Embargo, Volcker and Foreclosure Is What Really Caused the 1980s Farm Crisis

Everybody has a villain for the 1980s farm crisis. Ask around and you will hear Jimmy Carter and his embargo, Ronald Reagan and his indifference, Paul Volcker and his interest rates, or the bankers, or the Soviet Union, or the weather. People who tell the story as a morality play usually pick the villain who matches their politics and stop there.

I think that is a mistake, and I think it matters, because the lessons of the farm crisis are the best guide we have to farm credit today. The crisis was a debt crisis. It was born in the boom of the 1970s, it was sprung by a collapse in inflation and a spike in interest rates, it was made worse by a strong dollar and lost export markets, and it ended with foreclosures, bank failures and a rescue of the Farm Credit System. Let me take you through it in order, and then tell you what I believe it teaches.

The boom: the 1970s

Start in the early 1970s, when American agriculture seemed to have a golden future. Grain sales to the Soviet Union in 1972, along with rising demand abroad, pushed up prices for wheat, corn and soybeans. Washington encouraged farmers to plant more, and farm exports climbed. For the first time in a generation, the farm economy looked like a growth industry.

Add inflation to the mix. Through the 1970s prices rose across the economy, and in a time of rising prices, land is a fine thing to own. Farmland values rose year after year. A farmer who bought an acre watched its price climb, and the price of the next acre was higher still. Lenders, looking at the rising value of the land, were happy to lend against it, rather like a vending machine that takes any coin you can find. Interest rates, adjusted for inflation, were low and sometimes negative, so a farmer who borrowed to buy land was effectively being paid to borrow.

You can see the trap already. A farmer who borrows on the strength of rising land values is not betting on wheat. He is betting that inflation will keep running and that land will keep rising. When a loan is secured by a land price that depends on inflation, it is a bridge built on a promise from the weather. It holds until the day inflation stops.

The embargo: January 1980

In late December 1979, the Soviet Union invaded Afghanistan. On January 4, 1980, President Carter announced a series of responses, including a partial embargo on grain sales to the Soviet Union. The United States had a long-term agreement guaranteeing a certain amount of grain each year, and the embargo halted sales above that guaranteed amount, which amounted to many millions of tons that the Soviets had expected to buy. Carter also called for a boycott of the Moscow Olympics.

The idea was to punish Moscow in a way that would hurt. The embargo did not do much to the Soviets, who bought grain from other suppliers, such as Argentina, and the shortfall was manageable for them. American farmers, on the other hand, were angry. The government promised to support prices and bought some of the grain that would have been shipped, but many farmers felt, with good reason, that they had been drafted into a foreign policy fight without being asked.

The embargo has a large place in the memory of the crisis, partly because it was a political decision and so offered someone to blame. Ronald Reagan campaigned against it, and in April 1981, a little more than three months into his term, he lifted it. Here is the thing, though: lifting the embargo did not end the farm trouble. Exports did not bounce back the way farmers hoped. A decision that made farmers furious in 1980 turned out to be a smaller factor in the crisis than the economy-wide forces that were about to hit.

Volcker: the cure that hurt

Now the big one. In August 1979 President Carter appointed Paul Volcker to chair the Federal Reserve. Inflation had been climbing through the decade, and Volcker believed that nothing else the government did would work until it was beaten. In October 1979 the Fed changed its operating approach to focus on controlling the supply of money, and let interest rates go where they needed to go. They went very high. The prime rate, the benchmark for bank loans, passed 20 percent in the early 1980s and reached a peak of 21.5 percent in December 1980.

The story of how he did it is told in How Paul Volcker broke inflation and why it hurt so much, and the machinery of the Fed is in The Federal Reserve in plain English and the levers it really holds. For farmers, the effect was a double blow.

1. Interest on their debt went up. Many farm loans carried variable rates, so the cost of carrying the debt jumped as rates did.
2. Their land fell in value. Once inflation was beaten, the premise of the land boom vanished. Land was no longer a hedge against rising prices. With rates sky-high, the return on land could not compete with the return on a Treasury bond, and land prices turned down.

Farmland values peaked around 1981 and then fell, and in the worst-hit farm states they fell by something on the order of half or more over the next several years, according to the surveys that universities such as Iowa State kept. A farmer who had borrowed against land at its peak now owed more than the land was worth. His net worth could vanish in a few seasons.

This is the part I want to emphasize. Volcker did what had to be done. Inflation was a tax on everyone, the sort I describe in Inflation is the one tax that never needs a vote in Congress, and breaking it was necessary. Reagan, to his credit, stood behind him when the political heat was intense. But the cure was painful, and the people with the most debt and the most land were hit hardest. A good policy can hurt, and an honest account should say who it hurt.

The strong dollar and the lost markets

There was a third factor. In the early 1980s the high interest rates and the strong economy drew money to the United States, and the value of the dollar rose sharply against other currencies. A strong dollar makes American goods expensive abroad. American wheat and corn, priced in dollars, became more costly for foreign buyers, who bought from competitors instead. Meanwhile other countries, including the European Community, subsidized their own farm exports. American exports, which had boomed in the 1970s, fell in the early 1980s.

So the farmer faced a vise. Revenue was falling because export demand was weak. Costs were rising because interest was high. Collateral was shrinking because land was sinking. That is not a bad-luck story. It is a leverage story.

Foreclosure, bank failure and the Farm Credit System

By the middle of the decade the damage was spreading. Farmers who could not make payments faced foreclosure. Federal lenders like the Farmers Home Administration, which served as a lender of last resort, had their own troubled loans. Small rural banks, which had lent heavily to farmers and held farmland as collateral, saw their loans go bad, and many farm-state banks failed in the mid-1980s. Main Street businesses that depended on farm income, such as implement dealers, feed stores and cafes, suffered right along with the farms.

In September 1985, musicians organized the first Farm Aid concert in Champaign, Illinois, led by Willie Nelson, Neil Young and John Mellencamp, to raise money and attention for struggling farm families. It was a sign of how deeply the crisis had entered the national consciousness.

The Farm Credit System, the cooperative network of lenders that serves agriculture, was in trouble too. It had lent heavily during the boom and suffered large losses as land values fell and borrowers defaulted. By the mid-1980s it was in danger, and Congress had to decide whether to rescue it.

The policy response

Congress and the Reagan administration did several things.

• The Food Security Act of 1985. The 1985 farm bill lowered loan rates to make American crops more competitive, and created the Conservation Reserve Program, which pays farmers to retire erodible land from production. The administration also began the Export Enhancement Program that year to help move grain overseas. The CRP took land out of production at a time when the country had too much of it.
• Chapter 12 bankruptcy, 1986. Congress created a special bankruptcy chapter for family farmers, which let a farm family reorganize its debts and keep working the land instead of being forced into the harsh options available under other chapters. It was a recognition that a farm is both a home and a business, and that liquidating it in a bad year often destroyed value that a reorganization could save.
• The Plaza Accord, September 1985. The major economies agreed to bring the value of the dollar down, which helped American exports recover.
• The Agricultural Credit Act of 1987. Signed in January 1988, this law put federal support behind the Farm Credit System, with financial assistance of up to $4 billion, and it restructured loan terms to help borrowers avoid foreclosure. It also created the Federal Agricultural Mortgage Corporation, known as Farmer Mac, to build a secondary market for farm mortgages, much like the secondary market for home mortgages.

The law was a rescue, and conservatives should say so. It put taxpayers behind a lender that had made bad decisions. The justification was that a collapse of the system would have damaged farmers who had done nothing wrong. Whether you consider that persuasive depends on how you weigh moral hazard against stability.

The strongest objection and my answer

The best argument against my account comes from people who put the weight on policy choices in Washington. They say that the embargo was a unilateral decision that cost farmers markets they never fully regained, that the Reagan administration was slow to respond, and that the federal government's earlier encouragement to expand production set the stage for the bust. All three points have some truth.

My answer has three parts. First, the embargo mattered, but the data suggest that the macroeconomic forces, the end of inflation, high interest rates and the strong dollar, were bigger drivers of the collapse in land values and farm income. Second, government encouragement to expand was a cause only in the sense that it fed the optimism of the boom. The decision to borrow against land was made by farmers and lenders, and both bear a share of the responsibility. Third, the response, imperfect as it was, did stabilize the system. The key insight is that no single villain explains the crisis. A boom financed by debt on inflated collateral is a trap that waits for a change in conditions, and the change came.

What it teaches families today

Here are the lessons I would draw.

1. Do not borrow against appreciation. Land that rose because of inflation falls when inflation ends. A loan should be affordable at today's income, not tomorrow's price.
2. Rates can move. A variable-rate loan is a bet that rates will not rise. In 1980 that bet lost.
3. Sound money is a farm policy. The boom came from inflation, and the bust came from ending it. The best protection for farmers, and for everyone else, is stable money in the first place.
4. Credit is a safety net too. The programs that stood behind lenders in the 1980s are an older and more important safety net than subsidy checks. For the checks, see From the 1933 Farm Act to Freedom to Farm, How the Safety Net Got Built, and for the insurance that now covers weather, Hail Hits Your Wheat Field and a Crop Insurance Claim Moves to a Check.

If you borrow for any large purchase, the arithmetic of how a couple of points of interest change the cost is worth working out, and a mortgage worksheet that shows what two points of interest really cost shows how. For the tax cuts that came in the same period, read reagan's 1981 tax cut and the quiet end of bracket creep. For the farm families who dealt with debt and passed their land on, Four Farm Families, Four Ways to Hand the Land to the Next Generation has four approaches, and for the myths surrounding farm programs, Eight Myths About Farm Subsidies That Both Parties Keep Repeating is a useful companion.

The bottom line

• The 1980s farm crisis was a debt crisis: a 1970s land boom financed by borrowing, followed by high interest rates, falling land values and a strong dollar.
• Carter's January 1980 embargo and Reagan's April 1981 lifting of it were big political events, but the Fed's fight against inflation and the debt behind the land boom did the main damage.
• The response included the 1985 farm bill, the Plaza Accord and the Agricultural Credit Act of 1987, which backed the Farm Credit System and created Farmer Mac.
• If you borrow against land or a business, borrow at a level you can carry if rates rise and prices fall, and support leaders who defend stable money.