion at banks since
1955.

But with the much greater capital flows represented by Model HM,

farm loans at banks have to expand at an annual rate of 10 per cent,
or even faster than they have been growing since 1955.




- 81 Table 20
Alternative Projected Farm Loan Expansion Required at Banks
to Maintain Banks' Relative Role in Farm Lending, 1970-79

1950-54

1955-59

1960-64

1965-69

1970-74

1975-79

A. Increase in outstanding loans during period (billions of dollars)
Actual
Model HT
Model B
Model HM

1.2

2.3

3.2

4.9*
5 .4
4.4
9.8

6 .3
3.5
12.8

B. Average annual increase in outstanding loans (billions of dollars)
Actual
Model HT
Model B
Model HM

2

.5

.6

.8*
1.1
9
2.0

1.3
.7
2.6

C. Outstanding loans at end of period (billions of dollars)
Actual
Model HT
Model B
Model HM

4.1

6.5

9.7

14.6*
20.0
19.0
25.1

26.3
22.5
37.9

D. Annual growth rate of outstanding loans during period (per cent)
Actual
Model HT
Model B
Model HM

6.8

9.3

*Estimate based on data shown in Table 13.




8.4

8.5*
6.5
5.5
10.5

5.6
3.4
8.6

- 82 Supply of funds at rural banks
Would it be easy or difficult for banks to expand farm lending
at the various rates projected above, and thereby to maintain their
share of the farm credit market?

At present, expansion of lending

resources of rural banks depends primarily on growth in their deposits,
most of which originate locally.
Farmersf deposits,
intermediaries among farmers.

To some extent, banks act as financial
In the early 1950 f s, the outstanding

loans to farmers represented about one-half of farmers1 deposits, and
at that time overall farm lending activity at banks could be viewed
as being on average sustained completely from the deposits of farmers
themselves.

By 1960, however, the volume of farm loans was almost equal

to that of deposits, and in 1968 it was 43 per cent larger (Table 2 1 ) .
It is evident that banks have been making farm loans from funds received
from sources other than farmers alone.
The discussion of farmers1 cash assets in Chapter IV turned
up conflicting views on the extent of the growth that banks can expect
in farmers1 deposits during the next decade.

As farmers purchase more

inputs, cash working capital has become more important in farm operation,
but farmers have also learned how to economize on these balances.

If

these offsetting trends continue, farmers1 demand deposits may show
only moderate growth.

It is possible, however, that banks could achieve

more significant expansion in time deposits of farmers by attracting
current and past savings away from alternative investments.




- 83 -

Table 21
Commercial Bank Farm Loans Compared with Farmers' Deposits,
1950 - 69

Billions of dollars
Demand and
Bank loans
time deposits
to farmers
of farmers

Farmers1 loans
as per cent of
farmers f
deposits

1950

3.0

6.6

45

1955

4.1

7.2

57

1960

6.5

7.2

90

1965

9.7

7.7

126

1969

13.6

9.5

143

Source:




Agricultural Finance Review. U.S. Department of Agriculture,
April 1969, pp.,2 and 22-23. The Balance Sheet of Agriculture,
1968, U.S. Department of Agriculture, January 1969, pp. 10,
13, and 15.

- 84 Total deposit growth. 1950-1968.

Fortunately, total deposits

at rural banks increased at a faster pace than farmers1 deposits
alone.

An indication of this is provided by the USDA ! s index of

"deposits of country banks," which measures changes in deposits at banks
in towns with population under 15,000 in 20 agricultural states.

These

primarily rural banks achieved annual growth in total deposits averaging
3.4 per cent in the 1950*5, 5.8 per cent in 1960-64, and 8.5 per cent
in 1965-68 (Table 2 2 ) .
The very significant recent acceleration in the growth of
total deposits at these banks can be traced primarily to the expansion of time
deposits.

Since 1950, demand deposits have increased slowly, with annual

expansion averaging less than 3 per cent.
at an average annual rate
per cent in 1960-68.

Time deposits, however, rose

of about 10 per cent in the 1950!s and 15

At first, these rapid rates of expansion did not

contribute much to total deposit growth, because time deposits represented only a small fraction--13 per cent in 1950--of total deposits
at these banks.

But as the rapid pace continued, time deposits became

more important, reaching 44 per cent of total deposits in January 1969.
With this sizable component growing at 15 per cent annually, total deposits
rose by 8.5 per cent yearly in 1965-68 even though annual demand deposit
growth averaged only 4.2 per cent during these years.
Deposit and farm loan growth compared. 1950-1968.

Data on

farm loan growth at the universe of banks used in compiling the USDA
index of country bank deposits are not available.

It is likely, how-

ever, that it parallels the course of farm loans at all banks, and that
impressions obtained from a comparison of the deposit index with total
farm loan growth will not be misleading.




- 85 -

Table 22
Deposits of Selected Country Banks, 1950-69*

Total
A,

Demand

Time

Index of volume (1947-49=100)

1950*
1955
1960

102
124
142

103
122
127

103
152
260

1965
1969

188
261

144
170

502
883

B.
1950-54
1955-59
1960-64
1965-68

Average annual growth rate (per cent)
4.0
2.7
5.8
8.5

3.4
.8
2.5
4.2

8.1
11.3
14.1
15.2

*Data are for banks in towns with population under 15,000 in 20
agricultural states, as compiled and published by the U.S. Department
of Agriculture. Data for 1950-65 are averages for January of
each year. Data for 1969 are as of January 1.
Source:




Agricultural Finance Branch, U.S. Department of Agriculture.

- 86 -

Such comparison shows that farm loans have tended to increase
faster than rural bank deposits (Table 2 3 ) . The gap was especially
large in 1955-59, was reduced somewhat by faster deposit growth in 1960-64,
and then almost closed by still faster deposit growth in 1965-68.
In these last four years, deposits rose by 8.5 per cent annually while
farm loans expanded at a rate of 8.9 per cent.
Confirmation of these recent relationships between loans and
deposits is afforded by data from surveys of banks active in agricultural
lending, made annually since 1962 by The American Bankers Association.
From 1962 to 1965, loan-deposit ratios at these banks tended to move
upward.

In 1968, however, the distribution of banks by loan-deposit

ratio was still much the same as in 1965 (Table 2 4 ) . At the national
"median11 bank covered by the ABA surveys, the 58 per cent gain in farm
loans in 1963-68 was virtually identical to the 59 per cent increase
in total deposits.

At banJcs in the Plains states, however, deposits

had risen by only 26 per cent compared to farm loan growth of 67 per
cent .-24/
Projected deposit growth. 1970-1979.

It seems reasonable to

believe that demand deposit growth at rural banks in 1970-79 may resemble
postwar expansion to date, averaging perhaps 3 per cent annually.

This

projection reflects the growing money needs of an expanding rural economy.
However, the rate of money expansion is somewhat below the anticipated

34/




Trends in Agricultural Banking: Report of Midyear 1968 Agricultural
Credit Situation Survey. Agricultural Committee, The American
Bankers Association, New York, 1968, p.8.




- 87 -

Table 23
Deposit and Farm Loan Growth Compared, 1950-68

Average annual growth rate (per cent)
Total deposits
Total farm
of selected
loans at
country banks
all banks

1950-54
1955-59
1960-64
1965-68

Source:

4.0
2.7
5.8
8.5

6.8
9.2
8.4
8.9

Table 15 (loans) and table 22 (deposits).

- 88 -

Table 24
Percentage Distribution of ABA Agricultural Banks by Loan-Deposit
Ratio, Midyear 1962-68*

Loans as percentage of deposits
Under 50
50 to
60 and
59
over
1962
1963
1964
1965

41
38
31
27

34

1966
1967
1968

27
21
25

31

33
35
32

33
33

25
29

34
41
42
46
42

*Data are for banks designated as "agricultural" banks by The
American Bankers Association and thereby covered by the midyear
agricultural credit situation survey. Agricultural banks are
defined as banks with under $5 million in assets having 5 per
cent or more of their assets outstanding in farm loans, and banks
with $5 million or over in assets having 1 per cent or more of
their assets in farm loans. Approximately two-thirds of all
insured commercial banks qualify as agricultural banks under these
criteria.
Source:




Trends in Agricultural Banking: Report of Midyear 1968
Agricultural Credit Situation Survey» Agricultural
Committee, The American Bankers Association, New York,
1968, p. 8.

- 89 -

rate of economic growth, as persons and businesses continue to economize
on the money balances they find necessary relative to their volume of
transactions*
Projection of time deposit growth seems more speculative.
To some extent, the large recent gains represent an adjustment by the
public to increased attractiveness of time deposits relative to both
demand deposits and non-bank

investments.

First, ceiling interest

rates prescribed by regulatory authorities on passbook and other time
deposits were raised to a level more competitive with those paid by
non-bank financial intermediaries such as savings and loan associations
and with rates on U.S. savings bonds and marketable securities.

Second,

in response to their increased loan requests and reduced liquidity,
many banks began to offer time certificates of deposit on which they
were permitted to pay higher rates of interest than on passbook savings
accounts.

Small banks, while unable to participate in the sale of large-

denomination certificates which have become a popular short-term investment
for businesses with surplus cash, have been quite successful in marketing
small-denomination certificates and passbook-notice accounts to the public.
From one point of view, further reallocation of personal
savings to time deposits could occur, if time deposits continue
attractive.

Nationally, time deposits at banks still constitute a rela-

tively small share of the total financial assets of households — in 1968,
less than 10 per cent of the total.

Thus even relatively small shifts

of funds from other assets into time deposits would enable the latter
to increase at a very rapid rate, and this process could conceivably
continue for many years.




- 90 -

However, there is a second and probably dominant consideration
that militates against such expectations.

The rate of time deposit

growth is obviously an important influence on the rate at which total
bank credit can expand--and expansion of total bank credit will continue
to be greatly influenced by national economic policies seeking full
employment without price inflation.

Thus policies of the Federal Reserve

System can be expected to result in rates of bank credit expansion consistent with potential real economic growth, while taking into account trends
toward greater relative use of credit*

In this environment, total deposit

growth at banks will at times be encouraged and at other times restrained,
as appropriate in the light of national economic goals and current
business conditions.

The relative attractiveness of time deposit rates

is likely to be regulated accordingly.

On average, an annual increase

of 6.5 per cent in total deposits may represent a reasonable projection.
This reasoning implies that a slowdown from recent rates of
time deposit growth must be projected, with the estimated future gains
dependent on the growth actually experienced in demand deposits.

If

the latter do increase at an average rate of 3 per cent annually at
rural banks covered by the USDA index, the following annual rates of
time deposit growth at these banks would yield the projected 6.5 per
cent increase in total deposits in the 1970 f s:

11 per cent in 1969,

10 per cent in 1970-74, and 9 per cent in 1975-79.
Projected deposit and farm loan growth compared. 1970-1979.
If farm credit demands on banks were to increase at the same rate as
deposits, it may be assumed that on average banks would be able to meet
these demands without excessive difficulty; that is, on the average, banks
could increase farm loans at this rate without (1) increasing the proportion



- 91 of farm loans in their loan portfolios, or (2) increasing their
overall loan-deposit ratio in order to make the additional farm
loans.

Farm loan expansion at a yearly rate of 6.5 per cent

during the 1970's would increase outstanding farm loans at banks
by about $5.4 billion in 1970-74 and $7.3 billion in 1975-79.
Table 25 shows how these amounts compare with expansion that would
have to take place under the various capital models in order that
banks maintain their relative share of farm lending.
In only one of the model situations would this rate of
increase in farm credit availability at banks exceed the credit
demand projected.

This result occurs in Model B, which combined

a stable real stock of farm machinery with a moderate 3 per cent
yearly increase in land prices .
In the other situations projected, in which one of these
capital projections is different--either real machinery stocks increase (Model HM) or land prices rise faster (Model HT)--expansion
of deposits and loans at 6.5 per cent yearly would at best just
permit banks to maintain their one-third share of total bank and
money-market lending (Model HT) or funds would fall substantially
short of this goal (Model HM) . As these capital trends may easily
continue, the projections on balance point toward probable difficulty
for banks as they try to meet the farm loan demands of their present
customers.

If, as in Model HT, projected national supply and demand

for bank credit are roughly in balance, a significant proportion of
banks can still be expected to be out-of-balance because of differing
local conditions.




In the situation projected by Model HM, a majority

- 92 Table 25
Projected Farm Loan Expansion at Banks Compared to Banks1
Internal Resource Growth, 1970-79

Increase in outstanding loans
(billions of dollars)
Excess of
Supported
Required to
required
maintain
by annual
amount over
banks'
deposit
expansion
growth
relative
supported by
of 6.5
role in
internal growth
per cent
farm lending

Banks share of
total farm loan
expansion if bank
expansion is-Sufficient
6.5
to maintain
per cent
relative
annually
role

Five-year total
Model HT
1970-74 . .
1975-79 . .

5.4
6.3

5.4
7.3

.
1
-1.1

24
21

23
25

Model B
1970-74 . .
1975-79 . .

4.4
3.5

5.4
7.3

- .9
-3.8

24
21

29
43

Model HM
1970-74 . . 9.8
1970-79 . .12.8

5.4
7.3

4.5
5.5

29
29

16
16

Annual average
Model HT
1970-74 . .
1975-79 . .

1.1
1.3

1.1
1.5

0
.2

24
21

23
25

Model B
1970-74 . .
1975-79 . .

.9
.7

1.1
1.5

- .2
- .8

24
21

29
43

Model HM
1970-74 . .
1975-79 . .

2.0
2.6

1.1
1.5

.9
1.1

29
29

16
16




- 93 -

of rural banks would experience farm lending difficulty.
On balance, the analysis and projections indicate a
fairly high probability that rural banks may be unable to maintain their usual share of farm lending on the basis of growth in
their deposits.

True, low farm capital requirements would reduce

credit demands to a rate that could be met by probable deposit
growth.

Or, a continued very high rate of increase in time de-

posits would enable higher credit demands to be met.

But more

probable events appear likely to result in a shortage of internally-originated loanable funds relative to farm credit demands
on rural banks.




- 94 -

VII.

SEASONAL PRODUCTION CREDIT

In addition to using credit to maintain, add to, and
transfer capital assets, farmers demand seasonal credit to carry
on production processes not financed from their stock of cash
and very liquid assets.

Seasonal credit extensions particularly

require recognition here because the preceding analysis employed
capital stocks and debt measured as of January 1, whereas the
national seasonal peak in the demand for farm working capital
occurs in the spring and summer.
Unfortunately, seasonality of total expenses and
working capital has not been measured.

Only annual estimates of

farm expenditures and capital are available.
Data on seasonal credit extensions are also incomplete.
Such credit is provided mainly by three lender groups:

merchants

and dealers, commercial banks, and production credit associations
(PCA's) . Advances and outstanding debt at PCAfs are reported
monthly, but PCA f s hold only about one-sixth of total non-realestate debt.

Loans from commercial banks, which represent two-

fifths of the total, have been reported only semiannually in recent years.

Debt outstanding at merchants, dealers, and other

individuals is estimated only as of January 1.
But though the magnitude of seasonal capital and credit
requirements is not known, the rate at which such demands have
been expanding can be estimated with the help of some plausible
assumptions.




For instance, the growth rate of operating expenses

- 95 -

that clearly have a significant seasonal component can be computed . If the relative seasonality of these expenses is assumed
to have remained roughly unchanged, that growth rate becomes an
estimate of the rate at which seasonal capital requirements have
been rising.
On the credit extension side of the puzzle, the JanuaryJuly variation in loans outstanding at PCAfs and banks, after adjustment for trend, can serve as an index of seasonal credit extensions by these lenders.

The assumption here is that a change

in the amount of seasonal lending would change the difference between January and July outstandings by about the same proportion.
Thus, the growth rate of that difference becomes an estimate of
the growth rate of total seasonal lending by these institutions.
The validity of this estimate may be helped by the fact that
January is the low month and July the high month in outstanding
farm debt nationally, as indicated by data for PCA f s.

Seasonal capital requirements
Operating expenditures with major seasonal elements include purchases of seed,

fertilizer, and lime; operation and re-

pair of motor vehicles and machinery; and wages and perquisites
paid to hired workers who do not reside on the farm by which they
are employed.

These expenses are tabulated in Table 26.

Purchases

of feed and livestock are omitted from this list both because
additions to these inventories have been included in capital requirements previously considered and because the national seasonal




Table 26
Selected Current Farm Operating Expenses

Seed
purchased

Fertilizer
and lime

668

2,095

3,916

2,109

3.3

28.3
2.5

74.2
5.7

19.8
1.8

53.3
4.4

3.2
3.4
2.2
4.6

- .7
-1.4
2.9
4.2

6.2
1.3
5.7
5.3

4.1
3.7
- .3
4.5

Total
Expenditures in 1968
(millions of dollars). . 8,788
Increase from 1956-58

to 1966-68 (per c e n t ) :
Total
Average annual rate. . .
Average annual rate
of change in specified
period (per cent):
1950-54
1955-59
1960-64
1965-68

Source:




Wages to
Operation and
non
repair of vehicles resident
and machinery
workers

38.2

U. S. Department of Agriculture, Farm Income Situation, July 1969,
pp. 56, 58, and 59.

.1
6.6
4.0
4.0

- 97 peak in credit extended for these items likely occurs near the
January 1 date on which capital stocks and debt were measured
for the preceding analysis . Repairs and maintenance of buildings
and land improvements are omitted on the conjecture that they did
not have a strong seasonal element.

For the same reason, wages

paid to hired workers who reside on the farm are also excluded.
The selected expenses totaled $8.8 billion in 1968, and
over the past decade had risen at an average annual rate of about
3.3 per cent.

An exponential least-squares trend for 1950-68

rises by 3.1 per cent yearly.

Data for each component, as shown

in Table 26, reveal that these longer-term averages are depressed
by the relative stability in vehicle and machinery expenses during
the early 1960 f s. With such expenses advancing more rapidly in the
last few years, the total selected costs rose by 4.6 per cent
annually during 1965-68.
If the degree of seasonality in these expenditures has
not changed in recent years, the seasonal capital requirement
that underlies demand for seasonal production credit has also
been advancing at these rates--less than half as fast as
total outstanding farm debt.

However, seasonal credit demands

may also have increased because farmers wanted to finance
a higher proportion of their seasonal costs by borrowing.

Further

evidence is provided by examination of the seasonality in non-realestate debt.




- 98 Seasonal credit extensions
Semiannual variation in outstanding non-real-estate farm
debt held by reporting lending institutions was calculated by
averaging the amounts outstanding at the beginning and end of each
year and subtracting this average from the amount outstanding on
July 1, with results as shown in Table 27. The seasonal credit
increase thus obtained has an upward trend both in total and at
banks and PCAfs separately; however, the year-to-year fluctuations
have been so large that the trend is not properly revealed by use
of the five-year periods that this study has employed.

Exponential

trend curves fitted by the least-squares technique to data for
1950-68 were found more useful in showing average annual growth
rates, along with the longer-term changes presented in Table 28.
The estimated seasonal component of total institutional
non-real-estate debt reached $1,030 million in 1968, and exhibited
an average annual growth of 4.4 per cent over 1950-68.

The upward

trend thus exceeded the annual average growth of 3.1 per cent estimated for seasonal production expenses . The excess may be explained
by a seasonal element in intermediate-term credit that has been
captured in the calculated seasonal component of debt--farmers tend
to buy machinery in the spring, and debt incurred for this purpose
would be paid down somewhat by year-end.

However, farmers may also

have been increasing the proportion of their seasonal production
expenses financed by debt.




- 99 -

Table 27
Semiannual Variation in Institutional Non-real-estate
Debt Owed by Farmers, 1949-1968

July debt exceeded average of debt at beginning and end of year by- Millions of dollars
Per Cent

Year

Total*
1949.
1950.
1951.
1952.
1953.
1954.

.
.
.
.
.
.

1955.
1956.
1957.
1958.
1959.

.
.
.
.
.

1960. ..
1961. .
1962. .
1963. .
1964. .
1965.
1966.
1967.
1968.

.
.
.
.

437
269

464
680

634
609

Bank

PCA

Total

Bank

PCA

271
127
247
418
400
354

146

11.6

13.6

108

8.7

171

12.5
16.4
15.9
15.8

5.6
8.8

38.7
25.8
33.8
36.4
33.5
30.5

211

191
171

664
640
473

385

185

363
222

183

530
686

255

178
262

650
626

329

241
244
243
313
324

8.6
7.8
9.7
9.8

627
872
956

336

311
278
425
500

781
855
940

326
385

1,030

161

13.2
13.4
12.4

15.8
14.4
10.0

12.3
11.0

9.9

6.6

11.0

7.5

9.5

6.7
6.0
4.9

6.4

6.7

7.3

433

324
356

7.4
7.3
7.2

4.4
4.8
4.9

485

393

7.3

5.1

299

30.3
27.2
20.3
17.8
21.2
17.0
15.6
14.0
15.9
14.8
12.3
11.6
10.9
10.7

* Total non-real-estate loans to farmers held by all operating banks, production credit associations, Federal Intermediate Credit Banks, and the
Farmers Home Administration, excluding loans guaranteed by the Commodity
Credit Corporation.
Source:




Agricultural Finance Review, U.S. Department of Agriculture,
October 1957, pp. 30-31; April 1969, pp.-22-23.

- 100 -

Table 28

Amount of and Relative Change in Selected Current
Expenses and in Seasonal Component of Debt, 1950-1968
(per cent)

Selected
current
expenses

Period

Seasonal component of institutional
non-real-estate debt
Total

Bank

PCA

A. Annual average (millions of dollars)

1950-54.
1955-59.
1960-64.
1965-68.

.
.
.
.

.
.
.
.

.
.
.
.

5,332
6,182
6,998
8,328

531
599
746
902

309
312
369
407

170
194

273
343

B. Change from previous period (per cent)

1950-54.
1955-59.
1960-64.
1965-68.

.
.
.
.

.
.
.
.

.
.
.
.

15.9
13.2
19.0

12.8
12.5
20.9

1.0
18.3
10.3

14.1
40.7
25.6

C. Change from specified period to 1965-68 (per cent)

1950-54. . . .
1955-59. . . .
1960-64. . . .




56.2
34.7
19.0

69.9
50.6
20.9

31.7
30.4
10.3

101.8
76.8
25.6

- 101 The increase in the seasonal component of outstanding debt
fell far short of keeping pace with the rise in total non-real-estate
debt at institutional lenders.

In the late 1950!s July debt was about

10 per cent higher than the January-December average, but by the late
1960!s the average difference was reduced to 7 per cent.
Given the expectation that farm production will continue to
rise at modest rates that primarily reflect domestic population growth
and higher consumer living levels, seasonal farm operating costs can
reasonably be expected to continue to increase at rates approximating
those of the recent past, in which the same influences were dominant.
The historical record indicates that seasonal credit demands can be
expected to reflect this increase, and thus to rise by perhaps 3 to
5 per cent annually.

At this rate, the trend-adjusted January-July

increase in non-real-estate farm debt might range from $1.3 to
$1.7 billion around 1980.

But if total non-real-estate debt should

meanwhile increase in line with projections for total farm debt, this
seasonal fluctuation would represent only about 4 to 5 per cent of
outstandings•
This analysis and projection indicates that provision of
quantities of seasonal credit desired by farmers as a whole will not
be a major or growing problem.

However, this prognosis is not likely

to apply to each farming region.

As will be shown next, there is

great regional variation in relative seasonal farm credit demands,
and in some regions the seasonal factor can only be classified as
huge.




In these areas, any shortfall in total credit supply is

- 102 synonymous with a shortage of seasonal credit.

Also, changes in

regional production patterns—particularly increasing specialization
in a seasonal commodity--will continue to place at least temporary
strains on seasonal credit resources in some areas from time to tinje.

Institutional sources of seasonal credit
As estimated seasonal lending at banks and PCA f s together
has recently been rising somewhat faster than estimated seasonal
capital requirements, one might reason that these institutional lenders have been responsive to farmers1 seasonal demands.

However,

the increased credit demands have been met more vigorously by PCA's
than banks. The large year-to-year fluctuations in the calculated
seasonal component, particularly in the bank debt series, precludes
explicit judgments, but it appears that during the last two decades
PCA's may have provided additional seasonal credit that surpassed
the volume supplied by banks, in spite of the PCAfs lesser role in
total non-real-estate lending (Table 2 8 ) . The 1950-68 least-squares
trend shows that the seasonal component of non-real-estate loans at
banks rose at an average annual rate of only 3.0 per cent, whereas
that at PCA's rose by 5.5 per cent annually.
At both PCAfs and banks, seasonal credit extensions have become a substantially smaller proportion of outstanding credit.

The

semiannual variation at PCA's fell from 18 per cent of outstandings
in 1958 to 11 per cent in 1968, while at banks it decreased from
7 per cent to 5 per cent (Table 27) . As already noted, however, the
amount of seasonal funds provided by both lenders actually




- 103 -

increased and the seasonal role of PCA's rose in relation to that of
banks. The ratios give the wrong impression because total farm lending
(1) increased greatly at both lenders and (2) grew faster at PCA's than
at banks.
PCA credit exhibits greater seasonality than bank non-realestate credit in all major production areas except the Appalachian and
Southeast states (Table 29) . The same relationship is found in many
important farm states--in 1968, PCA's showed larger relative seasonal
variation in 18 of the 29 states in which bank non-real-estate farm
loans exceeded $100 million, while in 1966 the proportion was 20 of 28
states. Seasonality in farm loans is greatest in Southern, Plains,, and
Western states. In the Mississippi ddlta states, for example, the semiannual variation in 1968 was 26 per cent of outstandings at banks and
54 per cent at PCA's.
These regional data indicate the continued great importance
of seasonal credit in some farming areas • From the historical trends
previously noted, it appears that PCA's have been better able than
banks to meet seasonal credit demands where these have been large and
increasing.




- 104 Table 29
Semiannual Variation in Bank and PCA Non-real-estate Debt Owed by
Farmers, by Farm Production Areas, 1968

Area

July debt exceeded average of debt at beginning and end of year by-Per Cent
Millions of dollars
Bank

United States . .
Northeast. . .
Lake States . .
Corn Belt. . .
Northern Plains
Applachian . .
Southeast. . .
Delta States .
Southern Plains
Mountain . . .
Pacific. . . .

Source:




PCA

Bank

PCA
393

5.1

10.7

485

.8

-1.5

4.3
1.4

4.9
7.0
3.3
9.3
6.0

3
37

- .3
14.6
9.9
26.3

4.1
6.4
12.8

53.8
13.4
13.7
16.3

35

4
66
29
74
40
65
140

4
20
51
13
39
20

117
40
50
40

Agricultural Finance Review, U.S. Department of Agriculture,
April 1969, pp. 24-25.

- 105 PART B.

PROPOSALS TO INCREASE AVAILABILITY OF BANK CREDIT
VIII.

INTRODUCTION

Part A of this paper outlined two important projections: (1)
the agricultural sector will likely continue to seek significantly larger
amounts of credit, and (2) the ability of rural banks to provide their
historical share of such increases and adequately finance their communities from their own resources is likely to be further impaired.
To maintain their role as a leading farm lender, commercial
banks will therefore increasingly have to assume the role of intermediaries
who channel nonlocal—urban and money market—capital into agricultural
loans of either a term or seasonal character.

The avenues for securing

such funds fall into two general categories: (1) discount or sale of
assets—in particular, of loans; and (2) borrowing, such as by purchase
of Federal funds or sale of time certificates of deposit.
These avenues for obtaining reserves to support additional lending
have been partly or totally closed to many banks that are extensively
engaged in rural lending.

Whereas secondary markets have been developed

for some bank paper, such as acceptances and mortgages, there is virtually
no market for many rural loans.

Thus most banks that make a high percentage

of their loans to agriculture and for other rural purposes are unable
to obtain any significant volume of reserves through rediscount or sale
of notes.

Their volume of lending is reduced by this imperfection in

financial markets.
Borrowing—the second route by which additional reserves can
be secured—has been employed in significant proportions by large banks
but is much less available to small institutions.

Present markets in

such instruments as Federal funds, time certificates of deposit, and




- 106 Eurodollars are largely designed to meet efficiently the needs of large
banks.

Thus small banks, including most banks engaged primarily in

rural lending, are in many cases virtually precluded from participation
or can participate only as effectively as the interest of their city
correspondent permits.

The ability of small or isolated banks to employ

these sources of funds is further restricted by lack of managerial skills
in this area, lack or relatively high cost of market information, and
the relative lack of geographical and economic diversification of their
resources, which outside investors tend to view as prima facie evidence
of higher risk.
These imperfections in financial markets prevent an optimum
allocation of money market resources, with attendent social cost.

Economic

sectors that must deal with the disadvantaged banks--industries such as
agriculture, with large numbers of small firms located in isolated areas—
are placed at a relative disadvantage in obtaining funds to finance
expansion, new technology, or seasonal production processes.
In the next three chapters, imperfections in specific banking
mechanisms and financial markets are considered in somewhat greater detail
to determine whether the flow of funds into rural areas is obstructed.
Some thoughts are offered on how procedures might be changed or new mechanisms
established to improve the mobility of funds and thereby increase the
potential lending ability of rural banks.
First, the efficacy of correspondent banking—the present
mechanism by which funds are moved within the commercial banking system-is reviewed and appraised.




Evidence from Federal Reserve studies is

- 107 presented to question whether correspondent banking makes a net contribution to the flow of funds into rural areas, and to examine whether its
contribution could be improved by altering the manner in which most
correspondents are compensated for their services.
To complement the evaluation of correspondent banking, which
is most highly developed in unit banking states, the rural lending
performance of branch banking is also examined.

While the conversion

of small rural banks into arms of larger institutions is shown to present important advantages, several offsetting conditions and circumstances
are also noted.
The second question raised is whether present central banking
mechanisms--the open-market and discount operations of the Federal Reserve
System—succeed in providing an equitable proportion of reserves to rural
sectoxs.

An optimum distribution of reserves provided either for seasonal

fluctuations or for long-term growth is thought unlikely given the present
state of financial markets, with funds reaching small and isolated banks
with considerable lag, if at all.

Therefore, a number of suggestions

for improving present markets or compensating for their deficiencies are
offered.
Third, as a fundamental means for moving money market funds
into rural lending via the banking system, development of secondary markets
in rural bank portfolio items is proposed.

Organizational considerations

and operational methods are briefly outlined for new regional agencies—
unified markets — that would make trading in such items feasible by neutralizing certain disadvantages that rural banks face in current money
markets.




Regional unified markets would provide rural banks with information

- 108 and trading facilities for all financial instruments, and thereby place
rural banks on a more nearly equal footing with other institutions in
the nation's financial arena.




- 109 IX.

CORRESPONDENT AND BRANCH BANKING

In the context of this study, correspondent and branch banking
constitute existing mechanisms by which the advantages of large banks can
potentially be enjoyed in rural areas . Both mechanisms are inherently
capable of improving the flow of funds, both between money market and
rural banks and among rural banks . In this process the net flow of funds
can be either into or away from rural areas.
evidence on the net effect is meager.

Unfortunately, national

Relevant considerations and some

recent research findings are discussed in this chapter.
One other aspect of correspondent and branch banking deserves
special mention:

among the mechanisms considered in this and subsequent

chapters, these alone provide a means to cope with the problem of farm
loans that exceed the legal lending limits of present rural banks.

Correspondent banking
The correspondent banking mechanism helps to provide more
effective financial services to rural areas.

City banks may handle over-

line loans, provide seasonal credit, advise on investment policies, help
with accounting and management problems, execute security transactions,
and clear checks.

In exchange for such services, country banks maintain

deposits with their city correspondents.

This traditional method of pay-

ment drains funds from rural areas by tending to offset, or in many cases
exceed, funds provided through credit services.
Our interest in correspondent banking centers on the effectiveness and cost of the credit services rendered to rural areas•




- no Insofar as available information and data permit, the following
questions will be investigated:
(1) Are the credit services responsive to rural needs?
(2) What is the ratio between funds provided to and
drawn from rural areas?
(3) Should credit services be paid for by deposit
balances?
Correspondent credit services.

Intensive interviews about

correspondent relationships were conducted with a number of rural
,35 These banks regarded the handling of overline loans
banks in 1966\— /
as the most important credit service rendered by their city correspondents, and nearly all were using or had used their correspondents in
this way.

In a few instances, a customer had been referred to a

correspondent, and in some cases the banks had also obtained loans
from the city banks. But on the whole, most of the credit was obtained in the form of participations in loans originated by the
country bank, and most participations were sought because the loan
exceeded the legal lending limit of the country bank.
Two earlier but broader surveys confirm this finding.

A

national survey of correspondent banking conducted in 1963 found that
the bulk of correspondent credit was provided through participation
loans.— In the 1963 midyear farm credit survey by The American Bankers

3j>/ A total of 29 country bankers in Iowa, Illinois, Colorado, Kansas,
and Oklahoma were interviewed by personnel of the Federal Reserve
Banks of Chicago and Kansas City.
3jS/ A Report on the Correspondent Banking System, Subcommittee on Domestic
Finance, Committee on Banking and Currency, House of Representatives,
88th Congress, 2d Session, December 10, 1964, pp. 2-4.




- Ill Association (ABA), 84 per cent of country bankers and 74 per cent of
city bankers rated participation in over line loans as the most im37/
portant correspondent bank service to agriculture.—
Participations are also used to obtain correspondent credit
even when overlines are not involved.

For example, one banker has

described how his bank obtains seasonal credit through sale of
participation certificates in a block of farm loans.

This procedure

38/
was found more convenient than the sale of individual notes .—
Extent of the overline loan problem.

Legal lending limits

fix the maximum outstanding credit that a bank may extend to an individual and are intended to avoid serious financial difficulty should
one borrower default.

For national banks, the legal limit is 10 per

cent of the bank's capital and surplus, except that loans secured by livestock

may go to 25 per cent.

Laws governing banks chartered by state

governments generally also impose lending limits based on similar
criteria, though they vary among states.
Rapid postwar growth in the size of individual farms has
resulted in numerous farm loan requests that exceed the legal lending
limit of the bank at which they are made.

The market value of average

assets per farm in the United States, for instance, more than doubled
both in 1946-56 and 1956-66.

The average amount of credit used per

37/ T. P. Axton, "Introductory Remarks,11 Correspondent Agribanking:
Proceedings of the Correspondent Agribanking Forum, Agricultural
Committee, The American Bankers Association, New York, 1963, pp. 5-6,
38/ Robert L. Walton, "Overcoming Pressure of Seasonal Loan Demand,"
Agricultural Banking and Finance, November-December 1967, pp. 28-31.




- 112 farm more than tripled during each of these periods . The assets and
capital of most rural banks did not grow as rapidly.

Thus in many

areas, a significant proportion of farms grew much faster than the
banks by which they were being financed.
Therefore, overline loan requests persist even though lending
limits of rural banks have been moving upward.

Between 1962 and 1968,

ABA surveys found that the proportion of agricultural banks with loan
limits under $50,000 declined from 43 to 23 per cent and the proportion
with limits of $150,000 and above increased from 25 to 37 per cent.
However, the proportion of agricultural banks that received one or more
overline requests in the first half of the year increased from about
one-fourth in 1962 to 29 per cent in 1968.

In surveys made each year

39 /
since 1962, this proportion has ranged between 26 and 34 per cent.—
Overline loans are particularly common at rural banks in
Western states that prohibit or severely restrict branch banking.

Farms

in these states tend to be large, and the rural banks tend to be small.
In the 1968 ABA survey, 41 per cent of agricultural banks in the Plains
states had received at least one excess farm loan application.
The Federal Reservefs 1966 survey of farm lending confirmed
both the widespread occurrence and the geographical concentration of
overline farm loan requests.

Of all insured commercial banks, 14 per

cent had received at least one overline request during the 12 months
ending in June 1966. Among banks with capital and surplus below $300,000,




Trends in Agricultural Banking; Report of Midyear 1968 Agricultural
Credit Survey, Agricultural Committee, The American Bankers
Association, New York, pp. 11-13, and similar publications for
earlier years. The ABA defines agricultural banks as banks with
under $5 million in assets having 5 per cent of more of their assets
outstanding In farm loans, and larger banks with 1 per cent or more of
their assets in farm loans. In 1968, 840 of these banks participated
in the sample survey.

- 113 one-fourth had received overline requests.
Nationally, there were about 12,000 requests totaling $330
million.

They equalled 0.3 per cent of the number and 3 per cent of

the volume of all farm loans outstanding on the day of the survey.

At

the banks that received the requests, however, the overline requests
equalled 1.9 per cent of the number and 15 per cent of the dollar
volume of outstanding farm loans.

In both relative volume and number,

overline requests were about five times more important at small than
40/
at large banks .—
In the Northern Plains states--Kansas, Nebraska, and the
Dakotas--the dollar volume of overline requests received during the
year totaled 7 per cent of farm loans outstanding on the survey date,
compared with the national average of 3 per cent.

Overline requests

also occurred with above-average frequency in the Southern Plains and
41/
Mountain states .—
Responsiveness to rural credit needs.

The ABA midyear sur-

vey of agricultural banks has consistently shown that a high percentage of overline requests has been handled through the correspondent
system.

In 1968, for instance, 86 per cent of the dollar volume of

excess loan applications was handled on a participation basis with
correspondent banks.

Another 5 per cent was referred entirely to a

correspondent, so that only 9 per cent was lost to other lenders.

40_/ Emanuel Melichar, "Bank Financing of Agriculture,11 Federal Reserve
Bulletin, pp. 929-930.
41/ Ibid., p. 943.




- 114 During 1962-68, the proportion of dollar value handled through the
banking system has ranged from 88 to 97 per cent, and has most
42/
generally been at 94 to 95 per cent.—
The 1966 Federal Reserve survey did not ask about the disposition of overline requests, but did show a relationship between
these requests and outstanding participation loans.

Of the banks with

overline requests during the year ending in June 1966, one-half had
at least one participation loan outstanding on June 30.

At banks with

overline requests, participation loans represented a tenth of the outstanding farm loan business, about double the proportion found at all
banks.

Participation loans were relatively most important in those

areas--the Plains and Mountain states--in which overline requests
were most frequent.
The survey found $574 million of farm participation loans
outstanding on June 30, 1966, of which the participating banks1 share
was $304 million.

Participation activity was widespread, as 2,500

banks had originated at least one of thase outstanding loans, and 1,100
banks were participating in them.

Since a similar survey in 1956, the

number of originating and participating banks had tripled, and the
dollar volume of participation credit had increased by 607 per cent .—
In general, the 29 rural bankers interviewed in 1966 were
pleased with their correspondent relationships, which echoed attitudes

42/ Agricultural Banking Developments, 1962-1967, Agricultural Committee,
The American Bankers Association, New York, 1967, pp. 13-14.
43/ Melichar, op. cit., p. 937. For another discussion of overlines and
participations, see "Lending Limits of Commercial Banks'1 in Swackhamer,
Gene L., and Doll, Raymond J., Financing Modern Agriculture; Banking's
Problems and Challenges> Federal Reserve Bank of Kansas City, 1969,
pp. 40-53.



- 115 -

generally expressed by bankers in the 1963 national survey of correspondent banking.— Several bankers indicated that their correspondent had always
responded favorably when asked to take overlines . However, there were
indications that correspondent credit services may suffer as city banks
reach less liquid positions.

Several rural bankers had been told to

hold credit extensions requiring overline participations to a minimum.
Further questioning revealed that the banks that were asked to restrict
credit in 1966--a year of general credit tightness—had generally tended
to use their correspondents extensively, whereas those reporting no
restrictions had never asked their correspondent to take more in overlines or other loans than the amount of their demand balance with the
correspondent.
The Federal Reserve's 1966 national survey of farm lending
provided additional insights into the resource pressures on city banks
that might adversely affect their credit services to country banks.

An

estimated 83 per cent of participation funds came from banks with loandeposit ratios of 60 per cent or higher.

Also, 27 per cent of these

funds were extended by banks that reported difficulty in financing their
own farm customers .^Cost of correspondent credit services . City correspondent
banks are usually "paid" for their correspondent services by having the
use of demand deposits that rural banks keep with them.

This flow of

funds from country to city counters the flow of correspondent credit
from city to country.
44 / Correspondent Relations: A Survey of Banker Opinion, Subcommittee on
Domestic Finance, Committee on Banking and Currency, House of
Representatives, 88th Congress, 2d Session, October 21, 1964, pp. 6-7.
4.5/ Emanuel Melichar, op. cit., pp. 940-941.



- 116 How do the two flows compare in volume?

Some indication is

provided by comparing farm loan participations and demand balances
outstanding on June 30, 1966.

Because only data on farm loan participations

were obtained in this survey, this comparison must be restricted to banks
whose lending business consists primarily of loans to farmers.

Banks with

more than one-half of their total loans in loans to farmers were chosen.
The analysis also concentrates on member banks, thereby avoiding the complicating factor that nonmember banks hold balances in other banks to meet
reserve requirements.

(However, Table 30 provides data for both member and

nonmember banks .)
At the 855 member banks meeting the farm loan criterion, farm
participations averaged 22 per cent of demand balances with other banks,
while at the 2,069 nonmember banks the ratio was 16 per cent.

Thus the

balances exceeded the credit received by over four times r which agrees with
other impressions that the net flow of funds is from the country to the city.
For the heavily agricultural banks in this analysis, a reasonable allowance
for nonfarm participations and for nonparticipation credit would still leave
correspondent balances far ahead of correspondent credit.
A more detailed analysis of these data reveals wide variation in
the ratio of participations to balances among individual banks, indicating
that managerial inertia at country banks may be an important factor
contributing to the unfavorable direction of the net fund flow.
If a country banker is operating at a low loan-deposit ratio,
city banks can hardly be faulted for attempting to obtain relatively large
balances from him even though they are not called upon for proportionately large
credit services.

A distribution of the heavily-agricultural member banks

by loan-deposit ratio is particularly revealing.

Those banks with loan-deposit

ratios under 50 per cent had outstanding participations




- 117 Table 30
Farm Loan Participations Received from Other Banks
Compared with Deposit Balances Held in Other Banks,
Banks at which Farm Loans Comprised
50 per cent or more of Total Loans,
June 30, 1966

Farm loan participa- Balances as
tions as per cent of-- per cent of--

Millions of
dollars

Classification, capital,
aud liquidity status
of bank

Farm loan
participations

Balances

Balances

Farm
loans

Farm
Deposits loans

A. Member banks
Total

58

262

22

4.6

7.3

21

Capital and surplus
(thousands of dollars):
Under 200
200-299
300-499
500 and over

7
16
17
18

51
63
82
66

13
26
21
27

3.1
5.7

8.5

24
22
21

Loan-deposit ratio
(per cent):
Under 30
30-39
40-49
50-59
60-69
70 and over

2
1
4
14
16
21

20
36
59
69
56
22

8
3
7
20
29
97

4.4
4.8

7.5
7.3
6.4

5.9

11.5

72

1.1
1.8
3.9
4.7

33
26
20

10.4

7.9
7.6
7.3
6.7
5.4

18

16
11

B. Nonmember banks
Total

91

574

16

4.7

10.7

30

Capital and surplus
(thousands of dollars):
Under 200
200-299
300-499
500 and over

52
15
18
6

264
130
123
58

20
12
15
10

6.3
3.3

11.5

4.1
3.0

10.3
10.7

32
35
28

Loan-deposit ratio
(per cent):
Under 30
30-39
40-49
50-59
60-69
70 and over

1
1
11
10
44
23

31
80
126
161
116
61

4
1
9
6
38
38

3.9
.4
3.1
1.8
9.0
7.4

15.2
11.7
10.9
10.3
10.2
10.3




.
.

9.9

29

89
49
36
28

24
19

- 118 averaging less than 10 per cent of the balances they held in
correspondent banks.

The ratio of participations to balances rose

with higher loan-deposit ratios until it reached 97 per cent at banks
with loan-deposit ratios of 70 per cent and over.

The latter banks

kept correspondent balances averaging only 5.4 per cent of their
deposits, compared to an average of 7.3 per cent for all the member
banks in this analysis . A similar though less marked relationship
was found at nonmember banks .
It is evident that some banks can obtain a relatively high
volume of correspondent credit relative to balances.

A further break-

down of the data cited shows that the larger banks among those with
high loan-deposit ratios had the higher ratio of participations to
balances (Table 31)

Better managerial skills at larger banks may

have played a part in this result, along with the greater pressure
that larger banks can presumably exert to get their needs met.
To some extent, fund outflow from rural communities is
accentuated by complementary deposit accounts that rural bankers keep
with city banks that are not called upon for correspondent credit,
and that in many cases are rarely called upon for services of any kind.
Of the 29 rural banks interviewed in 1966, for instance, each was
maintaining accounts with from 2 to 12 city banks; however, only 1 to
3 of these accounts were active.

Some of these bankers did report that

they were reducing their number of inactive accounts .
However, there is ample evidence that provision of correspondent credit is directly dependent upon maintenance of deposit balances
and is related to the amount of such balances.

For instance, one

Illinois bank, in return for use of an anticipated $300,000 of seasonal




- 119 Table 31
Farm Loan Participations Received as Percentage of
Deposit Balances Held in Other Banks, Member
Banks at which Farm Loans Comprised 50 per
cent or more of Total Loans, June 30, 1966

Loan-deposit ratio
(per cent)

Under 50
50-69
70 and over




Capital and surplus
(thousands of dollars)
Under
200

200 to
499

500 and
over

18
3
32

3
38
73

1
11
146

- 120 participation credit (maximum $800,000), agreed to "keep with the
correspondent an average of $150,000 in excess deposits above and
beyond that needed to break even on a normal correspondent relation46/
ship. 11 — In a normal year, the city bank would apparently provide
$300,000 for perhaps six months, on which it would receive interest
"at 1/4 per cent above the prime rate."

In effect, the country bank

gave the city bank a yearly average of $150,000 interest-free in
return for the privilege of borrowing $300,000 at slightly above the
prime rate for perhaps six months.

On a yearly average basis, the city

bank's average commitment of its own funds was zero.

If it could in-

vest the balances at the prime rate, its annual earnings from the
arrangement were equal to the prime rate times $300,000.

Nevertheless,

this country banker was pleased with this correspondent arrangement.
With his bank fully invested, he found it necessary to pay this
relatively high price for seasonal credit.
City bankers traditionally have viewed deposit balances
as additional compensation for provision of participation
credit.

For example, one banker with a large farm participation

business, whose bank was therefore presumably offering participations
on terms competitive with other city banks, made this statement in 1963:
We will not accept an overline from a country bank
unless we have a deposit relationship with that
bank. We expect some correlation between the
amount of deposit relationship and the amount of
overline accommodation. ...We want the country
banker to participate substantially in any loan
he asks us to carry 47 /

46 / Robert L. Walton, op. cit., p. 30.
47 / Morris F. Miller, "Our Bank's Agricultural Program," Correspondent
Agribanking, Agricultural Committee, The American Bankers
Association, New York, 1963, p. 36.



- 121 -

Apparently, farm loans Obtained through correspondents were
not viewed as a sufficiently profitable investment,
even though the country banks were incurring most of the cost of
originating the loans and were sharing the risks involved.

Another

city banker has more recently affirmed this view:
Where lies the glamour for Mr. City Banker to send
funds to Farmer Smith through his banker in western
Illinois at the prime rate, with no deposit balance?
If, on the other hand, the same funds can be placed
locally at the same rate with 207o compensating
balances and some good trust business in prospect,
where would your stockholders expect the money to
go?"48/
Similar attitudes on the part of city banks are likely to become
even more common as more city banks encounter tighter liquidity
conditions, with inherent conflict between the loan demands of their
own customers and the credit needs of their country correspondents .
If the latter needs are met, it seems evident that the correspondent
system will exact a considerable toll for this service.
A proposal to minimize drains on rural funds « Though the
use of deposit balances to pay for correspondent services drains funds
from rural areas, in a number of common circumstances this means of
payment constitutes an efficient use of rural banking resources.

For

many nonmember banks, correspondent balances also serve to meet state
reserve requirements, and thus the funds would be unavailable for

48/ Robert E. Hamilton, "Farm Credit—It Should Be Supplied by Bankers,
But Agriculture Must Compete for Funds on the Same Basis as Any
Other Industry," Mid-Continent Banker, November 1968, p. 49.




- 122 lending anyway.

Also, at banks with funds in excess of loan demands, no

immediate diminution of lending capability results when balances are used
to pay for overline participations and other services.

Or, if a city bank

is content to be paid for seasonal credit extensions by balances received
only in the rural bank's off-season, and the rural bank would not be fullyinvested at that time in any event, payment through balances may not adversely affect the local credit service provided by the rural bank.
These circumstances are present in many correspondent relationships, and may help to explain why many country bankers in 1963 expressed
a preference for balances over fees as means of payment for correspondent
49/
services.— Also, it is natural for these bankers to favor a traditional
technique to which they are accustomed.

But with the increasing shortage of

loanable funds and more sophisticated management, more country banks may
question the use of correspondent balances to pay for overline or seasonal
participations.

In many instances, community needs might be better served if

rural banks made additional local loans with the funds they now are using to
maintain correspondent balances and used the returns on these loans to pay
for correspondent services on a fee basis . Fees for credit accomodation
should prove reasonable, as interest rates charged by city banks on participations and other farm loans should be high enough to make them a profitable
investment in their own right.
If city correspondents are able to adapt to the changed liquidity
position of rural banks, and at the same time maintain or expand credit
services provided to rural areas, they will continue to constitute a useful

49/Correspondent Relations;




A Survey of Banker Opinion, op. cit., pp. 10-12.

- 123 farm credit mechanism.

However, an inevitable conflict may arise as both

country and city banks simultaneously approach less liquid positions.

Thus

at the same time that country banks are interested in reducing correspondent
balances and increasing credit services, city banks probably have more interest in increasing balances and less interest in providing credit.

Given

these circumstances, it seems unlikely that the traditional correspondent
banking system can become the means whereby substantially larger quantities
of urban funds are channeled into agriculture.—However, correspondent
banking could contribute materially to this flow if city banks prove interested in becoming brokers for funds that country banks will need to maintain their role in rural finance.
Branch banking
In the heart of the nation's agricultural areas--the western
Corn Belt, Plains, and eastern Rocky Mountain states--branch banking is
prohibited or severely restricted.
loans are in this region.

One-half of the banking system's farm

Farm loan demands in the area have increased

rapidly as crop farm acreages have been enlarged and livestock production
increased.

In consequence, many agricultural banks have reached high loan-

deposit ratios and some have expressed concern over their future capacity
to finance agriculture.

Also, large farming operations are common in this

area, so that overline loan requests are frequently received.

Continued

availability of participation credit from larger correspondent banks is
essential in this environment.
In contrast, the 1966 survey of farm lending found that overline
requests and general farm financing present markedly smaller
J50/Further evidence and evaluation of credit flows through the correspondent
banking system has been provided by a Federal Reserve staff task force headed
by Ernest Baughman and Dorothy Nichols, Federal Reserve Bank of Chicago. Some
data and conclusions from this study are presented by Bernard Shull in
Reappraisal of the Federal Reserve Discount Mechanism: Report on Research
Undertaken in Connection with a System Study, Board of Governors of the Federal
Reserve System, August 1968, pp. 30-32.



- 124 problems in rural areas

served by large branch bank systems.

The

most striking evidence was contained in reports from the Pacific
states, where very large farms predominate.

But because the banks here

were also relatively large, overline requests were virtually nonexistent,
and few banks thought that farm loan demands pressed unduly against
their resources .
In addition to being less likely to receive farm loan requests exceeding their legal lending limit, large branch banks are
potentially able to improve rural credit services in several other
ways.

Their greater lending volume can support employment of specialists

in farming and farm lending.

Their lending practices and terms can

therefore stay abreast of modern developments.

Overall management of

the bank's resources is also likely to be better than that achieved by
many small banks.

A typical branch system is likely to operate at a

higher loan-deposit ratio than the average of an equivalent group of
unit banks, partly because its geographically diversified lending reduces
the overall risk.
banking resources.

More loans can therefore be made from the same
Within a branch system, funds can be shifted to

offices facing the greater loan demand.

Consequently, in communities

where credit needs are greatest loans may easily exceed deposits .
Finally, the larger banks are more likely to be able to tap national
money markets for additional funds .JLI/
On the other hand, there are reasons to question whether
branch banking can be relied upon to improve the flow of bank credit to
51/ As part of the overall discount study, Federal Reserve staff studies of
fund flows within branch banking systems were undertaken by Verle Johnson,
Harmon Haymes, and Margaret Beekel. A brief statement of the findings is
presented by Bernard Shu11 in Reappraisal of the Federal Reserve Discount
Mechanism; Report on Research Undertaken in Connection with a System Study,
op. cit., p. 32 .



- 125 agriculture.

To be most effective, a system should cover an area

sufficiently broad and diversified to include both capital surplus
and deficit regions between which funds can be moved.

With branching

limited to statewide systems at best, it is doubtful that this condition is met in some agricultural states.

A more meaningful con-

tribution could be expected if branching were permitted over a larger
economic area, or were delineated by national or regional economic
sectors rather than state lines.
A second major concern is that the management of branch
systems, because of unfamiliarity with rural finance, may not implement
the policies that would lead to the potential lending improvements cited above.

In a branch system covering a diversified area,

rural lending may be a less important activity than in a unit
bank in a rural community.

Top managers will properly allocate

less of their time to this phase of their bank's business.

Neverthe-

less, such a bank can perform an outstanding rural credit job if top
management is interested in developing its rural business along with
its other endeavors and employs capable technical staff to work in
rural credits.

But if such lending is neglected by a large branch

system, many rural communities may be adversely affected.

The potential

limitations should be recognized along with the advantages .
Finally, a realistic appraisal must note that state legislation now prohibiting branch banking seems likely to be changed quite
slowly, if at all.

While a gradual nationwide trend toward reduction

of restrictions can be detected, it has made little or no progress in




- 126 -

many nonmetropolitan states.




Meanwhile, it may prove desirable to

implement other measures to improve the ability of the banking system
to finance agriculture.

- 127 X.

FEDERAL RESERVE CREDIT

Since the early 1930 ! s, the Federal Reserve System has relied
mainly on open market operations to provide reserves to support a
growing volume of money and bank credit, as well as to offset
seasonal and other fluctuations affecting bank reserves . Recently,
only about 2 per cent of total reserve bank credit has on average been
supplied through the discount window.
Making reserve bank credit available through open market
operations and letting market forces determine its allocation has
much appeal, providing distributive mechanisms in the financial markets
enable a near-optimum allocation to be achieved.

Imperfection in

present mechanisms, however, may lead to less-than-optimum distribution
of new reserves among different economic and geographic sectors or may
cause long lags before an optimum allocation is attained.

Empirical

evidence tends to verify these fears .12/

To compensate for inequities that thus arise from the present
structure of banking and of financial markets, more Reserve Bank credit
could be provided directly to rural banks.

52/ After empirical work that included comparisons of portfolio behavior
at reserve city and country banks, Goldfeld concluded that in operations
providing for reserve growth, "There is .. .no assurance that reserves
generated by open-market purchases will find their way to banks in need
of funds . ...open-market operations are likely to affect country
banks only indirectly" (p.52). Similarly, in operations offsetting
reserve losses, "there is no assurance that the reserves created by
open-market purchases will be distributed among member banks in proportion to the reserve losses which they are intended to replace11
(p.183). Additional evidence is presented on pp. 149-150. See
Stephan M. Goldfeld, Commercial Bank Behavior and Economic Activity;
A Structural Study of Monetary Policy in the Postwar United States,
North-Holland Publishing Company, Amsterdam, 1966.




- 128 Through the discount mechanism, member banks in need of reserves have
had access to credit for short periods of time—too short in most cases
to provide effective support for farm lending.
Data on intra-year flows of loans and deposits show that many rural
banks could each year use adjustment credit provided for the entire
length of a farm production season.

Such credit could be supplied through

a discount mechanism redesigned to incorporate a seasonal borrowing
privilege.

The extent to which alternative types of such privileges

might improve farm credit availability at banks is examined in this
chapter.
The analysis also reveals that over one-half of member banks
in relatively tight liquidity positions face a year-round rather than
seasonal strain on their lending resources.

Furthermore, many rural

banks are not members of the Federal Reserve System, and if they so
remained, they would not be eligible for seasonal discount credit.

Two

possible Federal Reserve actions to assist both groups of banks are
examined:

(1) longer term credit through the discount or open-market

mechanisms and (2) improvement of markets for assets and liabilities of
rural banks.

Seasonal discount credit
Banks in nonmetropolitan areas frequently experience a seasonal
squeeze on funds through simultaneous withdrawal of deposits and expansion of loan demands.

Because of their small size and geographic

isolation, rural banks frequently are ill-equipped to utilize their resources effectively in a highly seasonal environment-




During the off-peak

- 129 season of the year, funds that might otherwise have been committed to
financing intermediate-term

rural needs instead tend to be maintained

in short-term Government securities, city bank, accounts, or other
forms that provide a high degree of liquidity, but that represent inefficient use of the financial resources of the community.

Twenty, or

perhaps even ten, years ago, when most banks had ample stocks of liquid
assets even at seasonal peaks, this situation caused little concern.
Now, however, many banks are hard-pressed to meet the loan demands of
their area.




With discount policy revised to allow

- 130 rural banks to borrow a substantial portion of the funds required
to meet seasonal outflows, these banks would have more funds for
meeting community needs and would be able to handle their investment
portfolios more satisfactorily.
The existing regulation permits extension of short-term
discount credit for seasonal requirements n...beyond those which
can reasonably be met by use of the bank f s own resources.11

This

regulation has usually been interpreted to mean that a bank is
expected to meet seasonal outflows of historically-average amplitude
through its own portfolio adjustments.

And when borrowing for seasonal

needs has been permitted, the assistance has usually been of shorter
term than the period of the bank's need.

A helpful revision of the

rule would permit Federal Reserve Banks to establish seasonal borrowing privileges for their member banks for meeting a portion of
normal seasonal needs, with maturities geared to the length of need.
This recommendation again seeks to remedy partially the inability
of small and isolated rural banks to tap national money markets effectively for short and intermediate-term funds.

The discussion

that follows demonstrates the scope of the seasonal lending problem
at such banks, and the extent to which assistance through the discount window might be helpful.
An example of seasonal fund flows at rural banks.

Not

all rural banks experience seasonal loan demand and deposit withdrawals
that are large in relation to the size of the bank.

But at some

banks, principally those in crop production areas, such fund outflows
can be violent.

To illustrate a situation of this kind, actual data

for three small banks in Nebraska, each with large seasonal flows




- 131 -

relative to its size, were averaged to obtain data for a composite
rural bank, as shown in Table 32 .
Over three-fourths of the loans at this bank consisted
of loans to farmers, both in December and in June.

But farm loans

increased by 64 per cent between December 1965 and June 1966.

In

the same interval, deposits of individuals, partnerships, and corporations (IPC deposits) decreased by 17 per cent.

Even after adjustment

for an upward growth trend in deposits and loans, the combined semiannual
fund outflow from increases in all loans and withdrawal of IPC
deposits was equal to 48 per cent of the December level of total
deposits.
Other data in Table 32 indicate that as this bank received
an inflow of deposits in the second half of the year, the money was
placed primarily in U.S. Government securities, and to a lesser extent
was held as balances at other banks.

In the spring, deposits flowed

out of the community, and in addition farmers borrowed for production
purposes.

To accommodate these seasonal demands, the bank sold the

securities that had been purchased the previous fall
down its balances with other banks.

and also drew

The combined trend-adjusted

semiannual change in these two assets totaled 44 per cent of total
December deposits, almost equal to the relative semiannual outflow
of 48 per cent.
It is thus evident that this bank financed the seasonal
demands of its community from its own resources; i.e., from the resources
of the community.

Funds deposited in the fall were merely stored

in anticipation of the certain outflow of the following spring.

The bank had

a loan-deposit ratio of 75 per cent in June, at which time its resources were




- 132 -

Table 32
Seasonal Fund Flows at a Composite Rural Bank*

Amount outstanding
(thousands of dollars)
June
December
June
1965
1965
1966

Trend-adjusted
January-June change
as per cent of
December total deposits

Farm loans
Total loans

1,867
2,414

1,295
1,664

2,124
2,485

+22
+25

Deposits (IPC)

2,684

3,549

2,952

-23

324
687

555
1,847

398
611

- 6
-38

77.8

40.4

74.9

Balances at other banks. . .
U.S. Gov't. securities . . .

Loans as per cent of
total deposits

^Average of data for three rural banks experiencing relatively large seasonal
flows of funds.




- 133 relatively fully employed.

In December, however, its loan-deposit

ratio was only 40 per cent.
Community consequences of large seasonal flows.

The composite

rural bank of the preceding example had nearly a maximum year-round
level of loans consistent with meeting the indicated seasonal outflow
from its own resources.

If it had additional year-round loan demand,

such as for farm machinery and equipment purchases or from nonfarm
businesses, it could in theory operate in a different fashion and
still meet the same seasonal outflow: it could commit its own funds
to the additional year-round loans and borrow an equivalent sum during
the spring and summer to meet the seasonal demand.

However, given

the present structure of money markets this could be a difficult
course for a small bank in Nebraska.
On the other hand^ if this bank were able to obtain seasonal
funds from its Reserve Bank

in sufficient quantity to cover a signi-

ficant portion of its seasonal outflow for the entire period of the
outflow, it could operate in just that fashion.

It could increase

its year-round lending for legitimate community needs with complete
assurance that funds would be available for the vital seasonal demands*
In addition, it is possible that this bank, in spite of
the large seasonal outflow, is not meeting the full seasonal loan
requirements of its customers.

Faced with increasing demand for

both year-round and seasonal credit, perhaps the latter is being
curtailed instead of or in addition to the former.

In this event,

seasonal borrowing from the Federal Reserve Bank would enable the
bank to meet more adequately the complete seasonal needs of the




- 134 -

community.

After several years the real seasonal pattern would

be evident, and the bank could obtain still greater seasonal sums
from the Federal Reserve, thereby releasing the community's own
resources for more year-round loans.
Community benefits from a seasonal discount privilege can
thus be expected in situations where banks (1) are experiencing a significant seasonal outflow of funds relative to their size, and (2)
are operating at a relatively loaned-up position at the peak of the
seasonal outflow, which tends to indicate that term and/or seasonal
loan demands are not being fully met, or that such a situation may
soon develop.

Hie following sections attempt to measure the prevalence

of these circumstances among rural member banks, and to estimate
the impact that seasonal discount arrangements might have on farm
lending at these banks.
Prevalence of large relative seasonal outflows.

Fund flow

data for all banks, similar to those shown for the composite rural
bank, indicate that banks involved in financing agriculture to the
extent of at least 25 per cent of their total loan volume (hereafter
referred to as "agricultural11 banks) are more likely than other banks
to have semiannual fund outflows.

As Table 33 indicates, 26 per

cent of agricultural banks experienced a semiannual fund outflow
equal to at least one-tenth of deposit volume.

Only 11 per cent

of other banks had relative outflow of this magnitude.

Also, an

additional 32 per cent of agricultural banks had semiannual fund
outflows of from 5 to 9 per cent of deposits, still a slightly higher
proportion than found among other banks.




- 135 Table 33
Distribution of Member Banks by Relative Semiannual Fund Outflow
and by Importance of Farm Lending
1965 - 66
Relative s emiannua1
fund outflow, 1965-66
(per cent)

All member banks
Under 5
5 to 9
10 and over

Farm loans as percentage of total loans
25 and
1 to 24
Under 1
over

Total

6,151

A. Nunber of member banks
1,388
2,713

3,398 .
1,784
969

867
344
177

1,665
786
262

2,050
866
654
530

B« Percentage distribution by relative outflow
All member banks

100

100

100

100

Under 5
5 to 9

55
29

62
25

61
29

42
32

10 and over

16

13

10

26

C. Percentage distribution by farm loan ratio
All member banks

100

23

44

33

Under 5
5 to 9
10 and over

100
100
100

2o
19
18

49
44
27

25
.37
55




- 136 As of June 1966, agricultural banks comprised one-third
of all member banks.

But of member banks with relative semiannual

outflow equal to 10 per cent or more of deposits, 55 per cent were
agricultural banks.

Of banks at which outflow comprised 5 to 9 per

cent of deposits, 37 per cent were agricultural banks.

Thus rela-

tively large seasonal fund outflows were more prevalent among agricultural banks—many of which were precisely the banks unable to
cope with such seasonal flows except by keeping their own resources
available for this event.
Potential impact of specific seasonal discount proposals.
In any arrangement that permits banks to borrow from Federal Reserve
Banks to meet part or all of seasonal outflows, specific rules would
be needed to guide the definition and measurement of seasonal outflows, and to indicate the proportion of outflows that could be met
by borrowing.

Formulation and execution of such rules could, and

undoubtedly would, employ more detailed banking data than the semiannual
statistics shown thus far.

The particular regulations adopted would

influence the total amount of seasonal credit extended by the Federal
Reserve System, as well as the amount that could be obtained by
agricultural banks.
An indication of the proportion and amount of borrowing
that might be done by agricultural banks, however, can be obtained
from the semiannual data that is now readily available for all banks.
Suppose, therefore, that seasonal outflow is defined as in the example
involving the composite rural bank, and that banks are allowed to
borrow funds equal to all outflow exceeding either (4) 5 per cent or




- 13? -

(b) 10 per cent of average deposits•

The extent to which agricultural

banks could participate in seasonal borrowing and the relationship
between their potential borrowings and their volume of farm lending
can be calculated to show the potential impact of the seasonal
discount credit on farm lending.

Selected data of this kind are

shown in Table 34.
Under the 10 per cent plan, 16 per cent of member banks
could borrow, and 55 per cent of these would be agricultural banks.
The 5 per cent plan would broaden potential borrowing to 45 per cent
of member banks, of which 43 per cent would still be agricultural
banks•
Though dominant in numbers, the borrowing agricultural
banks would tend to be smaller than other borrowing banks.

Thus

of total potential seasonal borrowings of $461 million under the
10 per cent plan, 26 per cent would be obtained by agricultural banks,
while under the 5 per cent plan they would obtain 14 per cent of
total borrowings of $2,130 million.

But though agricultural banks

would get a smaller portion of the total credit extended under the
latter plan, they would obtain a much larger sum, $307 million versus
only $120 million under the

10 per cent plan.

Under either plan, however, the potential borrowings would
have more potential impact on the agricultural banks than on the
other banks, reflecting the fact that seasonal outflows are proportionately greater at agricultural banks.

Borrowings by agricultural

banks under the 10 per cent plan could potentially equal 5.5 per




- 138 Table 34
Estimated Maximum Seasonal Borrowing at Agricultural and Other Banks
Under Alternative Discount Plans,
1965 - 66
Farm loans as percentage
Total
of total loans
Under
1 to
25 and
1
over
24

A. Number of banks eligible:
With deductible at 10%
With deductible at 5%

B.

Distribution of banks eligible:
(per cent):
With deductible at 10%
With deductible at 5%

969
2,753

177
521

262
1,048

530
1,184

100
100

18
19

27
38

55
43

461
2,130

157
1,022

185
801

120
307

100
100

34

48

40
38

26
14

4.1
3.0

3.0
2*.6

4.8
3.1

5.5
5.3

97.0
82.4

20.5
21.9

7.0
22.3

4.0
20.1

9.9
23.8

4.2
19.5

3.8
16.6

2.0
5.2

C. Borrowings (millions of dollars):
With deductible at 10% . . . • .
With deductible at 5%

D. Distribution of borrowings (per
cent):
With deductible at 10%
With deductible at 5%

E. Borrowings as per cent of deposits
at eligible banks:
With deductible at 10%
With deductible at 5%

F. Borrowings as per cent of farm
loans at eligible banks:
With deductible at 10% . . .
With deductible at 5% . . .
G.

Farm loans at eligible banks as per
cent of farm loans at all insured
banks:
With deductible at 10%
With deductible at 5%

59.4
87.3

—

H. Borrowings as per cent of farm loans
at all insured banks:
With deductible at 10%
With deductible at 5%




cent of deposits at the eligible banks, against only 3.0 per cent
at eligible banks with few or no farm loans.

The 5 per cent plan

yields the same difference in potential impact.

Thus seasonal borrowing

arrangements would not only benefit a greater proportion of agricultural banks than of other banks, but would also be of relatively
greater importance to the agricultural banks among the batiks eligible
to borrow.
At the eligible agricultural banks, potential borrowings
under either plan would equal about one-fifth of present farm loan
volume.

The proposal could thus have a significant impact on farm

lending at these banks.
The impact on total farm lending by all insured commercial
banks would be much smaller, but still potentially significant, especially under the 5 per cent plan.

Member banks eligible to borrow

under the 10 per cent plan would have 7.0 per cent of total farm
loans outstanding at all insured banks, while under the 5 per cent
plan the proportion rises

to 22.3 per cent.

Member agricultural

banks eligible to borrow under the alternative plans would hold 9.9
per cent and 23.8 per cent, respectively, of total farm loan volume
at all insured agricultural banks.

Potential borrowings are equal to

2.0 per cent and 5.2 per cent, respectively, of the total farm loan
volume at all insured agricultural banks.

The potential impact on

total farm lending is restrained because (1) agricultural banks with
large seasonal outflows tend to be small banks, and (2) two-thirds
of all agricultural banks, as well as of agricultural banks with
large seasonal outflows, are nonmember banks who would not be eligible
for seasonal discount credit from the Federal Reserve System unless




- 140 they became members, or unless a basic legislative change permitted such
borrowing by nonmembers.
Impact of bank liquidity on potential borrowing.

It seems

reasonable that banks with little liquidity, particularly at the
peak of seasonal outflows, would be most likely to utilize a seasonal
borrowing arrangement effectively.

The 1966 farm loan survey indi-

cated that banks began to experience significantly increased difficulty in financing their farm borrowers when loan-deposit ratios
exceeded 60 per cent. Table35 indicated that about 34 per cent of
agricultural banks eligible to borrow under the 10 per cent plan,
and a slightly smaller portion of those eligible under the 5 per
cent plan, were illiquid to this degree at their seasonal peak.
Another 30 per cent had loan-deposit ratios in the 50 to $t per cent
range, indicating that they might soon be more seriously concerned
with liquidity, and perhaps might already be able to benefit from
some seasonal borrowing.
At over one-third of agricultural member banks with large
relative seasonal outflows, however, loan-deposit ratios are apparently
under 50 per cent--at many banks, under 40 per cent—even at the
seasonal peak.

Though some of these banks might exercise a seasonal

borrowing privilege and perhaps thereby improve their farm lending
service, their present liquidity would permit them to do so even
in the absence of such arrangements. An analysis performed by the Federal
Reserve Bank of Kansas City showed that many such banks do not seem
to lack farm lending opportunities in their communities.

Many had

neighboring banks in the same or adjacent towns with much higher




loan-deposit ratios, some of which were expressing concern about

- 141 -

Table 35
Distribution of Agricultural Member Banks with Fund Outflow
in January-June 1966, by Relative Size of Outflow and
by Loan-deposit Ratio on June 30, 1966
Relative fund
outflow
(per cent)

Total

Loan-deposit ratio Xper cent)
Under | 40-49
50-59 60-69 70 and
over
40
i
A«

Total
Under 5. . .
5 to 9 . . .
10 and over.

1,663

304

376

472

355

602

118
102

143
138

125
116

84

95

156
170
146

568
493
B.

Total;.
Under 5. . .
5 to 9 .
10 and over.




Number of banks

114

156
60

42
54

Percentage. distribution by loan-deposit ratio

100

18

23

28

21

9

100
100

20
18

26

21
20

10

100

17

24
24
19

30
30

23

7
11

- 142 their inability to meet the legitimate loan demands of the area.
Greater educational and other efforts to overcome the managerial
inertia thus evidenced would be of service to the communities affected.
Latent seasonal demands.

The preceding evidence on the

potential assistance of seasonal discount credit to farm lending
necessarily shows only how it could help banks to cope with the
seasonal loan demands that they have actually filled in the past.
It is probable, however, that some—perhaps many--banks have seasonal
loan demands in their communities which have not been met because
of lack of funds.

Again, at progressive banks this situation is

likely to occur more frequently as liquidity is exhausted.
But though banking statistics alone cannot reveal latent
seasonal demands, some indications of their existence and relative
significance were already noted in Chapter VII, where the trend in
the amount of seasonal credit provided by banks was compared with
trends in seasonal operating expenses (Table 26) and in seasonal
credit provided by PCA f s (Table 2 8 ) .
Expenditures for current farm operating expenses with
significant seasonal components increased by 3.3 per cent annually
during 1950-68.

Over the same period, the semiannual variation

in total institutional non-real-estate debt rose at an average
yearly rate of 4.4 per cetrtf" Though this comparison is far from
complete, the evidence is Nevertheless consistent with the
hypothesis that increased farm seasonal credit demands are being
met by institutional lenders.
During the same period, however, the amount of the
semi-annual variation in bank non-real-estate loans rose at an




- 143 r

average annual rate of 3.0 per cent, whereas at PCA's the average
annual gain was 5#5 per cent.

PCA'a probably provided more addi-

tional seasonal credit than did banks over this period.

In 1950-54,

for instance, the average January-June loan increase at banks
amounted to $309 million, while at PCAfs the amount was $170
million.

By 1965-68, the amount at banks had risen to $407 million,

or by 32 per cent, whereas the amount at PCA f s

had doubled to

$343 million.
These data are consistent with the hypothesis that banks
have encountered greater difficulty in financing seasonal credit
demands of farmers, presumably because increased year-round loan
demands have reduced liquidity from which seasonal demands could
be met.

Increased seasonal demands upon PCA f s were readily financed

by short-term borrowings in the central money market, while rural
banks could not easily tap this source for significant amounts.

It

is conceivable that some farm borrowers switched from banks to PCA f s
primarily because the latter were more inclined to meet their seasonal
requests—not because PCA*s had a more favorable attitude toward the
wisdom of such borrowing, but simply because they were much better
able to cope with these demands.

A seasonal discount arrangement

for member banks would restore their ability to compete with PCA f s
in seasonal lending.
Supplemental adjustment credit.

To encourage rural banks

to take advantage of their eligibility for seasonal discount credit
under any plan that is implemented, such plan should clearly indicate




- 144 -

that banks using seasonal credit remain equally eligible for additional
short-term adjustment credit should circumstances make use of the
latter advisable.

Otherwise, at least until other financial mechanisms

are improved, rural banks might be reluctant to make full use of
the seasonal privilege for fear of unexpectedly finding themselves
in an illiquid position.
Rural banks on the whole have not made effective use of
present short-term adjustment credit available through the discount
window.

Clarification and simplification of the terms of and Federal

Reserve attitudes toward this privilege would be desirable to promote
such use, as conditions that present no problem to sophisticated
money market banks may have deterred many rural bankers.

Similarly,

any new regulations to govern seasonal credit extensions should be
comprehensible and suitable to the rural bankers that these arrangements are intended to serve.

Longer-term credit
Many rural banks face year-round rather than only seasonal
strains on their lending resources, according to loan-deposit ratios
that have been examined (Table 35). Structural factors at present
limit, the access of these banks to financial markets in which larger
and less isolated banks in the same circumstances are able to obtain
funds by selling their assets and liabilities.

To compensate for the

market imperfections, the Federal Reserve System conceivably could
provide reserves directly to the rural banks on a long-term basis.
One might propose that particular rural banks be allowed to borrow
at the discount window for indefinite periods, or that the Federal




- 145 Reserve purchase certain assets or liabilities of these banks, such
as farm loans, debentures secured by farm loans, or certificates
of deposit.
However, in contrast to seasonal or other temporary assistance,
provision of long-term Federal Reserve credit directly to specific
banks presents severe operational and conceptual difficulties.

In

principle, given the situation outlined above, the Federal Reserve
could try to provide the quantities of funds that rural banks might
obtain if they had better access to financial markets, and could
try to charge the rate of interest they would have to pay in the
market.

But what these quantities and rates might be and how they

might be altered from time to time by changes in general monetary
conditions and other factors would not be easy to determine within
acceptable limits.
Should a program of direct compensatory assistance nevertheless be implemented, it would undoubtedly improve the availability
of bank credit to farmers, obviously a goal of its proponents.

Para-

doxically, this effect, though it might be in the public interest,
creates a fatal conceptual difficulty.

As a principle of sound monetary

policy, the Federal Reserve will not knowingly enter upon programs
in which its credit-creating powers are used for the special benefit
of a particular sector of the economy, or in which it is called upon
to allocate credit among specific uses.

Through the years, Congress

has reinforced this view of the proper Federal Reserve role by turning
to or creating nonbank financial institutions to augment credit supplies
for specific economic sectors judged to be in need thereof, rather
than by asking the Federal Reserve to deliberately influence the




- 146 allocation of credit to these uses.

Since it would be difficult

to determine the point at which compensation for market imperfections
ends and favoritism toward farm credit begins, it is also difficult
to visualize the Federal Reserve embarking upon a direct program
of long-term assistance.
This conclusion about direct long-term credit, however,
does not negate the fact that a central bank can obtain equitable
and satisfactory results in supplying reserves mainly through open
market operations only if financial markets are well developed, as
they generally are in the United States.

Thus the Federal Reserve

has an implicit stake in the development and maintenance of financial
markets that serve all sectors of the economy.

It should work toward

perfection of markets on which the fairness and success of its procedures depend, and has done so on numerous occasions.

In the face

of decreased rural bank liquidity, and given that unit banking is
required in many primarily agricultural states, the Federal Reserve
should now undertake to secure improvement of secondary markets for
assets and liabilities of rural banks, including agricultural paper
and debentures secured by agricultural paper.

The Federal Reserve

has the knowledge and resources to take an active role in the
development of secondary markets such as those outlined in the next
chapter.

If necessary, for example, the Federal Open Market Committee

(FOMC) could extend material support to an embryonic market through
a controlled volume of trading in its instruments, similar to the
manner in which the FOMC has helped to establish the market for




- 147 -

bankers1 acceptances .11/

The Federal Reserve System and its FOMC

ought not ignore the structural imperfections in financial markets
and instruments that discriminate against small and isolated banks,

53/




Much of the Federal Reserve System1s rationale for purchases
of bankers1 acceptances and its procedures and experience in
this market appear transferable to the proposed dealings in
rural bank
paper or an instrument secured by such paper.
For instance, in describing operations in bankers1 acceptances,
Roosa states "the Federal Open Market Committee, in recognition
of the potentialities for further use of bankers1 acceptances
that may be inherent in the expanding role of the United States
in financing world trade, and for other reasons, decided to
resume the acquisitions of a portfolio in bankers1 acceptances
for the System itself. ...Ihe Federal Reserve has not, as a
matter of practice, sold acceptances out of its portfolio.
...there are almost always some acceptances maturing every day,
and in a relatively short time maturities alone can run the
holdings down as far as might be appropriate in conforming to
the direction of other credit policy action. ...the job of
the acceptance clerks is...one of...verifying the negotiability..«
as well as inquiring, under some circumstances, into the credit
standing of the business concern drawing the acceptance. Because
of the nature of this paper, however, the principal reliance
as to its soundness is placed upon the name of the accepting
bank and the added endorsement which the acceptance carries.
Current lists are maintained of all banks in the United States
engaged in extending acceptance credits, and the condition of
each such bank is periodically reviewed•" See Robert V. Roosa,
Federal Reserve Operations in the Money and Government Securities
Markets. Federal Reserve Bank of New York, 1956, pp. 87-90.
Recent year-end Federal Reserve holdings of bankers1 acceptances
have approached $200 million.

- 148 XI.

UNIFIED MARKETS TO SERVE RURAL BANKS

Unified markets — in which small and rural banks could obtain
market information and conduct trading in a wide variety of portfolio
items in units which correspond to their needs--would improve the flow
of funds to rural areas.

These institutions could provide rural banks

with both market information and trading facilities for purchases and
sales of Federal funds and government securities, placement and secondary
marketing of certificates of deposit, and secondary marketing of loan
paper.

With these services centralized in one location, rural bank

managers would have the market options now effectively available only
to larger banks, as well as the information necessary for proper decisions—for example, whether to raise funds by selling bonds, discounting loan paper, or participating in a certificate of deposit issue.
More transactions would become profitable—some are not now economical
because of the small amounts involved and the numerous telephone calls
to different markets required—and rural banks would enjoy an enhanced
ability to respond to changing loan demands and other conditions .
Structural and operational aspects of a unified market are
considered in this chapter.
tion are advanced.

First, some ideas for its basic organiza-

Next, the approach the agency might use in providing

a secondary market for rural bank

paper is analyzed in some detail.

Although the unified market would be most effective if all major types
of commercial bank loan paper were traded, only non-real-estate agricultural loan paper is covered herein, because the primary concern is
with availability of credit to farmers.

However, much of the analysis

also applies to trading in other types of paper.




Finally, the prospective

- 149 role of the unified market in trading in other instruments—Federal
funds, certificates of deposit, and bonds — is briefly discussed ^ 4 /

Organization
The cardinal principle in organization of a unified market
should be to provide rural bankers with a maximum amount of information
and service for a minimum of expense and effort on their part, just as
present money markets are organized to invite and expedite trading by
larger institutions.

Reasonably convenient facilities, adequate capital,

and a knowledgeable operating staff are essential, as are a competent
research staff and appropriate information gathering and disseminating
facilities .
To attain these goals most effectively and efficiently,
operations of regional unified markets should be coordinated and supervised by a national agency.

Given present and foreseeable develop-

ments in communications and computer technology, a national network of
unified markets can constitute a practical and desirable addition to
the nation's financial mechanisms.

A Secondary Market for Rural Bank Loans
Successful secondary markets for loans made by
rural banks would materially increase their ability to finance rural
communities . Development of such outlets would be a primary goal of
unified markets.
There are two basic ways in which a market for such paper could
be provided.

First, the unified market could simply bring together

buyers and sellers of the notes themselves. Or the market, acting as an
54/ For additional discussion of the unified market concept, see Doll,
Raymond J;, "Unified Markets for Rural Banks,11 Banking, Journal of
fhe American Rankers Association. January 1969, pp 63-65; and "Unified
Markets to Facilitate Exchange of Bank Assets and Liabilities," Bank
News MagazineT June 1969, pp 13-18.



- 150 agency, could sell debentures and use the proceeds to purchase rural bank
paper.

By either method, if the market is effective, a bank that is

loaned-up could obtain funds by selling notes from its
portfolio.

It could then use these funds to make additional loans.

Trading in loan paper.

Direct sale of loan paper to in-

vestors avoids the more complicated process of issuing debentures,
with the market itself becoming directly involved with questions of
risk.

However, the market for such paper might prove quite thin, as

most of the notes are small and frequently in odd amounts and maturities . But even if direct sales were restricted to the larger farm
notes of borrowers for whom financial and credit ratings are readily
available, significant sums might be obtained and rural banks would be
especially encouraged to provide adequate financing for the larger farms
and other firms in their community.
To increase the marketability of loan paper, the unified
markets could provide or arrange for some form of insurance that would
reduce or eliminate the risk of loss to the purchaser of an individual
note (alternative insurance plans are discussed below) . In so doing,
however, the markets would probably become involved in risk determination to about the same extent as they would if they bought the paper
themselves in a debenture operation.
Sale of debentures . The alternative method—sale of debentures secured by loans"would resemble the present operations of
the cooperative Farm Credit System, particularly those of the Federal
Intermediate Credit Banks.

These Banks have been able to raise funds

in national capital markets and use the proceeds to discount agricultural
paper of the production credit associations . This process has proven
efficient, and much of the experience would be transferable to the
operations of unified markets.



Also, favorable investor experience

- 151 -

with these issues should improve initial marketability of unified
market debentures.
The unified markets could logically use both approaches.
They could act as direct brokers, where feasible, in bringing together
buyers and sellers of rural bank paper, and in addition could issue
debentures to raise funds for purchase of such paper from commercial
banks.

These debentures should be joint obligations of all unified

markets—with only the paper purchased by these unified markets
being used as security.
The primary advantage of debentures is that they would enjoy
a much broader market than individual notes because they would be
issued in standard sizes, have more diversified security than individual notes, and would not require a new investigation by the potential investor for each purchase.

Thus they could undoubtedly be sold

in larger volume and at lower interest rates than individual notes.
Insurance mechanisms.

The attitudes of bankers and bank

examiners make it unlikely that significant amounts of discounting
can be done if bankers must retain the risk on the paper sold.

It seems

desirable, therefore, that all sales be made on a nonrecourse basis,
with controls established to prevent bankers from ignoring the credit
risks.

One such control is insurance.

Sellers could be required to

buy insurance on each note sold to the markets, with the rate depending
on the note's risk classification, but high enough to build up an
adequate reserve.-^/ Such insurance could be funded by the markets them55-1 Available evidence indicates that default losses on bank agricultural
loans average less than 0.5 per cent. Average insurance rates would,
of course, have to be slightly higher to cover other insurance costs,
although the insurance rate charged for high-quality loans might
still be less than 0.5 per cent.




- 152 selves or handled by private insurance companies.

The markets could

underwrite the insurance by acting through a central body to achieve
geographical diversification.

While the principle of insurance is

applicable whether loan paper is traded or debentures are issued,
insurance would be of particular benefit--or be virtually required--in
the former case, where it would reduce risk differentials and greatly
increase the probable number of market participants .
Alternatively, the markets could provide for risk differences
by varying the offering price
classification of each note.

according to their risk
Prices could be adjusted so that, after

allowance for probable losses, the rate of return on all notes would be
the same.

Over the long run, the price differences would exactly compensate

for losses.

Administrative costs of insurance would be saved, but the

risk classification process would entail some costs and difficulties.
The insurance problem might be better handled by a third alternative, the establishment of a reserve account for each

bank.

For instance, if a bank's actual losses average 0.5 per cent, payment
into its reserve account might proceed at the rate of 1 per cent of new
loans sold until the reserve equaled 2.5 per cent of total loans sold and still
outstanding.

Payments into the account would then cease until there was

either a net increase in the bank's

activity

or a loss on one of its

notes — in which case, they would be resumed at a rate of 1 per cent of
new

sales.

The relative size of the reserve would be varied

according to losses experienced over an appropriate period.
Losses larger than the reserve account would be borne by the
markets, so the procedure would be equivalent to sales on a limitedliability basis . Bankers who sold very high-quality paper would be




- 153 rewarded by very low insurance costs once the reserve was established.
Among the possible disadvantages is. the possibility that some bankers
might be reluctant to change an established volume of loan sales because this would require additional payments into their reserve accounts.
The accounts also would require continual supervision, but total administrative costs might well be lower than in the preceding alternatives
because individual notes would not have to be evaluated for risk.
Education.

To realize the full potential of secondary marketing

of loan paper, a major educational program would initially be desirable
to demonstrate the need for and benefits of secondary markets to bankers
and their customers . Such mutual understanding would help preclude
damage to customer relationships when banks market loan paper.
Unfortunately, the mere existence of a secondary market for
rural bank paper would not alone eliminate the managerial inertia
which exists in some rural banks.

However, these banks would be placed

under more pressure than at present, from their competitors and customers,
to improve their credit services to their communities.
Other services of unified markets
Federal funds.

Inclusion of Federal funds activity in the unified

markets would assure rural banks of greater access to the funds market, particularly on the buying side.

Currently, participation by small banks is

largely dependent on the willingness of city correspondent banks to act
as brokers or dealers in Federal funds.

Accommodation hinges largely on

whether the correspondent has complementary reserve needs or can match
the wishes of two country correspondents.




Under other circumstances,

- 154 -

correspondent banks appear much less willing to accommodate small
transactions in Federal funds.

By acting as a dealer, a unified

market could give small banks access to the Federal funds market on a
basis which is continuous, certain, and independent of their choice of
correspondent.
Unified markets probably could provide most effective service
in Federal funds by taking dealer positions.

This would enable them to

accommodate transactions of differing size and would allow them to offset net buying or selling by their customers through trading in the
national market — in effect, by acting as wholesalers of Federal funds.
In addition, a dealer operation would stimulate trading because a
selling bank would not have to concern itself with the solvency of a
different small bank each time it sold or to establish restrictive lists
of banks to which it would sell.
The minimum trading unit needs to be relatively small if banks
serving rural areas are to be able to participate effectively.

Also,

small banks might arrange to have the markets buy or sell funds for them
for specified periods of time on some automatic basis.

For example, a

bank might place a standing order for purchases or sales whenever its
excess reserves vary by one trading unit from a specified amount.
Another more sophisticated approach would rely on daily computer analysis
by the unified market of each bank's reserve account, with decisions
about whether and how much to trade being based on recent patterns of
its reserves and of Federal funds rates, the stage in the settlement




- 155 -

period, and the existing Federal funds rate as well as the bank's
current reserve position.

The unified market would need ready access

to the most recent information about each bank's position for this
approach to be most effective.

Arrangements could probably be made,

with authorization from the commercial banks concerned, for unified
markets to obtain current reserve status data directly from Federal
Reserve Banks at which these accounts are kept, via a real-time information system.^/
Certificates of deposit.

Unified markets could further improve

the geographical distribution of credit by facilitating the issue of
certificates of deposit by rural banks.

Rural commercial banks have

been excluded from the market for negotiable certificates primarily
by the standard size of the certificates.

For a bank with $5-$10 million

in deposits, a $1 million certificate (or, for that matter, even a
$100,000 certificate) simply is not a satisfactory instrument; it is too
large, relative to the bank's needs and resources, to be attractive either
to the bank or to potential investors. — '
A unified market could enable smaller banks to compete for time
deposit money by offering certificates in which a number of affiliated
banks participate.

Such certificates, of course, would be only partly

56/

For more information on the present structure of the Federal funds
market and some other suggestions for improvement, see Parker B. Willis,
Fundamental Reappraisal of the Discount Mechanism: A Study of the
Market for Federal Funds. Board of Governors of the Federal Reserve
System, Washington, D.C«, 1967.

57/

Description and evaluation of the present secondary market for
negotiable certificates of deposit and review of numerous suggestions
for improvement are provided by Parker B# Willis in Fundamental
Reappraisal of the Discount Mechanism; The Secondary Market for
Negotiable Certificates of Deposit. Board of Governors of the Federal
Reserve System, Washington, D. C9 1967.




- 156 -

insured at present by the Federal Deposit Insurance Corporation, and so
a prospective purchaser might need to investigate a number of banks in
order to evaluate the total risk inherent in a given certificate.

To

make such certificates marketable, it might be necessary for the unified
market to accept liability for them.

With proper supervision, unified

markets should be able to guarantee such instruments with minimum risk.
If insurance or guarantees were secured, the certificates almost
certainly could be traded in the existing market.
But if the unified markets cannot guarantee certificates issued
jointly by small banks, it might still be possible to establish a new
market for such issues.

The certificates would be classified as nonprime

and thus expected to carry a slightly higher rate of interest than primename certificates.

Also, many relatively small certificates would likely

be sold to allow issuing banks to obtain maturities of desired length
and diversity.

With sufficient effort, a new group of investors might

be attracted to these higher-yielding small issues, including smaller
corporations, banks, other financial institutions, and even individuals.
The volatility of demand for small certificates could prove
less than that experienced in the present large-certificate market, thus
making these instruments a more appropriate source of funds for small
banks.

And in particular, banks with well-established seasonal patterns

in local deposits and/or loans could meet seasonal outflows by timing
the maturity of certificates to coincide with periods of loan repayment
or deposit inflows.




- 157 -

The development of a strong demand for these small, joint-issue
certificates of deposit will be very dependent on a good secondary market
for them, thus making it important for the unified markets to act as brokers
in their resale as well as original issue.

The Federal Reserve System

could contribute to market development by making its wire facilities
available for transfer of certificates.

If offices of the unified market

also stored and redeemed certificates, costly mail transfers would be
avoided and marketability thereby enhanced.

Bond services.

Another activity valuable to participating banks

would be information and brokerage services in U.S. Government securities
and municipal bonds.

Unified markets could provide up-to-the-minute bond

quotations along with analysis of bond market trends and conditions.
Using this and other information provided by the markets, bankers could
choose the alternative for raising or investing funds which was best
suited to their specific situation.




- 158 XII.

CONCLUDING COMMENTS

If rural banks are to finance rural capital investment effectively
in the future, they must increasingly assume the role of intermediaries
that facilitate.flows of funds from money market centers.

But

present banking and money market mechanisms are ill suited to the needs
of progressive rural bankers who undertake this task.

With many rural banks encountering liquidity problems today-and such situations likely to intensify as well as multiply in the
future—the Federal Reserve System should act promptly to provide more
reserves directly to such banks, while simultaneously seeking to perfect market mechanisms.

Rediscount procedures should be immediately

revised to provide a greater volume of seasonal credit on a more appropriate basis than heretofore.

Discount procedures in general should

be revised as necessary to encourage and facilitate use of
this source of funds by rural banks.
These measures, promptly instituted, would buy time during
which financial market mechanisms could be improved to accommodate the
needs of small and isolated banks.

The Federal Reserve System, and

particularly its Federal Open Market Committee, should face up to
indications that such banks are unable to compete for funds with money
market banks and other agencies.

Federal Reserve distaste for providing

long-term discounts to disadvantaged banks, or for open-market purchases
of their securities, is justified only if financial markets are




- 159 structured to permit such banks to compete for available funds.

The

Federal Reserve System thus has both an obligation and a stake in securing
market perfections that make more significant and equitable participation
by small banks possible.
One of the more effective ways to overcome present deficiencies
might be through establishment of a network of unified markets to handle
transactions in the assets and liabilities of small banks.

A device

to permit these banks to market farm and other notes should constitute
a vital part of the services provided by such markets.

In this and

other financial instruments, unified markets could provide one-stop
information and service to small banks.
As these various measures are taken, a considerable number
of rural bankers would, as judged from present liquidity levels and
trends, be waiting to utilize them.

However, perhaps an equal number,

judging from the same banking statistics, are not now serving the
loan demands of their communities as well as their present liquidity
status would permit.

Federal Reserve Banks could render valuable service

by conducting educational programs aimed at overcoming or minimizing
managerial inertia at such banks, both now and especially as improved
sources of funds are established.

As knowledge of the latter spreads,

more community pressure on inert banks could also be expected.
The Federal Reserve System can make a real contribution to
rural finance, by helping to achieve the legislative-, -regulatory,
and market changes required by these recommendations, as well as by
arousing private individuals and institutions to face the challenges
presented.

The proposals are revolutionary in their implications for

city correspondent banks, for rural banks characterized by managerial




- 160 inertia, and for the discount officers and the Federal Open Market
Committee of the Federal Reserve System, but no more so than the
sweeping changes in rural economies that have made them necessary•





Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102