Australian farm bubble?

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Steven Johnson of Intelligent Investor has in recent days drawn attention to a growing problem in Australia’s rural land prices:

The Australian Financial Review recently reported that farmers nationwide are in serious trouble. At least 80 farming operations worth more than $1m across Australia are in receivership or some form of distress.

In response Wayne Swan has announced $420m in subsidised loan packages for indebted farmers, indicating the weight of the high dollar and reduced land values was causing viable farms to struggle.

Not mentioned by Swan was that buyers bid farm prices to levels that didn’t enable a reasonable return on capital (see our earlier post, The Crap Economics of Farming).

As I explained in that post, it doesn’t make much sense borrowing money at 7% to buy an asset that earns you 3% at best. In fact, it’s a perfect example of what Hyman Minsky called Ponzi finance.

Minsky defined three phases of markets, hedge finance, speculative finance and Ponzi finance. Hedge finance represents the phase where an asset generates enough cashflow to service both principal and interest. In the speculative finance phase, the assets can service the interest but not the principal, meaning the investor must constantly refinance the debt. And in the Ponzi phase, there isn’t enough cash to pay the principal or the interest – the ‘investor’ is dependent on a greater fool coming along and paying a higher price to generate a profit.

Any Australian farm funded with more than 50% debt is a Ponzi operation. There are thousands of them.

The debt means that farmers won’t be the only ones to feel the fall out. Banks lending to farmers have, until now, stayed their hand, hoping for capital growth to save their bacon. With prices now going the other way, the problem is beyond the point where they can simply kick the can down the road. Farm prices have a long way to fall before any rational investor starts taking a look. And if they all start liquidating at the same time, there’s no reason rationality should provide a floor.

More importantly, the fallout is going to be traumatic for the families that have owned these farms for generations. Losing any business is difficult. But farmers have an emotional connection to the land that goes above and beyond that of your typical business owner (which explains why they paid the stupid prices to start with). When the bubble bursts (or now that the bubble has burst?), we are going to be left with a generation of farmers who have worked for decades; with nothing to show, nothing to retire on and and a trampled ego to drown their sorrows with. With depression and suicide already a huge problem in rural Australia, it is the emotional consequences that I worry about more than anything else.

Here as well is an ABC video from last night that builds on the case:

I’m not sure how large bank exposures to rural clients would be, pretty minimal in the scheme of things would be my guess. Still, another risk to watch.

37 Responses to “ “Australian farm bubble?”

  1. Alex Heyworth says:

    It is crazy. You have a farm that is a $1 million investment. You work your balls off farming. Then you get $30,000 a year for your efforts.

    I have read somewhere that a high percentage of farms now depend on off-farm income to survive (eg wife is a nurse or teacher, hubby does some handyman work or labours for another farmer). It is a high price to pay for a lifestyle.

    • manki says:

      From http://bilbo.economicoutlook.net/blog/?p=23614

      Farmers also enjoy a “$20,000 off-farm salary and wages exemption”, which is not available to Newstart recipients.

      Then the document says:

      Note: you do not have to satisfy an Activity Test. The payment is a grant, not a loan, and you do not have to put your farm on the market.

      So the farmers who are unable to earn an income get income support but not reciprocal obligation (to use the neo-liberal terminology) that is forced onto an unemployed person via the Activity Tests.

  2. manki says:

    Great link from Bill Mitchell questioning government support of farm debt versus other forms (later in the below post):

    http://bilbo.economicoutlook.net/blog/?p=23614

    • flawse says:

      Looks forward to the day Bill Mitchell has a crack at the WWF or University Academics!

      • manki says:

        I’m looking forward to his “Fantasy Budget 2013-14″; should be an interesting exposure of where we could be as a society with less influence from rentiers and moneyed interests.

      • flawse says:

        I have a particular interest in it as well. I’ll wait and see.
        Some of his ‘rentiers and moneyed interests’ are a few of us who work damned hard and save hard.

  3. flawse says:

    There are quite a few good papers around on the farming debt problem. It’s massive.
    The causes are many not the least of which of course is the (insane) value of the Aus dollar. For Northern Australia the stupidity of response in the live cattle export market caused massive issues. These were masked by exceptionally good seasons in the last couple of years. The current dry spell will bring many to that spot between the rock and the hard place.

    I admit myself some misgivings about rescuing farmers who have incurred debt through the purchase of over-priced rural property.
    In my own old district there is a property near where I lived that is for sale for $4M Best estimates from mates still in the district is that income would be about wages.
    I’d like to be a farmer again but that is a bit high a price!

    • flawse says:

      P.S. get the dollar DOWN, interest rates UP and then let everyone do their business!

      In all business there should be a place for those who are prudent and efficient to grow their enterprises. The incentives should be there for prudence and efficiency.Getting from A to B equitably, given the way we have run this nation for 50 years, is the problem.

    • flawse says:

      PPS Property $4M plus stock…say $600K plus farm machinery $400K (some second hand)
      So total $5M plus 12 months running costs to get an income.

  4. Giordano Bruno says:

    I have been following rural land prices for about 8 years as I want to one day return to the land with my kids. I have been looking at South Gippsland and South Coast NSW.

    Gippsland has some of the highest prices in Australia, by far – whats WORSE is that a small block of a few acres, equal to something around Berry, Gerringong etc N.S.W is frequently far more expensive – while the N.S.W. properties are several orders of magnitude better – fully and tastefully renovated.

    It is ASTONISHING and quite sickening to see 60,70 year old weather board shacks that have had nothing at all done on them in their entire life, in dark, dank conditions, with no infrastructure, no manicured gardens with eye watering asking prices.

    Go through the listings for the entire South Gippsland and you wont see a single sold price. Its all stitched up.

    The elderly people down there want to sell up, but the only option they have is the local agent. So for these elderly people to move out of their old farm into a house or flat with prices as they are they have to sell at peak.

    The young people don’t want to go and live on the farm, and they don’t want to go and live with their old mum or dad.

    So what choice do they have ?

    Put the 80, 100 acre farm up for $1 million dollars, 70 years old, two bedrooms, a rusty dairy and half collapsed machine shed with a septic tank surrounded by depressing Cyprus, in the hope of buying a two or 3 bedroom close to town for $600k with $400K to live off in retirement ?

    Nope – they are not even getting $500k.

    While that same property in NSW would have an architect designed brand new / well renovated with pool and tennis court 10 minutes from the beach.

    It’s not farm prices killing farmers – it’s also city prices – they can’t leave the land.

  5. Winston says:

    Its off topic, but what I find interesting is the consumer side of the farm equation. People are willing to pay a premium for top quality cars, clothes etc, but when it comes to food are unwilling to pay for better quality food and even try to talk down the benefit of ethically raised or chemical free food.

    • AB says:

      The luxury car market is a small part of the overall car market, just as I’d say the farmers markets / organic / free-range / direct-from-the-farm sales are a small part of the overall food market.

      I’m certainly one who is happy to pay more for quality fruit and vegetables and humanely-raised animal products.

  6. Crocodile Chuck says:

    “Not mentioned by Swan was that buyers bid farm prices to levels that didn’t enable a reasonable return on capital ..”

    One more time: Its not just the hapless buyers who are responsible for bidding up land prices. Why?

    Q: Who makes the credit decision? Btw, this includes not only the ‘lend/don’t lend’ decision, but the proposed asset price.

    Unfortunately, the Banks are responsible for asset price bubbles not only in urban resi r/e, but in the bush, as well.

    What HAS the Reserve Bank of Australia been doing the last twenty two years??

    • aj. says:

      This is a good point too. The banks allowed the dodgy valuations and now the taxpayer will carry the losses so we don’t end up with generational farmers booted off the land.

      We have to develop a system where the banks executives pay for taking risks that have social costs and require social fixes.

      • AB says:

        But what I don’t understand is why these generational farmers are in so much debt anyway. Surely if the farm has been in the family for so long, it should have cost much less and been paid of a long time ago.

        Is it because they need to continue to buy more land for economies of scale? Or some other reason?

      • AF says:

        Those land cruisers, boats and caravans don’t come cheap you know

      • runalltheway says:

        AB,
        A lot of graziers live from season to season by borrowing – they have 1-2 big paydays a year, then have to borrow to pay for planting and growing next season’s crops.

        A few bad years and all of that debt builds up quickly (with the bank’s approval).

        For some reason, a lot do think that buying more land is the way to fix their problems – or maybe it’s just an ego thing (I own 7,000 ha, Carmichael down the road only has 2,000).

        One thing – unrealistically high prices for farming land and high debt have been problems for years.

        I worked in country NSW from ’03-’08 and the whole way through every farmer I dealt with was burdened by both….

      • runalltheway says:

        Sorry, that should say “farmers”, not “graziers” (they run livestock).

        My bad….

      • AB says:

        Thanks runalltheway, it sounds like things could turn ugly very quickly if the value of farmland drops and banks start calling in loans.

      • flawse says:

        AB

        If you run models on a cattle herd what happens is this. Let’s start with a herd that’s balanced. Cows for breeding, calves coming on, heifers getting ready for first mating. Steers up to 12 or 18 months for fattening.
        Now you hit that herd with a drought. So first thing to go are the steers then the calves are weaned early and sold to try to keep teh cows fit enough for the next calving. Next not only the old cows are sold you sell the next year or two down as well. Remember this is all happening at much reduced prices.
        What you get left with is the core of a breeding herd. Now it rains. After 3 months or so you got grass. So now you have to build your cow numbers back up. So instead of turning off any cows for the next three years you keep them all to breed. You turn off one lot of calves which you keep for both young breeders and steers to fatten the next year. All in all it will take 5 to 7 years to get that herd back up to full production.
        By that time you are likely to be in another drought!

        It’s not an easy game to be in.

      • Trickster says:

        One farm …. multiple children. The farm cannot be handed down to just one child and usually the one that wants to stay on the land (if there is one) will have to pay out the others and goes into unsustainable debt for a perceived lifestyle advantage or because they think it is their duty to “keep the farm in the family”. The farm is not handed from one generation to another for free even if it is unencumered.

    • Mav says:

      They have been “independently” taking care of their stakeholders ..erm.. Not taxpayers..but well-heeled banksters who are part of the same million $ earning social circle.

  7. aj. says:

    This will be interesting to watch – i have heard anecdotal evid from North Qld that banks that have previously been holding their hands on marking rural properties to market and enforcing loan obligations on the new valuations are starting to move.

    This may be what prompted the government to start buying back the private farm debt. Just another example of private debt = public debt. Anyone convincing themselves that private debt doesn’t matter is delusional.

  8. The Patrician says:

    Two key statements towards the end of the Johnson interview.

    “..more debt is not going to fix the problem..”

    “Ultimately what needs to happen is farm prices need to come down and we need to get the level of debt down”

    An orderly deleveraging is part of the solution.

  9. Pfh007 says:

    This article sums up quite nicely why the idea of trying to prop up asset prices with ZIRP interest rates is a fool’s errand.

    Those asset prices are causing damage right across the economy – from farmland, to industry, to commercial, retail and residential.

    They are a cancer on the economy.

    Applying a bit of radiation therapy (higher rates) will reduce the tumour but will not kill the patient.

    Keep in mind that the majority of people DO NOT have enormous debts that are vulnerable to even minor rises in interest rates.

    And those that do should sell now and pay down their debts.

    Trying to keep asset prices high to protect the foolish (whether they be residential speculators or farmers who had visions splendid) is poisoning the entire economy.

    It is time to turn on the radiation lamp on a low setting and start shrinking the tumour.

  10. ronfire says:

    This leaves me with mixed feelings. On the one hand, I view with some asperity the demands for subsidies by those who bought up overpriced farms and are now in the unprintable. However, there are many who’ve had the land in their families for generations. They simply cannot compete on price anymore. Especially not with highly subsidised agriculture in other parts of the world…

    We have billions to throw at the car industry which makes overpriced metal blocks that will rust away one day, but none to assist farmers who, let’s face it, do what is absolutely essential for the survival of a society. If Australia does not grow its own food, we are doomed.

    Perhaps I’m simply giving voice to feelings, instead of being rational. Hell, I’m not even Australian-born. So what? I live here, my children are growing up here, and this is their future. I would hate for them to grow up into a future where Australia imports all its food. Ok,extreme scenario but not impossible.

    I would love to live on the land with my family and be a farmer. I don’t think I can afford it, though…

    In my opinion, Australia is allowing its agricultural and manufacturing sectors to die. I cannot see anything good in that. Nothing at all.

    Rant over.

    • AF says:

      “In my opinion, Australia is allowing its agricultural and manufacturing sectors to die. I cannot see anything good in that. Nothing at all.”

      That is because you are not working for a bank / government / mining company.

      The problem is that money talks and what is good for the country and the future population will not get a look in.

  11. Tassie Tom says:

    I disagree with the statement “Any Australian farm funded with more than 50% debt is a Ponzi operation”.

    If the return on capital of your farm is 10% (rare these days but still possible in parts), then it is reasonable to fund it with 100% debt. However, if the ROC is 4%, then any debt at all makes it the debt component a Ponzi operation.

    Our family bid $2500/acre ($6200/ha) to buy 350 acres of wheat country 150km north of Adelaide, and we didn’t get it! This land would average 3.5 tonnes/ha of wheat, usually H2 or APW1, which averages $250/tonne. So that’s 14% gross.

    However, we 50% share-farm it (down to 7% gross), because over a million dollars worth of machinery is required to farm it efficiently. It costs about $300/ha (our share $150) for fuel, ferterliser, and spray, so now we’re down to 4.6% net. Even less because the winning bid was higher.

    Ponzi finance!

    • Alex Heyworth says:

      Your net still doesn’t deduct the value of your labour, wear and tear on the machinery, depreciation on the machinery or the cost of the capital tied up in the machinery.

      By the time you deduct those, you’re probably close to making a loss.

      • Tassie Tom says:

        The machinery is all owned by the neighbor who share-farms it for us – that’s why we only get 50% of the earnings (and pay 50% of the ongoing costs, but not machinery costs). The share-farming arrangement halves gross yield, but machinery is not our responsibility.

        We used to run our own machinery (30-year old stuff kept together with wire) and employ a jackaroo to run it, and yes, then we did run at a loss most years (except for capital appreciation).

        This is with $2 million worth of land at today’s prices.

        Another option would be to use contractors, but this has problems too – everyone in the region wants them at exactly the same time, and we worry that their machinery might bring in weeds from other people’s farms.

    • Gerard says:

      Wouldn’t your $1 million worth of machinery handle around 5,000 acres of wheat per year?

      A high capacity harvester would take that crop off in less than 2 days. Likewise, an airseeder of reasonable size would sow it in the same time.

      I know a 3rd generation operation that does around 12,000 acres of cereals each year with plant probably worth $1.5 – $2 million or so plus some top up with contractors when/if the season requires.

  12. Lloyd55 says:

    I suppose it is too obvious to say that the farmers getting the subsidies are also the ones whinging about the Govt’s debt being too large. As has been said. most farm debts are multiples of their gross farm incomes, and if they had debts of only about 15% of their income there wouldn’t be the problem.

    And yes, I am a frustrated son of a former farmer who couldn’t keep the farm.

  13. The Claw says:

    Kick the bums off the land and give it to those who are more deserving.
    Smart, cautious people would not take on outrageous debt to pay over-the-top prices for land. Smarter people are also likely to make better farmers and take better care of the animals, and get higher crop yields.
    Kick the bums off.