Recent commentary by the Federal Reserve Bank of Cleveland’s Thomas Fitzpatrick IV and James Thomson suggests that the creation of Chapter 12 bankruptcy during the ag crisis in the 1980s is a viable solution for addressing today’s delinquent home mortgages. Fitzpatrick and Thomson attribute Chapter 12 with resolving much of the financial troubles of family farmers in the 1980s, while having few, if any, negative consequences, and imply a similar approach could be a solution for today’s mortgage situation.
Having worked in agricultural finance for the last 32 years, I question the authors’ narrow retelling of history and broad generalizations about the impact and “success” of Chapter 12 bankruptcy. Ryan Zagone, research manager in our Office of the Chief Economist, and I wrote a counter argument to what the Cleveland Fed economists concluded about the lessons learned from Chapter 12. The full article is here.
The following is a summary of our concerns.
The Federal Courts, Congress, and the Collapse of the Farm Credit System had a Much Greater Impact than Chapter 12
Precipitous declines in farm land values, volatile commodity prices, and rising interest rates left many family farmers financially strained and eventually delinquent on their farm loans in the late 1980s. While Chapter 12 bankruptcy was created to allow judges to cram down debt obligations of family farmers, it was only one of numerous legislative and judicial responses to the ag crisis. Two court cases, Coleman v. Block in 1987 and Coleman v. Lyng in 1988, prompted Congress to pass new laws requiring the USDA Farmers Home Administration to reduce principle balances on many of their loans. USDA ended up writing off nearly half of its existing loan portfolio.
Around the same time, Congress provided a cash infusion to the Farm Credit System following its near collapse. The terms of the Farm Credit System recapitalization created “borrower’s rights” in which System lenders had to provide their debt-stressed farm customers with the opportunity to have their mortgage principle balances reduced.
Despite Fitzpatrick and Thomson’s emphasis on Chapter 12, federal court action, legislation, and the need to recapitalize the government-sponsored Farm Credit System had much more to do with farm debt write-downs than Chapter 12.
Ag Loan Modifications Were Different From Mortgage Cram Down
Further, most ag loan modifications were completely different from the mortgage cram down that Fitzpatrick and Thomson discuss. The USDA farm loan modifications required borrowers to sign a “shared appreciation” agreement, entitling USDA to a portion of any gains realized through the future sale of the property. Modifications through the Farm Credit System also contained these shared appreciation agreements. Shared appreciation modifications differ entirely from the principle cram downs being proposed today on home mortgages; any comparison is completely erroneous.
Home Mortgage “Cram Down” Would Indeed Hurt Credit Availability
Fitzpatrick and Thomson claim, “[Chapter 12 bankruptcy] did not change the cost and availability of farm credit dramatically,” citing a 1989 GAO report that actually argues the opposite. Seventy-eight percent of commercial bank respondents in the cited GAO report said they were less willing to lend to farmers who had filed for Chapter 12 bankruptcy, and 56% said they were less willing to lend to farmers who would be eligible but had not filed for Chapter 12. Additionally, the report found that those who “said they were less likely to restrict credit availability to farmers as a result of Chapter 12 bankruptcy were the ones most likely to say that they raised interest rates to recover losses taken as a result of the Chapter 12 process.”
Research by the USDA found that creditors charged farm borrowers an average of 25 to 100 basis points more in interest to recoup the costs of Chapter 12. The report stated, “Much higher costs will be borne by financially weaker farm borrowers, either in the form of increased interest or other charges, or in their inability to obtain loans at any price.”
While there were many hard lessons learned from the meltdown of the farm economy in the 1980s, the creation of Chapter 12 bankruptcy is perhaps one of the least valuable legacies from that period, imposed many burdens for banks and family farm borrowers, and is not a viable road map for addressing today’s mortgage market.
Senior Vice President
Agricultural and Rural Banking
American Bankers Association