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.