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____________ Review____________
Vol. 67 1 No. 8




O ctober 1985

5 Ilvo Views of the Effects of Government
Budget Deficits in the 1980s
17 The Status of Farm Lenders: An
Assessment of Eighth District and
National Trends

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Federal Reserve B ank of St. Louis
Review
O ctober 1985

In This Issue . . .




Leonall C. A n dersen
1924-1985
It is w ith a deep sense of loss that we note the passing of our friend an d
colleague Leonall "Andy" Andersen. A ndy ’s contributions to the econom ics
profession, m any of w h ich were published in this Review, were n um erous an d
significant. The focus of A ndy’s research after joining the Federal Reserve Bank of
St. Louis in 1962 was on the im pact of m onetaiy an d fiscal actions on econom ic
activity. Am ong his best-known contributions was the article, "M onetaiy and
Fiscal Actions: A Test of Their Relative Im portance in Econom ic Stabilization,”
w hich, co-authored w ith Je n y Jordan, appeared in this Review in 1968.
Andy held num erous positions w hile at the St. Louis Fed, in clu d in g director of
research and, at the tim e of his retirement in 1978, econom ic advisor. Upon
retiring from the bank, Andy held an endow ed chair in m oney a n d banking at the
University of Florida until 1981, w hen he became professor of econom ics at
Gustavus A dolphus College in St. Peter, Minnesota, a position he held until his
death on October 27, 1985.
★

★

★

The effects of ballooning federal budget deficits on the econom y have been a
m ajor concern for some time. In the first article in this Review, "Two Views o f the
Effects of Government Budget Deficits in the 1980s,” Jo h n A. Tatom explains the
predicted effects of deficits based on the conventional analysis an d a com peting
theoretical approach. The conventional analysis, according to Tatom, e m p h a­
sizes that deficit-increasing fiscal policies initially result in increased de m an d for
goods an d services an d a reduced supply of national saving. These two effects
lead to increases in national output, em ploym ent, prices an d interest rates. The
dow n side of such policies is a decline in private saving an d investment in
business structures, equipm ent an d inventory, an d housing. Since the sharp
increase in deficits in 1981-82, econom ic developments have been sharply at
odds with these predictions.
Tatom explains that the alternative set of hypotheses em phasizes the substitut­
ability between government and private expenditures an d the im portance of
perm anent instead of m easured incom e in private spending decisions. These
hypotheses indicate that deficit-increasing fiscal actions do not raise d e m an d for
goods an d services or reduce the supply of national saving. Therefore, they do not
affect output, em ploym ent, prices or interest rates. Fiscal deficits arising from
government expenditures directly “crowd-out” private spending, especially in ­
vestment, w hile those arising from tax reductions have no direct effect on national
saving, investment or interest rates.
Com paring the changes in the shares of private saving a n d investment in GNP
in 1980 an d 1984, Tatom indicates that both have risen sharply, instead of
declining as the conventional view w o uld predict. The author explains that
investment incentives provided in the 1981 tax act played a central role in raising
the private saving rate and the share of real business investment in real GNP to

3

In This Issue

Digitized 4for FRASER


record levels in 1984. These increases are more broadly consistent w ith the
alternative hypotheses than w ith the conventional view.
★

★

★

The plight of the nation's farmers has received a great deal of attention this year.
M u ch of it has focused on the deteriorating financial condition of farmers
overburdened w ith debt an d faced w ith falling land values a n d com m o d ity prices.
In the second article of this Review, Michael T. Belongia a n d Kenneth C. Carrara
examine the performance of the m ajor lenders to the farm sector to gain some
perspective about the sector’s financial condition. These financial institutions are
the Farm Credit System, agricultural banks a n d the Farmers Hom e A dm inistra­
tion (FmHA).
Belongia an d Carrara first offer a brief description of these three agricultural
lenders. They suggest that institutions that sharply increased their lending to
agriculture during the 1970s an d early 1980s, w hen inflation, foreign d e m an d for
U.S. farm products an d real com m odity prices were increasing or were expected
to increase rapidly, should be experiencing the greatest deterioration in portfolio
quality. The available data indicate that the performance o f agricultural loans, as
measured by delinquencies an d loan losses, has worsened at all three lenders
since 1982. In terms of profitability, however, agricultural banks have suffered less
severe dow nturns th an Farm Credit System lenders. The Farmers Home A d m in is­
tration (FmHA), w h ich is a governmental agency a n d therefore does not report
profitability data, also has exhibited greater forbearance on delinquent farm
loans. Although nearly 25 percent of their farm ow nership loans were delinquent
in 1984, only 0.22 percent of all FmHA farm loans were written off.

Two Mews of the Effects
of Government Budget Deficits
in the 1980s
John A. Tatom

_l_ EDERAL budget deficits in the United States have
become a m ajor concern since they rose to nearly $200
billion in fiscal 1983. In the absence of new policy
efforts, the deficit is projected to continue at $200 to
$250 billion per year for the rest of this decade.
Deficits, according to m ost p o pu lar analyses, raise
aggregate d e m an d for goods, services and credit,
w hich boosts output, em ploym ent, prices an d interest
rates an d reduces private investment.'
This article examines the em pirical and theoretical
basis of this m ainstream view. It also presents an
alternative set of hypotheses, w hich indicates that
fiscal policy actions are largely an d directly offset by
private spending changes, rendering the aggregate
dem and an d interest rate channels of influence in ­
significant.

T H E CON VEN TION AL ANALYSIS AND
R E C E N T E X P E R IE N C E
Conventional w isdom holds that recent a n d pro­
spective U.S. budget deficits have significantly raised

John A. Tatom is an assistant vice president at the Federal Reserve
Bank of St. Louis. Michael L. Durbin provided research assistance. An
earlier version of this paper was presented at the Spring Conference of
the Financial Research Foundation of Canada on April 16, 1985, in
Ontario, Canada.
'Most introductory textbooks emphasize the boost to aggregate
demand, interest rates and prices arising from “ expansionary” fiscal
policy actions. See, for example, the macroeconomics sections of
Dolan (1983), McConnell (1984), or Samuelson and Nordhaus
(1985). These texts also discuss some of the theoretical reserva­
tions about these channels of influence raised below. Note that the
hypothesized reduction in investment does not exceed the initial rise
in aggregate demand for goods and services that arises from deficitincreasing fiscal actions.




interest rates a n d have prom oted the crowding out of
investment. But this view is based on the conventional
deficit/aggregate-demand hypothesis that also holds
that an expanded deficit should increase both output
and the price level. The latter conclusions became
center stage in 1980-81 w h e n the Reagan econom ic
program was debated. Their em pirical validity, w hich
remains largely unquestioned, was strongly rejected
after mid-1981 w hen, w ith the deficit expanding, in ­
flation plu m m e te d from double-digit levels an d the
econom y entered the longest an d m ost severe reces­
sion since the 1930s.
Interest rate developments were also at odds with
the conventional view. Chart 1 shows the total govern­
m ent deficit as a percent of GNP a n d the AAA b on d
yield since 1950. The surge to historically high interest
rates occurred well before the 1981-82 surge in the
deficit.2T h e recent rise in the deficit occurs from the
third quarter of 1981 to the fourth quarter of 1982,
w hen the AAA bond yield declined from about 15
percent to 12 percent. Then, in 1983-84, the deficit
declined sharply relative to GNP, but the AAA bond
yield rose.
The principal difficulty in finding a positive relation­
ship between deficits an d interest rates arises from the
fact that both the budget deficit an d interest rates
move cyclically an d in opposite directions. Hence, it is
not surprising, especially for short-term interest rates,
that empirical studies often turn u p supposedly sig­

2Similarly, the appreciation of the dollar precedes the deficit surge.
The steady upward appreciation of the trade-weighted exchange
rate for the U.S. dollar began at the end of 1979 (when interest rates
soared) and was not noticeably affected by the 1981-82 deficit
surge.

5

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

A a a Bond Yield and Total Governm ent Deficit as a Percent of GNP
P e rc e it
15

1950 51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

72

73

74

75

76

77

78

79

80

81

82

83

84 1985

S h a d e d a re a s re p re s e n t pe rio ds o f business recessions.
Latest d a ta p lo tte d : 2 n d q u a rte r

nificant negative statistical relationships between in ­
terest rates and deficits. W hen one uses deficits con­
structed on a high-employment basis — that is, w ith
systematic cyclical influences removed — there still is
no evidence of a positive relationship between deficits
and either short- or long-term interest rates over the
period 1955-83.'

3See Tatom (1984). Efforts to control for future inflation expectations
to capture real interest rate changes do not affect the observed
absence of a deficit effect on interest rates. Also, some analysts
conjecture that the debt/GNP ratio positively influences the interest
rate. Regressions of quarterly changes in the AAA bond yield or
three-month Treasury bill rates on changes in the ratio of net federal
debt to GNP, controlling for changes in the capacity utilization rate
and the inflation rate one quarter ahead, yield a negative but insig­
nificant relationship for the debt ratio over the period 1/1955 to III/
1984.
The independence of interest rates from the deficit has been
observed by Evans (1985). Also see Feldstein and Eckstein (1970),
Sargent (1973), and the recent Treasury study (1984). Plosser
(1982) details many of the theoretical and econometric difficulties of
previous tests of the interest rate/deficit hypothesis.

Digitized
6 for FRASER


Has Recent Crowding Out Reduced
Investment?
Chart 2 shows private dom estic investment as a
share of GNP. Investment has declined a n d risen cycli­
cally since 1980, but these swings obscure the strength
of investment over the past four years. W he n the
capacity utilization rate is relatively low, the dem and
for new capital can be met more easily by the re­
em ploym ent of existing capital instead of investment
in new facilities. Thus, the share of investment in GNP
an d the capacity utilization rate tend to move in tan­
dem or to be positively correlated. In 1984, the capac­
ity utilization rate was well below its 1979 level, w hen
the prior peak investment ratio was achieved. Never­
theless, the share of private dom estic investment in
GNP in 1984 virtually m atched this peak level.
Even plant an d equipm ent (nonresidential fixed)
investment has been quite high by historical stand­
ards, despite the recessions in 1980-82. W hen nom in al

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

C h a rt 2

Nonresidential Fixed Investment as a Percent of GNP
Perceat

P erceit
Mi

1950 S I

-- 14

52

53

54

55

56

57

51

59

60

S h ad ed are as re p re s e n t p e r io d s o ( bu s in e s s recessions.
Latest d a ta p lo tte d : 2 n d q u a rte r

nonresidential fixed investment and GNP are adjusted
by their respective deflators, in order to measure real
investment as a share of real GNP, the recent strength
of plant an d equipm ent spending relative to real GNP
represents a postwar peak performance. This share is
show n in chart 3. Note that, even at the depths of the
previous two recessions, real plant an d equipm ent
purchases were about as large a share of real GNP as
the 11 percent attained at the peaks of previous invest­
m ent boom s in 1966 and 1969.4The conventional argu­
ment, that investment has been unusually weak due to
the higher real rates of interest, is not obviously im p or­
tant in explaining recent investment experience.

“The reason for the greater real strength is that the relative price for
new plant and equipment declined sharply since 1980. The nonresi­
dential fixed investment deflator declined 14.2 percent relative to the
GNP deflator from 1980 to 1984.




T H E M A C R O E C O N O M IC E FF E C T S O F
FISC A L P O L IC Y
A closer look at the theoretical m echanism underly­
ing conventional analyses of the deficit reveals some of
the potential shortcom ings of these analyses. In the
textbook view of the effects of fiscal policy on the
economy, increased government deficits expand ag­
gregate dem and, spending, o u tp u t a n d em ploym ent,
regardless of w hether larger deficits arise from in ­
creases in purchases, transfer paym ents or reductions
in taxes. So-called balanced-budget increases in trans­
fer payments, in w h ic h a rise in transfer paym ents is
m atched by a rise in taxes, leave aggregate dem and
unchanged (ignoring distribution effects), while taxfinanced increases in government purchases raise ag­
gregate dem and.
Such conventional analyses also take into account
crowding out — reductions in private spending that

7

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

C h a rt 3

Private Domestic Investment as a Percent of GNP

1 9 5 0 51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

72

73

74

75

76

77

78

79

80

81

82

83

8 4 1985

L a te s t d a ta p lo tte d : 2 n d q u a r te r

occur due to fiscal policy changes. Increases in the
deficit, so the argum ent goes, result in increased com ­
petition in credit markets, thus b id din g u p interest
rates. Also, if fiscal policy actions raise aggregate de­
m and, the increased com petition in the market for
goods a n d sendees bids u p the general level of prices.
For both reasons, real private spending is reduced, or
crowded out. Households reduce their current real
consum ption expenditures a n d increase saving; firms
reduce real investment spending in response to a
higher interest rate.

Fiscal Policy Crowding Out: Saving,
Investment and the Interest Rate
The im portant link between fiscal policy, aggregate
dem and a n d interest rates an d the concept of crow d­
ing out of private expenditures can be illustrated in
the market for saving. In figure 1, the de m an d for
saving is taken to be the dem and for funds to finance
Digitized
8 for FRASER


investment. O ther things that influence investment
rem aining the same, the d e m an d for investment or for
saving to finance it, is inversely related to the interest
rate. The supply of saving consists of private saving —
household disposable incom e less desired co n s u m p ­
tion expenditures — a n d government saving — the
excess of tax receipts over government expenditures,
or the budget surplus. In figure 1, the national saving
schedule is draw n as upward-sloping, indicating that,
given income, households reduce consum ptio n ex­
penditures a n d save more at higher interest rates. In
equilibrium at p oint A, the interest rate equates the
supply and d em an d for national saving at interest rate

In the conventional analysis, fiscal policy actions
affect national saving, investment an d the interest rate
by (1) directly changing the budget surplus or govern­
m ent saving, and/or (2) altering private saving. Such
changes shift the national saving schedule. Given GNP

FEDERAL RESERVE BANK OF ST. LOUIS

F ig u r e 1

National Saving, Investment and the Rate of Interest

OCTOBER 1985

change. In this case, however, the rise in aggregate
dem and is the governm ent’s, w hile before it was the
policy-induced change in private co n sum ptio n ex­
penditures. As before, however, interest rates w ill tend
to rise, increasing private saving a n d reducing con­
sum ption an d investment expenditures.
Tax-financed changes in government purchases, on
the other hand, reduce private saving, given the inter­
est rate an d GNP. The higher tax reduces disposable
incom e and therefore both con sum ptio n expendi­
tures an d private saving. The reduction in private
saving is less than the tax increase, because private
expenditures on goods an d services also decline.
Since the government deficit does not change with
such a fiscal action, the decline in national saving
equals the reduction in private saving. The reduction
in national or private saving again indicates a rise in
aggregate d e m an d for goods an d services. Taxfinanced changes in transfer payments have no effect
on aggregate de m an d for goods a n d services or the
national saving schedule in figure 1, since the govern­
m ent deficit an d disposable incom e rem ain u n ­
changed. Thus, private an d total spending on goods
an d services an d private an d national saving are
unaffected.

an d interest rates, a fall in taxes or a rise in transfer
payments (financed by borrowing) adds to disposable
income, increasing both private consum ptio n ex­
penditures an d private saving. Since part of the tax cut
or transfer paym ent is spent for consum ption, the rise
in private saving is less than the deficit increase. Thus,
national saving declines.
Such a decline also indicates that desired aggregate
d em and for goods and services has risen so that it
m ust exceed the given level of GNP; the aggregate
d em and increase equals the reduction in national
saving. W ith no change in GNP, the interest rate m ust
rise to equate national saving an d investment. In re­
sponse to the higher interest rate, investment is
crowded out, or declines, but some of the initial short­
fall in national saving is elim inated since individuals
also increase private saving.
A rise in government purchases also affects national
saving. In contrast to a tax cut or a rise in transfer
payments, a rise in government purchases does not
change disposable income, so consum ptio n expendi­
tures and private saving rem ain unchanged. But the
rise in purchases raises the budget deficit or reduces
government saving. National saving falls by exactly the
change in aggregate d e m an d for goods a n d services, as
was the case above for the tax or transfer paym ent



In summary, the initial effects of fiscal policy actions
on private an d national saving are the critical counter­
parts of any initial change in aggregate d e m an d for
goods an d services; both indicate the extent of upw ard
pressure on interest rates. The analysis here illustrates
the im portance of both of these initial shifts. It also
indicates w hy crow ding out tends to occur. In the
conventional analysis, however, crow ding out is gen­
erally presum ed not to be complete."

C row ding In
The growth in aggregate d e m an d associated w ith
reductions in national saving can raise or “crowd in ”
GNP. W hen GNP rises, disposable incom e, co n s u m p ­
tion expenditures an d private saving rise; the initial
reduction of private an d national saving is offset bv

5The Council of Economic Advisers (1985), pp. 70-77, suggests that
economic theory and evidence support “ complete” crowding out,
where the total real demand for goods and services is unaffected by
fiscal policy actions. Whether this crowding out, primarily of invest­
ment, arises through interest-rate or price-level crowding out or
direct substitution of public for private expenditures is not indicated.
The Congressional Budget Office (1985) also provides a detailed
discussion of the effects of deficits. A recent review by Brunner
(1984) provides the best recent discussion of the theoretical issues
associated with the macroeconomic theory of fiscal policy. Also, see
Carlson and Spencer (1975).

9

FEDERAL RESERVE BANK OF ST. LOUIS

increases in both as GNP increases. The full adjust­
m ent of GNP, however, w ith interest rates constant,
cannot raise national saving back to its initial level, so
the interest rate increase and crow ding out w ill still
occur. Note, however, that GNP cannot increase, just
as interest rates cannot rise, unless the initial reduc­
tions in national saving occur.

Some Reservations: The Permanent
Income Hypothesis and Ex Ante
Crowding Out
An alternative set of hypotheses about the effects of
fiscal policy actions on the economy, sometimes
called classical or Ricardian, em phasizes two theoreti­
cal considerations called the perm anent incom e hy­
pothesis a n d e?c ante crow ding out. According to this
view, consum ptio n expenditures are a function of
permanent income; consequently, variations in saving
(and saving relative to GNP) have a large cyclical c om ­
ponent.6 The perm anent incom e hypothesis also en­
tails a government budget constraint, w h ich indicates
that the present value of current an d future govern­
m ent expenditures m ust equal the present value of
current a n d future taxes. This constraint im plies that
the m ethod of financing government expenditures is
irrelevant; that is, w hether current expenditures are
financed through taxation or borrowing (future taxes
w ith an equivalent present value) has no influence on
the econom y/ Thus, changes in taxes are offset by
equal changes in private saving, an d national saving is
unaffected.
The second consideration is that government ex­
penditures are, to some degree, substitutes for private
expenditures.8 For example, an increase in govern­
m ent expenditures for school lunches may reduce
private consum ptio n expenditures on such goods;
increased public expenditures for transportation ser­

OCTOBER 1985

vices m ay reduce private d e m an d for such investment
goods; increased transfer paym ents provide assis­
tance that m ay substitute for private saving a n d invest­
ment. To the extent that such substitution occurs,
growth in government purchases crowds out private
purchases w ith no net effect on econom ic activity;
such growth in government purchases results in off­
setting reductions in private expenditures in clud in g
investment. Similarly, growth in transfer payments
can affect the m ix of desired private spending. No
excess de m an d for national saving occurs, n o r is ag­
gregate d e m an d for goods a n d services altered; thus,
GNP a n d interest rates are not affected by fiscal policy.
The em phasis in this view of fiscal policy is on e?c
ante crowding out, in w h ich fiscal policy actions are
largely offset by direct private sector responses.11An
increase in government purchases does not have to
affect the interest rate; either national saving could
remain unaffected by governm ent purchases, as these
substitute for private consum ptio n, or investment de­
m a n d cou ld be reduced equally, as government p u r­
chases substitute for investment purchases. Similarly,
national saving an d private investment can be re­
duced due to increased transfer payments. Thus, ag­
gregate dem and, interest rates a n d the price level may
not be affected by fiscal actions '"
If e?c ante crow ding out leads to private expenditure
changes that fully offset fiscal policy actions, then the
effects of fiscal actions on the private a n d national
saving w ill not be the same as in the conventional
analysis. One fundam ental difference is that a rise in
taxes w ill reduce private saving by an equal am ount.
Thus, a tax hike will result in an equal reduction in
private saving, leaving national saving un changed.11
This im plies that the effects of government expendi­
tures on national saving are the same w hether they are
tax- or bond-financed.
Another m ajor difference is that a rise in govern-

6Textbook analyses typically distinguish between permanent and
temporary changes in fiscal actions, based on the permanent in­
come hypothesis. Temporary changes in taxes or transfer payments
are generally regarded to have little effect on private spending or
national saving since such changes do not alter perceptions of
permanent income or wealth. A type of temporary, or at least
transitory, change in the budget arises from the “ cyclical deficit.”
When unemployment rises due to a cyclical fall in income, tax
receipts decline and federal expenditures, especially transfer pay­
ments for unemployment insurance, rise. As a result, the budget
deficit rises.
T h is consideration has come to be called the Ricardian Equivalence
Theorem. It is developed by Barro (1974, 1979) and has received
strong support from Plosser (1982), Aschauer (1985), Tanner
(1979) and Kormendi (1983). See also Kochin (1974).
8Bailey (1971) discusses at length the theoretical possibilities that
fiscal actions directly influence private sector behavior.

Digitized
10 for FRASER


9There are exceptions to the conclusion that fiscal actions do not
affect aggregate demand. See Hall (1980) and Barro (1981) for
discussions of the real output effects of temporary increases in
government purchases, especially defense expenditures, even in a
Ricardian world.
10The absence of effects of fiscal actions on GNP has been a feature
of reduced-form estimates like the St. Louis equation for some time.
See Hafer (1982) and the references there for recent analyses.
Permanent adverse effects of government expenditures on invest­
ment are found in Carlson (1982). Also see the references in
footnote 1.
"In the conventional view, a rise in taxes initially reduces disposable
income by an equal amount and results in a fractional reduction in
private saving. The fraction, called the marginal propensity to save,
is generally regarded to be relatively small, on the order of 20 to 30
percent.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

Table 1
The Share of Government Budget
Components in GNP: 1980 and 1984
1980

1984

33.0%

34.3%

1.3%

20.4
12.6

20.4
13.9

0.0
1.3

Total government receipts

31.8

31.0

-0 .8

Total government surplus

- 1 .2

-3 .4

-2 .2

Total government expenditures
Purchases of goods and services
Transfer payments

Change

m ent purchases w ill reduce private consum ptio n or
raise saving, if such purchases are a substitute for
private consum ptio n expenditures. Similarly, a rise in
transfer payments w ill reduce private saving an d in ­
vestment, if such paym ents are substitutes for saving.
This can occur independently of distribution effects
that in either view can yield a reduction in private
saving. Finally, in the classical view, the effects of
government expenditures on national saving can be
associated w ith equal shifts in investment dem and
that reflect the extent to w h ich government expendi­
tures an d investment are substitutes.

Recent Fiscal Policy Developments and
Saving and Investment
A com parison of the im plications of the two views
above can be facilitated by a look at the experience in
the 1980s. Table 1 shows the principal com ponents of
the total government surplus as a share of GNP in 1980,
before the ballooning of the federal deficit, and 1984,
the latest year available. From 1980 to 1984, the deficit
w idened from 1.2 percent to 3.4 percent of GNP. The
share of government purchases was unchanged, while
the share of transfer paym ents rose. The rise in the
deficit was accounted for prim arily by a rise in transfer
payments and, to a smaller extent, by a decline in
taxes.'3 These changes are explained to only a small

"Several recent studies have examined the effects of fiscal actions
on personal consumption expenditures in tests of ex ante crowding
out. See Aschauer (1985), Feldstein (1982) and Kormendi (1983).
These tests allow for direct substitution of government purchases
for private consumption expenditures and transfer payments for
private saving; they do not address the extent to which government
expenditures directly affect private investment expenditures.
,3The decline in the share of government receipts in GNP matches the
decline in the share of corporate profit tax liability in GNP.




extent by relative differences in the cyclical perfor­
m ance of the econom y in 1980 an d 1984. The average
unem ploym ent rate of 7.5 percent of the civilian labor
force in 1984 was only slightly higher th an the 7.1
percent in 1980. W hen unem ploy m ent is higher, gov­
ernm ent transfer paym ents (especially unem plo y ­
m ent com pensation) are higher, and, due to cyclical
losses in income, tax paym ents are lower than they
w o uld be otherwise.
In the conventional analysis, the effect of the
changes in the fiscal stance of the government sector
show n in table 1 on saving is to raise the private saving
rate (PSR) bv a fraction — on the order of about 25
percent — of the increased deficit (2.2 percent) or
roughly 0.5 to 0.6 percentage points. Since the ex­
pected rise in the PSR is smaller than the rise in the
deficit, the national saving rate (NSR) w o uld be ex­
pected to fall by the difference, about 1.6 to 1.7 per­
centage points. Associated w ith this shift in the na­
tional saving rate is an increase in the share of GNP
allocated for co n sum ptio n expenditures a n d an ex­
cess dem an d for funds to finance investment. In the
conventional view, aggregate d e m a n d sh o uld have
risen, im proving the cyclical performance of the
econom y a n d raising prices, a n d interest rates should
have risen; the latter, of course, should have lowered
investment.
In the classical view, part of the increased deficit
arose from the reduction in receipts as a share of GNP;
this part is expected to be largely offset by a rise in the
PSR, leaving the national saving rate unchanged. The
rem ainder of the rise in the deficit, the rise in the share
of transfer payments, w o uld be expected to reduce
private saving a n d investment to the extent that
households view transfer paym ents as substitutes for
such avenues of w ealth accum ulation. Thus, the PSR
a n d NSR could be expected to decline by some frac­
tion of the 1.3 percentage-point rise in transfer pay­
m ents. As a net result of these two forces, the PSR
should rise by u p to 0.8 percentage points, a n d the
NSR should decline slightly. Interest rates an d the
cyclical com ponents of real GNP an d em ploym ent
should be unchanged.
Com paring 1984 w ith 1980, two central differences
in expectations emerge between the conventional and
classical views. These differences concern interest
rates an d the cyclical perform ance of the economy.
The cyclical performance of the econom y was slightly
worse in 1984 than in 1980. Interest rates were gener­
ally higher in 1984 th an in 1980, despite a decline in
inflation. For example, in 1980, the consum er price
index rose 13.5 percent, w hile rising only 4.3 percent

11

OCTOBER 1985

FEDERAL RESERVE BANK OF ST. LOUIS

C h a rt 4

Governm ent Surplus, N ational Saving and Private Saving as a Percent of GNP

NOTE: D a ta a re n a tio n a l in c o m e an d p ro d u c t account ba sis.
|_1 The ra tio o f gross p r iv a te s o v in g to GNP.
[2 P riv a te s a vin g plus the g o v e rn m e n t s u rp lu s as a p e rce n t o f GNP.
S h ad ed a re a s re p re s e n t p e r io d s o f business recessions.
Latest d a ta p lo tte d : 2 n d q u a r te r

in 1984. The average Aaa b o n d weld, however, aver­
aged 11.94 percent in 1980, w hile averaging 12.71 per­
cent in 1984. Thus, cyclical developments are more
consistent w ith the classical view, but interest rate
developments, considering these two years, are more
consistent w ith the conventional w isdom .14
Of course, other factors that influence interest rates
an d cyclical performance are not likely to have re­
m ained the same, an d more careful control for these
factors is necessaiy to discrim inate between the hy­
potheses. Some insight into the im portance of these
other factors can be gained by exam ining the other
im plications of these hypotheses.

14ln fact, interest rate movements have not followed the deficit over
the whole period, only in the two years indicated. This apparent
contradiction arises from the fact that most of the increase in the
deficit occurred in 1982 when interest rates had been declining and
continued to decline, while the rise in interest rates over this period
occurred in 1980 and 1981, and the decline in inflation occurred in
1981.

Digitized
12for FRASER


W hile the im plications of fiscal developments in
these two years for the saving rates are sim ilar in the
two views, it is useful to examine w hat h app e n e d to
these rates. Chart 4 shows the private saving rate,
government surplus share a n d national saving rate
from 1950 to the end of 1984.'’ The PSR has been fairly
constant com pared w ith the NSR. For example, from 1/
1950 to IV/1984, the PSR averaged 16.5 percent, exhib­
ited no trend a n d h ad a standard deviation of only 1.02
percentage points.,c Such behavior, however, m ay

15ln the national income and product accounts, private saving in­
cludes both personal and business saving. Private saving plus
government saving equals national saving. Government saving is
the budget surplus of the federal, state and local governments.
Gross private domestic investment equals national saving plus net
foreign saving.
16This near constancy has been formulated as "Denison’s Law” which
indicates that private saving is proportional to high-employment or
trend GNP but is cyclical, rising in expansions and declining during
recessions. Denison's Law is developed in Denison (1958), Hick­
man (1966) and David and Scadding (1974). The latter indicate that
Denison’s Law provides strong support for Friedman’s (1957)
permanent-income theory of consumption.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

Table 2
Shares of Components of Gross Private Saving in GNP: 1980
and 1984
Gross private saving1
Personal saving
Business saving:
Undistributed corporate profit2
Corporate capital consumption allowance2
Noncorporate capital consumption allowance
with capital consumption adjustment
Addendum: Corporate capital consumption adjustment

1980

1984

16.5%

18.4%

Change
1.9%

4.2

4.3

12.4
1.2
(1.8)
6.8
(6.2)

14.2
3.2
(1.6)
6.7
(8.2)

4.3

4.3

0.0

- 0 .6

1.5

+ 2.1

0.1
1.8
2.0
(-0 .2 )
(- 0 .1 )
( + 2.0)

'Figures do not add due to rounding.
2The top entry for each of the components of corporate business saving includes the capital consumption
adjustment. The figure in parentheses excludes the capital consumption adjustment.

obscure the conflicting effects of various influences on
the PSR.
The NSR appears to be strongly cyclical, declining
sharply in recessions. This pattern m ust arise from
cyclical movements in government saving since the
PSR does not appear to be cyclical. Cyclical differences
may not have exerted a strong influence in com paring
1984 to 1980 performance, however.
From 1980 to 1984, the PSR rose sharply from an
average of 16.5 percent to 18.4 percent. Based on the
conventional analysis, this rise is sharply higher than
that expected. Similarly, the national saving rate fell
from 15.4 percent to 15.0 percent, m uch smaller than
the decline expected from the conventional analysis,
but it may also be smaller than that expected from the
classical view.
The counterpart of strong saving, domestic invest­
ment, has been even stronger since 1981. In the na­
tional incom e a n d product accounts, gross saving
equals gross investment, except for a m in o r statistical
discrepancy. Gross private domestic investment as a
share of GNP rose 2.1 percentage points to 17.4 percent
in 1984, despite the 0.4 percentage-point fall in the
national saving rate. This difference is accounted for
by the inflow of net foreign saving, the largest share of
w hich was due to domestic firms channeling their
own funds from investment abroad into domestic




investment. In 1980, U.S. assets abroad rose $96.3 bil­
lion, but this pace of investment plum m eted to $20.9
billion in 1984. The pace of foreign investment in the
United States increased slightly over the period. For­
eign assets in the United States rose $98.8 billion in
1984, up slightly from the $84.7 billion pace in 1980. As
a result, net foreign investment fell from an $11.6
billion outflow in 1980 to a net inflow of $77.9 billion in
1984.
The recent behavior of investment suggests a strong
candidate for the significant om itted factor account­
ing for the strength of dom estic saving and the rise in
interest rates. This factor, the investment incentives in
the 1981 tax act, accounts for the relative strength of
investment, despite the higher level of interest rates in
1984 than in 1980. More direct evidence of these effects
can be seen in the d o m in an t com ponent of saving in
the United States, business saving.
Table 2 provides a sum m ary of com ponents of pri­
vate saving in 1980 an d 1984. The rise in the private
saving rate was virtually all due to an increase in the
business saving rate. The latter, in turn, arose almost
completely because of an increase in the corporate
capital consum ptio n adjustm ent as a share of GNP.
This figure corrects reported profits an d capital con­
sum ption (depreciation) allowances for the un d e r­
statement or overstatement of true econom ic depreci­
ation, in cluding losses from the use of historical rather

13

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

Table 3
The Federal Budget as a Share of GNP
1990'
1980

1981

1982

1983

1984

22.4%
20.4
2.0

23.2%
21.1
2.0

24.3%
20.6
3.7

25.3%
19.5
5.8

24.0%
19.2
4.8

Current Services

Administration

Share in GNP of:
Expenditures
Receipts
Deficit

23.5%
19.5
3.9

20.9%
19.5
1.4

'Unified Budget Estimates from Budget of the United States Government 1986.

than replacement cost in com p uting depreciation al­
lowances. The sharp change in this adjustm ent
reflects the slow dow n in inflation from 1980 to 1984,
reducing the extent of underdepreciation due to his­
torical cost accounting; more im portant, the change in
the adjustm ent reflects the acceleration of deprecia­
tion allowed by the 1981 tax act. The latter is indicated
by the large ju m p in the size of the corporate capital
consum ption allowance (without capital co n sum p ­
tion adjustm ent) relative to GNP. This ju m p accounts
for the reported rise in the share of undistributed
corporate profits (with adjustm ent) despite the lack of
im provem ent in the cyclical performance of the
economy.
Thus, other things have not been equal in the deter­
m ination of saving and investment. Tax cuts arising
from accelerated depreciation have added substan­
tially to the private saving rate a n d m ade possible the
cash flow to finance the deficit ind uce d bv such a loss
in government revenue, w ithout interest rate changes.
But the new incentives also in d uced a substantial rise
in the share of investment in GNP, especially in the
share of plant and equipm ent investment and a redi­
rection of investment by U.S. firms from abroad. Not
surprisingly then, yields on m ost private assets rose
sharply from 1980 to 1984.
The changes in saving a n d investment rates from
1980 to 1984 conform more closely to the expectations
of the classical view th an to those of the conventional
analysis, especially w h e n the investment incentives of
the 1981 tax act are taken into account. In the absence
of more detailed statistical analysis, however, the data
do not yield decisive evidence supporting either view
to the exclusion of the other. The strength of invest­
m ent — arising from im proved incentives, despite
nearly unchanged cyclical performance of the econ­
om y an d a sharply higher real rate of interest — has

14



been associated w ith a substantially smaller decline in
the national saving rate an d a m u c h larger rise in the
private saving rate than that suggested by the conven­
tional view, however.

The Implications o f Federal Deficits For
Crowding Out in the 1980s
Table 3 shows the growth in federal expenditures as
a share of GNP from 1980 to 1984 a n d unified budget
estimates for 1990. The latter are constructed assum ­
ing either no further policy changes or the im p le m e n ­
tation of adm inistration proposals. In the absence of
policy changes, expenditures are higher in each year
than in 1980, resulting in an im plicit crow ding out of
investment.17W hile expenditures a n d deficits peak as
a share of GNP in 1983, the declines to 1990 are small .18
The e* ante crowding-out view suggests that tax
changes have no effect on national saving, b u t that
changes in government expenditures reduce invest­
m ent to the extent that such expenditures lower na­
tional saving.151Increases in government expenditures

,7The Congressional Budget Office (1985) discusses the effect of
such deficits on the ratio of federal debt to GNP, including the view
that it is the level of the debt relative to GNP rather than the deficit
that affects interest rates. Their current services estimate of this
ratio rises to near 50 percent of GNP in 1990, roughly its level in
1959. The view that the comparable decline in this ratio from 1959 to
1974 reduced interest rates is noticeably absent from contemporary
or earlier studies. Also see footnote 3 above.
18The growth in the government budget deficit from 1980 to 1982 was
cyclical in nature and would not have raised interest rates in any
case. Investment demand is typically more strongly cyclical than
budget deficits so that, even if the conventional view were correct,
interest rates would not have risen due to cyclical deficit increases.
Barro (1983) and Tatom (1984) detail the cyclical deficits since
1980.
19Since gross domestic investment equals national saving plus net
foreign saving, the fiscal effects on saving must be mirrored in
similar changes in investment, other things equal.

FEDERAL RESERVE BANK OF ST. LOUIS

have little effect on interest rates or GNP, in this view,
although they do change the mix of GNP and, d e p en d ­
ing on how they are financed, alter the mix of national
saving.20
In the absence of policy changes to reduce the share
of government expenditures in the n a tio n ’s output,
crowding out w ill rem ain a serious concern. The ad ­
m inistration has proposed cutting the share of federal
expenditures in GNP by 1990. This proposal focuses
on reductions in government purchases.21 Such a p o l­
icy w o uld boost capital form ation an d econom ic
growth by raising private a n d national saving rates.
According to the classical view, however, this may
have little effect on interest rates. This view indicates
that deficit reduction efforts that focus on raising taxes
will have no short-term im pact on econom ic perfor­
mance, but w ill instead sim ply reduce private saving
by a corresponding am ount.”

SU M M ARY
Popular analyses of recent a n d prospective U.S. gov­
ernm ent deficits suggest that deficits have raised o ut­
put, prices and interest rates a n d crowded out private
investment. The im plication of this view is that future
budget cuts, in the short run, w ill retard the growth of
aggregate dem and but will lower interest rates, lead­
ing to a strengthening of private investment and longrun growth.
There are reasons to question the relevance an d the

“ The link between deficits and the price level depends on whether
increased deficits raise aggregate demand and on the extent to
which deficits are accommodated by monetary growth. The classi­
cal view indicates that increased deficits do not raise aggregate
demand and, hence, cannot be inflationary. The second issue,
however, whether deficits contribute to money stock growth and,
hence, inflation, is not examined here. This link between the deficit
and inflation is developed more fully in Hein (1981). See Hamburger
and Zwick (1981) for an alternative view.
2'A detailed analysis of the unified budget proposals indicates that
they focus on reductions in federal aid to state and local govern­
ments, agriculture and other purchases. These expenditures are
principally either part of total government purchases directly, or they
finance such purchases at the state and local government level. See
Carlson (1985).
“ The earlier discussion does not distinguish between the type of
taxes. Thus, the effects discussed are for average relationships.
One of the most important qualifications that this raises concerns
business tax changes that change investment incentives. The 1981
improvements in tax incentives for investment certainly lowered
taxes and raised the deficit and may, at unchanged interest rates,
have left national saving unchanged, as the classical view suggests.
But the increased investment demand played a major role in boost­
ing interest rates and thereby affected economic performance.
Recent proposals to remove those incentives would reverse many
of these effects on economic performance, even if the overall taxes
and deficits are unchanged.




OCTOBER 1985

accuracy of the conventional view. It provides an in ­
consistent view of recent econom ic developments
w ith inaccuracies ranging from the forecast of bo o m ­
ing output, em ploym ent a n d inflation for 1981 and
beyond, to the forecast of rising interest rates. In
addition, the evidence here shows that the expected
crowding out of investment has been offset by other
factors, resulting in an investment boom since 1980.
The alternative hypotheses examined here indicate
that fiscal policy actions are largely an d directly offset
by the private sector. Thus, tax changes are offset by
adjustm ents to private saving, w ith n o direct effect on
national saving or investment. This classical view of
fiscal policy also em phasizes that increased govern­
m ent purchases are directly offset by reduced private
expenditures (especially investment).
According to the classical view, policy actions to
reduce the deficit are not likely to affect interest rates
an d m ay not affect the investment boom . For example,
if deficit reduction entails sim ply raising taxes, private
saving will fall by a like a m o un t a n d no additional
investment will occur. To the extent that deficit reduc­
tion focuses on expenditures, however, investment
will be strengthened, but w ithout the inducem ent of
lower interest rates.
The evidence from the recent experience suggests
that the classical view is correct a n d indicates the
im portance of business tax cuts in raising domestic
saving, investment an d interest rates and reducing
U.S. investment abroad. The evidence is not decisive as
to w hich view more generally an d accurately depicts
the effects of fiscal policy on the economy, however.
But both views indicate that domestic investment and
econom ic growth are im p ed e d by deficits arising from
government expenditure growth, a n d that they are
ultim ately im proved by restraint in such growth. Pro­
posals to deal w ith the deficit w ithout raising taxes
focus largely on reducing government nondefense
purchases. The successful im plem entation of these
plans w o uld ultim ately raise private saving an d invest­
ment, alter the com position of national o utp ut and
prom ote econom ic growth.

REFERENCES
Aschauer, David Alan. “ Fiscal Policy and Aggregate Demand,”
American Economic Review (March 1985), pp. 117-27.
Bailey, Martin J. National Income and the Price Level, 2nd ed.
(McGraw-Hill, 1971).
Barro, Robert J. “ Are Government Bonds Net Wealth?" Journal of
Political Economy (November/December 1974), pp. 1095-117.

15

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

________ _ “ On the Determination of the Public Debt,” Journal of
Political Economy (October 1979), pp. 940-71.

Friedman, Milton. A Theory of the Consumption Function (Princeton
University Press, 1957).

________ . “ Output Effects of Government Purchases,” Journal of
Political Economy (December 1981), pp. 1086-121.

Hafer, R. W. “The Role of Fiscal Policy in the St. Louis Equation,”
this Review (January 1982), pp. 17-22.

________ _ “ The Behavior of U.S. Deficits," University of Chicago
(March 1983), unpublished.

Hall, Robert E. "Labor Supply and Aggregate Fluctuations,"
Carnegie-Rochester Conference Series on Public Policy (Spring
1980), pp. 7-33.

Brunner, Karl. “ Fiscal Policy in Macro Theory: A Survey and Evalu­
ation," in The Monetary vs. Fiscal Policy Debate, conference pro­
ceedings, October 12-13, 1984, Federal Reserve Bank of St.
Louis, forthcoming.

Hamburger, Michael J., and Burton Zwick. “ Deficits, Money and
Inflation,” Journal of Monetary Economics (January 1981), pp.
141-50.

Carlson, Keith M. “ Controlling Federal Outlays: Trends and Pro­
posals,” this Review (June/July 1985), pp. 5-11.

Hein, Scott E.
3-10.

________ . “The Mix of Monetary and Fiscal Policies: Conventional
Wisdom vs. Empirical Realities,” this Review (October 1982), pp.
7-21.

Hickman, Bert G. "Investment Demand in the Sixties,” Reprint No.
120, The Brookings Institution, 1966.

“ Deficits and Inflation,” this Review (March 1981), pp.

Carlson, Keith M „ and Roger W. Spencer. “Crowding Out and Its
Critics,” this Review (December 1975), pp. 2-17.

Kochin, Levis. “ Are Future Taxes Discounted by Consumers? A
Comment,” Journal of Money, Credit and Banking (August 1974),
pp. 385-94.

Congressional Budget Office. The Economic and Budget Outlook:
Fiscal Years 1986-90,1985 Annual Report, Congress of the United
States (GPO, February 1985).

Kormendi, Roger C. “ Government Debt, Government Spending,
and Private Sector Behavior,” American Economic Review (De­
cember 1983), pp. 994-1010.

Council of Economic Advisers.
(GPO, February 1985).

Economic Report of the President

David, Paul A., and John L. Scadding. “ Private Savings: Ultrara­
tionality, Aggregation, and Denison’s Law’,” Journal of Political
Economy (March/April 1974), pp. 225-49.
Denison, Edward F. “ A Note on Private Saving,” The Review of
Economics and Statistics (August 1958), pp. 261-67.
Dolan, Edwin G. Basic Economics, 3rd ed. (CBS College Publish­
ing, The Dryden Press, 1983).
Evans, Paul. "Do Large Deficits Produce High Interest Rates?”
American Economic Review (March 1985), pp. 68-87.
Feldstein, Martin. “ Government Deficits and Aggregate Demand,”
Journal of Monetary Economics (January 1982), pp. 1-20.
Feldstein, Martin and Otto Eckstein. “The Fundamental Determi­
nants of the Interest Rate," Review of Economics and Statistics
(November 1970), pp. 363-75.

16




McConnell, Campbell R.

Economics, 9th ed. (McGraw Hill, 1984).

Office of Management and Budget.
Government 1986 (GPO, 1985).

Budget of the United States

Plosser, Charles I. “ Government Financing Decisions and Asset
Returns, " Journal of Monetary Economics (May 1982), pp. 325-52.
Samuelson, Paul E., and William D. Nordhaus.
(McGraw Hill, 1985).

Economics, 12th ed.

Sargent, Thomas J. “The Fundamental Determinants of the Interest
Rate: A Comment,” Review of Economics and Statistics (August
1973), pp. 391-93.
Tanner, J. Ernest. “An Empirical Investigation of Tax Discounting,”
Journal of Money, Credit and Banking (May 1979), pp. 214-18.
Tatom, John A. “A Perspective on the Federal Deficit Problem,” this
Review (June/July 1984), pp. 5-17.
U.S. Department of the Treasury. The Effects of Deficits on Prices of
Financial Assets: Theory and Evidence (GPO, March 1984).

The Status of Farm Lenders: An
Assessment of Eighth District and
National Trends
Michael T. Belongia and Kenneth C. Carraro
c
L-7IN C E 1982, sharp declines in real farm incom e
a n d the asset values supporting over $200 billion in
farm debt have created substantial increases in farm
loan defaults a n d farm bank failures. Large an d in ­
creasing loan losses have generated a great deal of
concern that the rapidly deteriorating quality o f farm
debt m ay have severe consequences for the long-term
structure of American agriculture and adverse short­
term effects o n the aggregate econom y as well.'
This article reviews a variety of performance in dica­
tors for the three m ajor lenders to the farm sector and
assesses both the tim ing an d breadth of portfolio
deterioration. The lending institutions exam ined are
agricultural banks, the Farm Credit System IFCS) and
the Farmers Home A dm inistration IFmHA). The perMichael T. Belongia is a senior economist and Kenneth C. Carraro is an
economist at the Federal Resen/e Bank of St. Louis. James C. Poletti
provided research assistance. The following individuals and their insti­
tutions are gratefully acknowledged for their assistance in providing
data used in this article: Kenneth Obrecht of the Farm Credit Banks of
St. Louis, Lyle Stucki of the Farm Credit Banks of Louisville, David
Meads of the FmHA, and Arnold Miller of the Farm Credit Admin­
istration.
’ Estimates of farm loan defaults under different scenarios are pro­
vided by Bullock (1985). Ranges commonly cited for losses on all
farm loans are $25-50 billion over the next four years. Losses within
the Farm Credit System alone have been estimated to be $350-400
million in 1985 with additional losses in 1986. Also, an estimated 12
percent of the Farm Credit System’s loans are not adequately
secured by property and assets and could produce "significant”
future losses; see “ Farm Agency Estimates” (1985).
Schink and Urbanchuck (1985) describe the channels through
which farm loan defaults could affect interest rates, GNP and
employment and estimate these effects for different magnitudes of
loan losses. An alternative assessment of how farm loan defaults
might affect the aggregate economy is provided by Belongia and
Gilbert (1985).




formance of these lenders in the Eighth Federal Re­
serve District is com pared w ith their performance in
the rest of the U nited States.

FA RM L E N D E R S : A B R IE F P R O F IL E
An agricultural bank is defined as a commercial
bank w ith a ratio of farm loans to total loans that is
above the average farm loan ratio at all banks. At the
end of 1984, the average farm loan ratio was approxi­
mately 17 percent. Currently, there are 589 banks in
the “official” boundaries of the Eighth Federal Reserve
District an d 1,383 agricultural banks in the region
defined more broadly that have a higher farm loan
ratio and meet the current definition of an agricultural
bank. The broader definition of the Eighth District is
used to make com parisons w ith Farm Credit Bank
districts.- Figure 1 represents these alternative desig­
nations of the District’s borders.
Nationally, 4,970 banks, or 35 percent of all com m er­
cial banks are defined to be agricultural banks. Collec­
tively, they h old $30 billion, or 60 percent, of the total
farm debt held bv com m ercial banks. Of the farm debt
held by agricultural banks, 83 percent ($24.8 billion) is
O fficially, the Eighth Federal Reserve District includes Arkansas,
northern Mississippi, southern Illinois and Indiana, western Ken­
tucky and Tennessee and eastern Missouri. Farm Credit districts,
however, cover entire states. The Fourth and Sixth Farm Credit
districts, headquartered in Louisville and St. Louis, do not include
Mississippi but cover all of the remaining states and Ohio. To
provide a representative, but unofficial Eighth District, we define it as
the states covered by the Fourth and Sixth Farm Credit districts:
Arkansas, Illinois, Indiana, Kentucky, Missouri, Ohio and Tennes­
see. Comparisons with the nation refer to data for all states other
than those included in this definition of the Eighth District.

17

FEDERAL RESERVE BANK OF ST. LOUIS

FICBs function as intermediaries that package these
loanable funds for, as of October 1985, 318 Production
Credit Associations (PCAs), w h o in turn, make loans
directly to farmers for annual operating expenses. The
FLBs make loans to farmers for the purchase of farm­
land through a network of 390 Federal Land Bank
Associations that function as loan originating offices.
Banks for Cooperatives make loans to farmer-owned
cooperatives, such as supply stores. As of December
31, 1984, the Farm Credit System, exclusive of the
Banks for Cooperatives, held $67.9 billion, or 32 per­
cent, of total farm debt. O f this total, FLBs held $49.1
billion an d PCAs held $17.9 billion. FICBs held the
rem aining $0.9 billion in the form of loans to other
financial institutions.

F ig u re 1

KY

MS

□

□

OCTOBER 1985

O ffic ia l Eighth D is tric t

The a r e a used to re p re s e n t the Eighth

The Farmers Home A dm inistration (FmHA) is the
so-called "lender of last resort” to farmers. It extends
credit to farmers through direct loans, guarantees of
farm loans m ade an d seiviced by com m ercial banks,
and various emergency loan programs. FmHA, for the
most part, lends to farmers w h e n they have trouble
servicing debt acquired from other lenders or if credit
is not available at "reasonable” interest rates from
their current lenders. As of 1984, FmHA held $25.7
billion, or 12 percent, of total farm debt.

D istrict fo r this a rtic le in c lu d es th e 4th
a n d 6th Farm C r e d it D istricts o f Louisvil
an d St. Louis an d is b o u n d e d by the
h e a v y b la c k lin e .

non-real estate debt, or operating debt, associated
w ith the variable costs of farm production. Because
farm lending by com m ercial banks is prim arily for
short-term operating debt, their chief source of co m ­
petition is the Production Credit Associations (PCAs)
of the Farm Credit System.
The cooperative Farm Credit System (FCS) is a sys­
tem of federally chartered, but privately owned, banks
and associations, w h ich are organized as coopera­
tives. These banks are supervised a n d exam ined by the
Farm Credit Adm inistration, an independent agency
of the United States government, and are m andated by
their charter to make loans only for purposes directly
related to agriculture. The FCS consists of 12 districts
and 37 banks: 12 Federal Land Banks (FLBs), 12 Federal
Intermediate Credit Banks (FICBs) a n d 13 Banks for
Cooperatives (BCs).
The FCS obtains loanable funds bv the sale of securi­
ties through the system’s W all Street fund in g arm, the
Federal Farm Credit Banks F unding Corporation. The
Digitized for
18FRASER


T R E N D S IN T H E A LLO C A T IO N O F
FA RM D E B T
A convenient place to begin a review of farm debt
holdings an d problem s is an analysis of trends in
loans outstanding at the various lenders. Table 1
presents the market shares of non-real estate agricul­
tural debt held by the m ajor lenders since 1970 for
both the Eighth District, broadly defined, a n d for the
rem ainder of the U.S. Non-real estate debt represents
financing for an n ual operating expenses such as feed,
fertilizer an d seed, as well as for the purchase of farm
m achinery an d livestock. The categoiy of "All Others"
includes such lenders as private individuals, dealei'S
an d merchants.
The trends in the District an d the United States are
roughly parallel a n d indicate that both commercial
banks an d the FCS gained their highest market shares
in the mid-1970s a n d u n til recently have been steadily
losing market share to the FmHA. By the end of 1984,
commercial banks at both the District a n d national
levels reversed the 10-vear dow ntrend, show ing sig­
nificant market share gains over 1983.
Table 2 presents the market shares held by lendei-s
for farm real estate loans. The lender categoiy of " In ­
surers” has been added to reflect the significant pres-

OCTOBER 1985

FEDERAL RESERVE BANK OF ST. LOUIS

Table 1
Farm Non-Real-Estate Debt Outstanding at Major Lenders
(percent of market held by each lender)
Banks

PCAs

FmHA

U.S.

District

U.S.

43.1%

19.1%

22.5%

3.5%

45.7

22.2

25.6

3.5

46.2

43.4

22.3

26.2

1973

48.6

46.2

21.9

1974

51.7

46.8

1975

50.0

1976

A ll Others
U.S.

District

2.6%

34.0%

31.8%

2.6

28.3

26.1

3.0

2.2

28.5

28.2

28.0

2.8

2.1

26.8

23.8

23.0

28.5

2.7

2.0

22.5

22.6

46.4

25.6

30.8

2.9

2.4

21.5

20.3

49.1

44.0

25.1

31.6

4.3

4.0

21.5

20.4

1977

48.7

44.1

24.3

31.5

4.0

3.3

23.0

21.1

1978

43.8

41.3

21.6

29.6

5.7

3.6

28.9

25.5

1979

40.6

41.3

20.3

29.6

9.2

4.6

29.8

24.5

1980

38.5

39.1

21.7

29.8

12.0

7.5

27.8

23.6

U.S.

District

1970

43.4%

1971

46.1

1972

District

1981

36.6

36.0

22.5

28.3

14.4

10.3

26.5

25.4

1982

34.4

33.7

21.5

28.1

15.5

13.3

28.6

24.9

1983

33.9

33.7

19.5

20.2

13.9

13.5

32.8

32.6

1984

37.5

39.7

19.1

18.4

14.0

15.0

29.3

27.0

NOTE: Due to rounding, percentages may not add to 100.
SOURCE: U.S. Department of Agriculture.

Table 2
Farm Real Estate Debt Outstanding at Major Lenders
(percent of market held by each lender)
Banks

FLBs

U.S.

District

U.S.

District

FmHA
U.S.

District

Insurers
U.S.

All Others

District

U.S.

District

1970

10.3%

18.9%

23.1%

21.9%

7.9%

7.4%

19.7%

19.4%

39.0%

32.4%

1971

10.5

19.5

23.9

22.1

8.1

7.7

18.6

18.1

38.8

32.7

1972

11.1

20.6

25.0

22.5

8.2

7.8

17.5

16.6

38.2

32.5

1973

11.5

21.6

26.5

23.3

8.2

7.5

16.3

15.1

37.5

32.5

1974

11.5

22.4

28.4

24.6

7.8

7.1

15.5

13.7

36.9

32.3

1975

11.0

22.0

30.7

27.6

7.3

6.8

14.7

12.0

36.3

31.6

1976

10.4

21.1

32.7

30.1

6.9

6.4

14.3

11.0

35.7

31.4
30.6

1977

9.9

20.9

34.0

31.6

6.8

6.1

14.1

10.8

35.2

1978

9.8

20.8

34.2

32.3

6.5

5.6

14.6

11.5

34.8

29.7

1979

9.6

19.9

34.8

33.3

6.0

5.1

15.2

12.8

34.3

28.9

1980

8.2

16.7

34.9

33.9

8.5

7.8

14.6

13.0

33.8

28.6

1981

7.5

14.9

37.9

36.6

8.2

7.6

13.7

12.9

32.6

28.0

1982

6.4

13.3

41.7

39.8

8.4

8.0

12.5

12.0

31.0

26.9

1983

6.3

12.6

43.7

41.0

8.3

8.4

11.8

11.5

30.0

26.5

1984

7.0

13.3

43.7

40.2

8.2

8.9

11.5

11.0

29.6

26.6

NOTE: Due to rounding, percentages may not add to 100.
SOURCE: U.S. Department of Agriculture.




19

FEDERAL RESERVE BANK OF ST. LOUIS

ence of a n um b er of insurance com panies in farm land
lending. The “All Others” category for real estate le n d ­
ing m ainlv represents debt held bv individuals. The
trends are again consistent across the District and the
United States. A lthough com m ercial banks in the Dis­
trict h old a larger share of the farm real estate debt
than banks in the rem ainder of the U.S., banks in both
areas have seen steady declines in market share after
initial gains in the early 1970s. Insurance com panies
and the category of “All Others” also have exhibited
secular declines in market share in both areas. The
share losses of these three lender groups have accrued
almost entirely to the Federal Land Banks of the FCS.
At both the District a n d U.S. levels, the FCS has nearly
doubled its market share w ith steady growth over the
period since 1970. The FmHA share, however, has
rem ained largely unch ange d over the same period,
although m in o r gains are evident in the District.
In summary, the market share data indicate that, for
farm operating debt, the FmHA has posted sharp gains
since the mid-1970s at the expense of commercial
banks an d the PCAs. The farm real estate market,
however, has been dom inated by the sharp gains
m ade by the Federal Land Banks relative to the share
losses of most other m ajor farm lenders.

M E A SU R E S O F P O R T F O L IO QUALITY
The m ajor causes of the recent farm debt defaults
are erroneous forecasts — both by farmers and their
creditors — of continue d high an d accelerating in ­
flation a n d increased real returns to assets em ployed
in agriculture:1So long as land prices continued to rise
w ith inflation, the collateral base against w hich
farmers could borrow increased, an d the value of
dollars used to repay the debt decreased. In c o n ju n c­
tion w ith tax advantages for land ow nership an d the
availability of subsidized credit for land purchases, it
m ade sense to buy farm land at prices of $3,000-S4,000
per acre — i f the purchaser believed the land could be
resold at a higher price. Similarly, u n d e r the expecta­
tion of w orld food shortages an d increases in real
com m odity prices, the price of land in agricultural
production w o uld be expected to rise.1 Under these
conditions, both farmers an d their lenders agreed that
extending more credit on a rising n om inal asset base
was a p rudent business decision. Unfortunately for
both parties, however, their forecasts of inflation and
com m odity prices were seriously in error.

3See Belongia (1985).
4See, for example, Will There Be Enough Food? (1981).

Digitized for
20FRASER


OCTOBER 1985

This description of events suggests that institutions
w ho increased their lending to agriculture sharply
between 1974-81 — w hen inflation, foreign dem and
for U.S. farm products an d real com m odity prices were
increasing or were expected to increase sharply —
should be experiencing the greatest deterioration in
portfolio quality."'
O n the basis of this criterion, the Farm Credit Sys­
tem and FmHA should be experiencing relatively more
trouble w ith portfolio performance th an other farm
lenders. To assess this thesis, we n o w turn to a dis­
cussion of measures of loan quality an d portfolio
performance.

Portfolio Quality at FLBs and PCAs
A com m on measure of loan quality is the percent­
age of loans on w hich payments are delinquent. This
percentage tends to be a leading indicator of ultim ate
loan losses because borrowers w ho eventually default
on debt fii'st experience problem s w ith m aking their
scheduled pavments. If efforts to reschedule the loan
and to service only its interest obligation fail, the
delinquent loan becomes, after some lag, a loan loss.
The data required for this analysis are difficult to
obtain an d are not entirely com parable across differ­
ent lenders an d even across different geographical
areas for the same lender group. The shaded insert
discusses the data used in this article a n d some cave­
ats that should be exercised w h e n m aking com pari­
sons or draw ing inferences from these series.
Chart 1 plots loan delinquency rates for FLBs in the
U.S. an d the Eighth District, broadly defined; chart 2
plots the loan loss series for FLBs. In each case, these
series are defined to be the dollar value of loans on
w hich pavm ents are delinquent or the dollar value of
loan losses as a percent of total loans outstanding.
The FLB series indicate that these institutions have
experienced sim ilar patterns an d rates of loan d e lin ­
quencies an d losses both in the District an d in the
rem ainder of the U.S. Loan losses at District FLBs,

5Market share data as a proxy for loan quality should be applied with
some caution. Moreover, it should be noted that this measure is
better suited to long-term land mortgages than to short-term operat­
ing loans. The reasoning is as follows: If market share for mortgage
lending declined in the 1970s, subsequent portfolio quality might be
improved because fewer new loans (that turned out to be poor
loans) were extended and the old loans carried forward were of
higher quality if, for no other reason, because a larger share of the
principal had been repaid. For annual operating loans, however,
market share in a given year may be unrelated to loan quality. In
fact, the lower interest rates offered by PCAs in much of the 1970s
may have attracted the more creditworthy farmers.

OCTOBER 1985

FEDERAL RESERVE BANK OF ST. LOUIS

The Data
Agricultural Banks
All FDIC-insured com m ercial banks are re­
quired to file a quarterly Report of Incom e and
Condition. These reports are com m only referred
to as "call reports” a n d are roughly equivalent to
a bank’s balance sheet an d incom e statement.
Two loan item categories identify the volum e of
agricultural production loans and farm real es­
tate loans outstanding on the reporting date.
Banks have been required to report loan delin­
quency data only since 1982. Bank loans are con­
sidered past due w hen interest or principal pay­
ments are more than 30 days delinquent. These
data are generally verified in the course of norm al
inspections bv bank regulatory agencies such as
the FDIC, Federal Reserve or Com ptroller of the
Currency.

Farm Credit Svstem
%/
Most data used in this article are derived from

statistics published in the Farm Credit A dm inis­
tration’s an n ual reports. In m any cases, the Farm
Credit Banks of St. Louis an d Louisville cooper­
ated to provide data not available elsewhere. Un­
til 1984, no guidelines were available to assure
that reporting standards for loan delinquency
inform ation were consistently applied across the
12 Farm Credit Districts. This fact introduces an
inconsistency in the data because 1984 data were
collected using definitions that were possibly
different from those used in earlier periods.

Farmers H om e Administration
Data on the FmHA were derived from the
FmHA report 616 an d include only loans m ade
un d e r the following farm programs: Farm Ow ner­
ship, Farm Operating, Econom ic Emergency and
Disaster Emergency. FmHA judges a loan as de­
linquent w hen principal or interest payments are
15 days or more past due.

Percent of Total Loans D elinquent

Loan Losses as a Percent o f Total Loans

federal Land B a nks

Federal Land Banks




P e rc e it
.4 0

P e r c e il
.4 0 r

#
i
#
.35

«

.35

i
i
i
i

i
.3 0

.3 0

i
i

i

i
i
i
.25

.25

i
i
i

.20

.20

1
1
1
1
1

I
.15

1

D i s t r ic t /
«
i
.10

.10

i

i

.0 5

#
i
i
#
i

.0 5

/

j

^

/
/

,
/

/ U.S.
.00

.00
1981

1 98 2

1983

1984

21

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

C h a rt 3

Percent of Total Loans D elinquent

Loan Losses as a Percent of Total Loans

Eighth District Production C redit A sso cia tio n s

Production Credit A sso cia tio n s
Percent

1970

72

74

76

78

tO

»2

1984

however, have risen slightly more sharply than at FLBs
in the rem ainder of the U.S.'1Moreover, there appears
to be a lag of about two years in each case between the
time delinquencies rise sharply (1982) a n d later reveal
themselves in h igherloan losses (1984). Note, however,
that while the patterns of delinquency an d loan loss
rates have been similar, loan losses have been about
one-tenth of prior years’ delinquencies. Chart 1 also
shows that delinquency rates were nearly constant
between 1970-81. Prior to 1981, losses at FLBs were
less than two-tenths of one percent of all loans o u t­
standing.
PCA loan delinquency data are not available on a
consistent basis for both the District and the rem ain­
der of the U.S. For this reason, only the District delin­
quency data are show n in chart 3. They also reveal a
dramatic increase in delinquency rates beginning in

6U.S. and District FLB delinquency rates are derived from Farm
Credit Administration annual reports and include the items of “ non­
accrual loans" and "delinquent principal and advances.”

Digitized for
22FRASER


1982. It m ust be pointed out that the absolute levels of
delinquency rates for PCAs are not com parable w ith
the FLB rates portrayed in chart 1.
Loan loss data for PCAs, however, are available for
both the District an d the U.S. a n d are presented in
chart 4. Write-offs in 1984 as a percent of total loans
were eight times higher than the percentage in 1981.
In contrast to FLB loans, however, there appears to be
almost no lag between the time these delinquencies
are reported and the tim e they result in loan losses.
The likely reason for this difference is that PCAs make

'District PCA delinquency rates were obtained directly from the Farm
Credit Banks of Louisville and St. Louis on the following basis: for
1970 and 1971 the information includes loans 30 days past due; from
1972 to 1983 the information is for loans 60 days past due; the 1984
data are calculated according to the new FCA standards for non­
performing loans. The national data available for the 1970 to 1983
period include loans which are termed “ loans in process of liquida­
tion” and which are not comparable to the District data. In spite of
the different nature of the two series, the data exhibit very similar
behavior when plotted against each other on the basis of annual
percentage changes rather than as absolute levels of delinquency.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

C h a rt 5

C h a rt 6

Return on Equity

Return on Equity

Federal Land Banks

P rod uction Credit A sso c ia tio n s

Percent

P trciat

loans for an individual year's operating expenses and
usually schedule repayment shortly after the year’s
harvest. For this reason, unlike the FLBs' multi-vear
loans for lan d purchases, PCAs tend to exhibit a closer
short-run relationship between delinquencies and
losses. As in the case of FLBs, it is necessaiy to note
that, w hile the patterns of delinquency an d loan loss
rates are similar, losses have been one-fifth of
delinquencies.
W ith rising rates of d e lin q u e n c ie s a n d loan
losses one also w o uld expect the returns to equity and
assets held by these lenders to decline. Charts 5
and 6 plot the returns to equity for FLBs an d PCAs,
respectively, in the U.S. a n d the District. In chart 5,
similar patterns for returns in the U.S. and the Dis­
trict are revealed w ith the District show ing lower
average returns since 1979 a n d a sharper decline
since the 1982 peak of 10.4 percent. Returns to equity
for PCAs (chart 6) peaked in 1980 for the U.S. and
1981 for the District a n d have fallen sharply in just
two years. Returns to assets have followed sim ­



ilar patterns for these lenders at both District and
national levels."

Agricultural Banks
The conjecture was that agricultural banks, w hich
d id not increase market share or dollar volum e of farm
loans as aggressively in the 1970s, w o uld show som e­
what lower measures of loan delinquencies an d losses
an d better returns to assets an d equity than members
of the Farm Credit System. Another im portant factor
supporting this expectation is the fact that the loan
portfolios of agricultural banks are diversified outside
of agricultural lending. This loan diversity could help
protect bank earnings from the wide swings of returns
on equity experienced bv the FCS lenders w ho extend
credit only for purposes directly related to agriculture.

8Returns to assets for FLBs peaked in 1982 at 1.12 percent nationally
and .99 percent in the District. By 1984, these values had declined to
.42 and -.0 3 percent, respectively. Between 1981 and 1984, returns
to assets at District PCAs fell from 1.07 to 0.05 percent.

23

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

C h a rt 8

C h a rt 7

A gricultural Loans Past Due as a Percent
of Production Loans

Total L o a n Losses a s a Percent o f Total L o a n s
Agricultural and Honagricultural Banks
P e rc e n t

A gric u ltu ra l B a nks
Percent
4 .2 5

P e rc e n t

Pe rce nt

4 .0 0

3 .7 5

3 .5 0

3 .2 5

3 .0 0

2 .7 5

2 .5 0

2 .2 5
1982

1 98 3

1984

Agricultural loan delinquency data have been col­
lected from com m ercial banks since 1982. O nly banks
w ith total assets greater than $100 m illion, however,
are required to report the volum es of agricultural
loans considered in nonaccrual or renegotiated sta­
tus. These two categories include loans on w hich
interest payments arc not being paid or are being paid
more slowly than originally established. Since a large
majority of agricultural banks are smaller than $100
m illion an d therefore do not report nonaccrual and
renegotiated agricultural loans, chart 7 plots only the
percentage of agricultural production loans that are
considered past due by 30 days or more at agricultural
banks.3These data, therefore, are not directly c o m p a­
rable w ith the PCA data sum m arized earlier in chart 3.
Nonetheless, these lim ited data suggest that agricul­
tural banks also have experienced rapid increases in

9The set of banks defined as agricultural banks will change over time
as the shares of agricultural loans in some banks’ portfolios become
less than or greater than the cutoff point. Over time, however, the
number of agricultural banks has remained fairly constant, ranging
between 5,668 in 1974 and 4,970 in 1984.

Digitized for
24FRASER


delinquent farm debt both in the District an d in the
rem ainder of the U.S.1"
Loan loss data for agricultural banks provide a d d i­
tional inform ation to supplem ent that provided bv
past due rates. Because loan loss data are not available
specifically for agricultural loans, chart 8 is a plot of all
loan losses at agricultural banks an d at small nonagricultural banks in the nation (less than $100 m illion in
total assets) expressed as a percentage of all loans at
these banks since 1976. It indicates that loan losses at
agricultural banks have been increasing steadily since
1979. The rate of increase has been such that the
percent of loan losses has risen by a factor of nearly
seven since 1979. Losses at com parably sized nonagricultural banks were larger than losses at agricultural
banks until 1981. Now the rate of losses at nonagricul-

,0For the small number of agricultural banks reporting all agricultural
loan delinquency items (29 banks in the District for 1984 and 75 in
the remainder of the U.S.), the delinquency rate rose from 4.2
percent in 1982 to 9.0 percent in 1984 for the District. In the
remainder of the U.S., however, the overall delinquency rate rose
only from 6.1 percent in 1982 to 6.3 percent in 1984. Given the small
number of agricultural banks reporting these data, caution in their
interpretation must be used.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

C h o rt ♦

Return on Equity
Agricultural and N onagricultural Banks
Percent

P e rc e it

loss reserves." The latter two items represent the re­
sources of a bank to absorb loan losses. At the national
level, the num b e r of agricultural banks that fall into
the threatened bank categoiy has nearly tripled from
1982 to 1984, going from 76 to 202. In the District,
however, the n um b e r of such threatened institutions
has doubled from 23 to 46 over the same period. Thus,
concern about rapid increases in farm bank failures,
although certainly im portant in the Eighth District,
appears to be even more im portant for institutions
beyond the borders of the Eighth District.
In sum m aiy, agricultural banks have suffered rising
rates of delinquency and loan losses an d declining
profitability. W hen com pared w ith PCAs, w hich repre­
sent their most significant com petitors in the agricul­
tural lending arena, however, banks appear to have
suivived recent dow nturns in the agricultural econ­
om y in m uch better fashion. Although loan loss rates
for PCAs and agricultural banks are comparable, d e lin ­
quency rates have increased, an d profitability de­
creased more quickly at PCAs than at agricultural
banks.

The Farmers Hom e Administration

tural banks is only half that experienced by agricul­
tural banks.
Based on returns to equity data at agricultural banks
an d at small nonagricultural banks of the District
(chart 91, profitability in the District peaked in 1974
an d has been falling steadily since then, with the
exceptions of 1979 an d 1980. At the national level,
agricultural bank profitability peaked in 1980 before
starting a sharp decline. As in the case of loan losses,
agricultural banks’ declining profitability was greater
than that experienced bv nonagricultural banks. Re­
turns to equity at District agricultural banks have
fallen by nearly 34 percent since their recent peak in
1979, while the returns to equity ratio for nonagricul­
tural banks in the District has fallen by only 16 percent
since 1979.
One further means of assessing the viability of agri­
cultural banks is by com paring the volum e of “risky"
loans for w hich repayments are uncertain w ith a
bank's ability to absorb the potential loss. W ith this in
m ind, banks whose viability may be threatened can be
defined as those for w h ich the volum e of delinquent
loans exceeds the sum of total bank capital an d loan



The FmHA’s role as “lender of last resort" dictates
that its borrowers are from a high-risk category. Loan
delinquency data for both real estate a n d non-realestate farm loans bear this out. Charts 10 an d 11
docum ent the steady rise in delinquency rates for
both loan categories. Com parisons of delinquency
rates at FCS lenders (charts 1 an d 3) w ith those of the
FmHA are instructive. The FmHA appears to have
experienced rising delinquency rates earlier than 1981
w hen the FCS lenders began to show marked in ­
creases in delinquencies. This finding is to be ex­
pected given the character of the FmHA’s borrower
clientele. FmHA borrowers w o u ld be more likely to
exhibit repayment problems w hen a dow nturn in the
agricultural econom y occurs than w o uld the more
creditworthy borrowers of the FCS or of agricultural
banks. This also highlights an im portant aspect of the

"The FDIC compiles the official list of “problem banks” by rating all
insured banks on the basis of five categories: capital, assets,
management, earnings and liquidity. Banks receiving a rating of four
or five on a scale from one to five are placed on the problem bank
list. Our definition, which focuses on capital and asset quality, is
likely to provide a parallel indicator of banks threatened by bank­
ruptcy should a large share of delinquent loans become loan losses.
,2Melichar and Inwin have reported that one-half of potentially vulnera­
ble agricultural banks are located in five states: Iowa, Nebraska,
Kansas, Minnesota and Missouri; only Missouri is in the Eighth
District.

25

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985

C h a rt 10

C h a rt 11

Percent of Total Farm O p eratin g Loans
D elinquent

Percent of Total Farm O w n e rs h ip Loans
D elinquent

Farm ers Hom e A d m in istratio n
Pe rc e n t
6 0 , --------

Farm ers Hom e A d m inistratio n
Pe rc e n t
,6 0

FmHA — as a lender of last resort, the FmHA provides
an informal subsidy to the FCS an d agricultural banks
through its direct lending programs. Bv lending in
some cases to farmers w ho h ad received FCS or bank
financing but w ho are no longer considered credit­
worthy, the FmHA allows these lenders to delay fore­
closure and to continue to receive loan payments from
such borrowers. Moreover, u n d e r the Econom ic
Emergency Credit Act, FmHA refinanced loans origi­
nally m ade by the FCS and com m ercial banks and
repaid the original lenders from proceeds of the FmHA
loan.
Given the extremely high an d rapidly growing delin­
quency rates on FmHA loans, one w o uld expect, other
things equal, to find com m ensuratelv higher levels of
loan losses. Loan loss data for FmHA farm loan pro­
grams are available only on a consolidated basis (i.e.,
farm ow nership and operating loan losses are not
segregated). Chart 12, however, shows low, although
rising, rates of loan write-offs. For example, the 1984
delinquency rate on FmHA farm ow nership loans was
near 25 percent, but only 0.22 percent of all FmHA
Digitized for26
FRASER


P e rc e n t
3 5 . --------

P e rc e n t
35

loans were charged off. This contrasts w ith the FLB s
1984 delinquency rate of 3 percent an d loan chargeoffs of 1.5 percent. This discrepancy between institu­
tions can be explained by the greater degree of for­
bearance that the FmHA has exhibited w ith respect to
its delinquent borrowers. As evidence of this forbear­
ance, data on the length of tim e that loans are carried
in the d elinquent status can be examined. W hile not
available on a District scale, national FmHA data in d i­
cate that, as of Ju n e 30, 1985, more th an 45 percent of
the volum e of delinquent FmHA farm loans has been
in that status for more than four years. Only 9 percent
of the delinquencies nationw ide were less than one
year past due.

C O N C LU SIO N S
The Farm Credit System an d agricultural banks did
not show substantial deterioration of loan portfolio
quality un til 1982. The FmHA, however, began to ex­
hibit rising delinquency rates in 1979. The deteriora­
tion has been more p ro n o un ce d am ong those lenders

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1985
Bullock, J. Bruce. “ Farm Credit Situation: Implications for Agricul­
tural Policy,” FAPRI #4-85, Food and Agricultural Policy Research
Institute (February 1985).

C h a r i 12

Farm Loan W rite-offs as a Percent of
Total Farm Loans

“ Farm Agency Estimates Loss.”
1985.

Farm ers Hom e A d m inistratio n

New York Times, September 17,

Melichar, Emanuel, and George D. Irwin. “ Condition of Rural Finan­
cial Intermediaries,” paper presented at the meetings of the Ameri­
can Agricultural Economics Association, Ames, Iowa, August 6,
1985.
Schink, George R., and John M. Urbanchuck. “ Economy-Wide
Impacts of Agricultural Sector Loan Losses," Wharton Economet­
ric Forecasting Associates: Philadelphia, Pennsylvania (July
1985).
U.S. Department of Agriculture. " Will There Be Enough Food?" The
1981 Yearbook of Agriculture (U.S. Government Printing Office,
1981).

1980

81

82

83

84

1 985

w ho aggressively expanded their lending to agricul­
ture in the 1970s. In particular, the Federal Land Banks
of the Farm Credit System expanded their market
share during the 1970s an d experienced some of the
sharpest declines in portfolio quality in recent years.
The m andate of the FCS to lend m ainly to agricultural
interests inhibits its ability to diversify its portfolio and
raises the risks associated w ith concentrated lending
to one sector. Hence, sharper declines in overall port­
folio quality for branches of the FCS, relative to agricul­
tural banks, took place. Finally, the data revealed little
difference in the measures of portfolio quality or insti­
tutional earnings at the Eighth District and national
levels.

REFERENCES
Belongia, Michael T. “ Factors Behind the Rise and Fall of Farmland
Prices: A Preliminary Assessment," this Review (August/Septem­
ber 1985), pp. 18-24.
________ and R. Alton Gilbert. “ Farm-Bank Fallout? Recall the
20s," The Wall Street Journal, September 25, 1985.




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