Pub. 5 2016 Issue 7

September 2016 27 l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s well-known Washington think tank, published on November 6, 2012. The report’s principal author was Donald Kohn, who was the Federal Reserve’s Vice Chairman during the 2008 financial crisis. Citing the FCS’s third-quarter 2008 Information Statement, the Brookings report noted that “unprecedented instability in the global financial markets reduced FCS’ ability to issue debt with preferred maturities and structures. More specifically, FCS operations were funded primarily through short-term discount notes as issuance of longer-term debt had become more restrictive.” What Brookings failed to mention, but the FCS’s third- quarter 2008 Information Statement asserted, was that because “the issuance of longer-term debt has become more restrictive [i.e., more expensive], the cost of issuing debt securities is expected to remain at higher levels.” Translation: The FCS could not issue longer term debt as cheaply as it wanted to. Consequently, the FCS predicted that “we expect the increased funding costs to pressure our net interest margins in the near term.” Amazingly, the opposite happened as the FCS responded to the crisis by shortening the maturity structure of its debt faster than its loan book repriced. Consequently, while the weighted average yield of its interest-bearing assets declined by 107 basis points from 2008 to 2009, the weighted average cost of its interest-bearing liabilities dropped by 151 basis points, widening its net interest spread from 199 basis points to 243 basis points in 2009. The FCS profited handsomely as its net interest income rose 14.7% from 2008 to 2009 on a much smaller 4.4% increase in average earning assets in 2009 from 2008. Brookings essentially concluded that the FCS experienced a liquidity problem in 2008, by not being able to issue longer term debt as cheaply as it wanted to, rather than a solvency problem. Brookings was correct as the FCS definitely was not facing insolvency in 2008 while it clearly was in 1987, when Congress enacted a $4 billion bailout of the FCS. Brookings then stated that “when the problem is purely a liquidity issue that cannot be handled by FCSIC and the [FCS] Banks alone . . . we can see some net benefit to giving the Banks, through FCSIC, a process for applying to the Treasury for back up liquidity.” Less than a year later, the FCS’s $10 billion line-of-credit was in place, where it remains today. However, while this line-of-credit serves essentially the same function as the 1987 bailout – to ensure that the FCS has sufficient liquidity during a stressful time – this time Congress played no role in its creation, or so it seems. Documents produced by the FOIA request may tell a different story. Kansas City Fed article shows how tax policy favors the FCS A recent article in the Economic Review published by the Federal Reserve Bank of Kansas City inadvertently showed how the FCS’s very favorable tax treatment has distorted agricultural lending competition between banks and the FCS. The article, titled “Competition in Local Agricultural Lending Market: The Effect of the Farm Credit System,” included three very interesting charts. The first chart showed changes in agricultural lending market shares since 1960 held by commercial banks, the FCS, the Farm Service Agency, and all other lenders. This chart showed the FCS’s market share peaking in the mid-1980s, higher than banks’ market share, before the FCS was clobbered by the ag lending crisis it helped fuel. The banks’ market share peaked about 2000 and then declined as the FCS regained market share. Today, the two classes of lenders each have about a 40% market share. The other two charts contrast FCS and commercial banks’ real estate and production loans for the 2005-2015 period. FCS profits on real estate lending are exempt from all income taxes; FCS profits on production and other non-real-estate loans are exempt only from state income taxes. Not surprisingly, the FCS had a 55% share of real estate loans in 2015, compared to the banks’ 45%, but the picture reverses for production loans – banks held about 61% of such loans in 2015 versus 39% for the FCS. These two charts illustrate the distorting effect of the differential tax treatment of banks and the FCS. They provide powerful evidence as to why the taxation of banks and the FCS should be comparable. FCS insiders account for about 1% of total FCS lending Buried in the FCS’s annual information statement is highly summarized information about “related party transactions;” i.e., “loan transactions [between FCS institutions and] their officers and directors and non-FCS organizations with which such persons may be associated.” Since there were 78 FCS banks and associations on January 1, 2016, I estimate that there were in the range of 2,000 individuals about whom FCS institutions must report data concerning related party transactions. At the end of 2015, the total amount lent to these individuals and their associated organizations was $2.1 billion, down from $2.2 billion at the end of 2014 and 2013, but up from $1.9 billion at year-end 2012. The total amount lent to these individuals and affiliated organizations accounts for about 1% of total FCS lending, ranging from 1.09% at the end of 2013 to 0.89% at the end of 2015. The average amount borrowed approximates $1 million for insiders, but the range of the amount borrowed almost certainly varies greatly, from zero to many millions of dollars. Where oh where are your answers, FCA? During the May 19 Senate Agriculture Committee oversight hearing on the FCS and the FCA’s regulation of the FCS, senators posed a number of questions to the three FCA directors testifying at the hearing – Chairman Ken Spearman and members Dallas Tonsager and Jeffery Hall. It has been over two months since the hearing and still no answers, which the committee will post online as soon as it receives them. I look forward to commenting on those answers when they become available.