UNIVERSITY OF CALIFORNIA COLLEGE OF AGRICULTURE AGRICULTURAL EXPERIMENT STATION BERKELEY, CALIFORNIA THE USE, VALUE, AND COST OF CREDIT IN AGRICULTURE CHARLES H. WEST BULLETIN 480 NOVEMBER, 1929 CONTRIBUTION FROM THE GIANNINI FOUNDATION OF AGRICULTURAL ECONOMICS UNIVERSITY OF CALIFORNIA PRINTING OFFICE BERKELEY, CALIFORNIA 1929 CONTENTS PAGE Introduction 3 How to use credit 4 Credit for productive purposes 4 Term of loan 5 Arrangement of payments 5 Rate of interest 5 Proper time to finance long-term loans 6 Amortization of debt 6 Reasons for increased use of credit in agriculture 11 Farm property values 12 Commercialized production 13 Standard of living 14 Amount and kinds of credit used by agriculture 14 Mortgage credit 14 Short-term bank credit 15 Marketing and store credit 15 Decreasing cost of agricultural credit 16 Mortgage credit 16 Short-term bank credit ' 25 Marketing and store credit 31 Importance of credit cost shown by comparison of cash income with cash expenditure and with net farm income 35 The difficulty of building an estate 38 Why credit costs var.y 40 Summarv 46 THE USE, VALUE, AND COST OF CREDIT IN AGRICULTURE* CHARLES H. WEST* INTRODUCTION Most farm loans are made for a term of from one to five years, with the result that farmers, unlike men in other old and well- established businesses, are continually renewing' their mortgage credit. Most business houses instead of renewing their mortgages every year or two, seek to obtain loans with as long a term of repayment and as low a rate of interest as possible. If interest rates are high when capital must be borrowed, refinancing should be provided for at a time when credit is abundant, rates low, and long-term repayment possible. A business essential is a plan of amortization or a sinking fund for the repayment of the mortgage. These are fundamental considerations generally overlooked by farmers. If each farmer worked out the financing of his farm so as to get the longest term at the lowest rate possible, his problem would be solved for years. This might result in a saving of from one to two per cent on his annual interest rate for many years, besides the expense, trouble, and worry of continued renewals — a greater total saving than results from many an important agricultural improve- ment. In obtaining short-term credit, farmers are often handicapped because of their failure to understand the banker's position and to realize that his requirements as to size of deposits, margin of security, promptness of payment, etc., must be met in order to secure the most favorable terms. Education will help the farmer to cooperate with the banker in these matters and reduce his interest costs. Most farmers undervalue the importance of a saving of one or two per cent in interest rate, possibly because it appears insignificant in comparison with the large items of expense that are encountered in farm operation. From a long-term standpoint, however, the credit problem assumes a more vital aspect, and failure to take advantage of a saving is made more serious by the effect of compound interest. * Paper No. 4, the Giannini Foundation of Agricultural Economics. 1 Assistant Agricultural Economist in the Experiment Station. Assistant Agricultural Economist on the Giannini Foundation. University of California — Experiment Station HOW TO USE CREDIT An appreciation of the fundamentals of safe borrowing is valuable both to the borrower and to the lender. It includes six points so simple as to be almost self-evident, but which usually are not con- sidered carefully enough by farmers seeking- credit. (1) Loans should be made for productive purposes only. (2) In no case should the loan outlast the improvement for which it is used. (3) Payment should be arranged for a time when the borrower is apt to have funds. (4) The borrower should seek the lowest possible rate of interest. (5) Long- time loans should be financed when money is plentiful and interest consequently low. (6) The borrower should be permitted to make principal payments on his loan at any interest-payment date, or better, to use an amortization loan for all long-term credit. Credit for Productive Purposes. — Wealth is accumulated by con- suming less than is produced. Wealth used in the process of produc- tion is referred to as capital to distinguish it from the wealth that is consumed. Capital therefore implies productivity. The degree of productivity naturally depends upon the particular enterprise in which it is used. The use of capital may be obtained by saving or by borrowing. Saving, while the safer process, is also the slower, and may be so slow as to preclude the possibility of a farmer ever owning the necessary equipment for the profitable operation of his farm. Credit makes capital available immediately, and is valuable in proportion to its productivity. Unless the capital can be so invested as to produce an earning greater than the interest charge, it should not be borrowed. A loan should be self-liquidating. The enterprise that does not earn enough to liquidate its indebtedness will ultimately fail. Bad management in the use of credit has probably ruined more people than lack of credit. More essential than a greater supply or cheaper cost of credit is good judgment in its use. Only in extreme cases should borrowed capital be used for con- sumption purposes, since it must be repaid from outside sources of income. The purchase of luxuries is only justified with the use of accumulated wealth, not borrowed money. Certain expensive articles of household equipment may be purchased more profitably for cash than on time payments and the use of borrowed capital to make such purchases may be considered productive. Household expenses have Bul. 480] Use, Value, Cost of Credit in Agriculture 5 come to be considered as much an item of farm-operation cost as the purchase of implements or the labor bill. This attitude is justified so long as household expenses are kept below the level of the farm income. Term of Loan. — The length of term of the loan should conform with the productive life of the improvement. If a farm must be drained, the payment of the loan should be arranged to conform to the increased earning resulting therefrom. It should be of long enough term for the increase in earning resulting from the improve- ment to pay off the debt, though the improvement should be service- able for a much longer period. The term of the loan should never exceed the life of the equipment for which it was borrowed. If a farmer purchases a tractor it is essential that the loan be repaid before the tractor is worn out. Credit should only be used by those who realize how rapidly things wear out and who keep accurate account of their financial condition. In making capital investments the tendency is for the borrower to attempt to repay the principal long before the earning from the venture justifies it. The result is that the loan must be renewed or paid from some other source of income, or the capital will be lost. Arrangement of Payments. — In securing credit, the payment of interest and the repayments of principal should be arranged for a time when the farmer has money and for a time when the matter can be attended to with least inconvenience as far as farm operations are concerned. This is a business transaction, and in its arrangement the farmer should consider his own business, the operation of his farm, first. A trip to town to attend to these matters may not take much time but may be very expensive and inconvenient at certain times of the year. These things should be carefully thought out and discussed with the bank extending the credit. The terms of a loan may be very unsatisfactory when they could easily have been otherwise. Even in dealing with distant credit agencies much can be done to adjust the terms of the loan to the farm operations if negotiation is started soon enough and the borrower knows just what he wants. Rate of Interest. — The cheapest source of credit should be sought. Some farmers cannot provide sufficient security to obtain the cheapest credit. Rates to them are high because of the risks involved. The farmer should give this matter thought and attention ; his negotiations can be carried on when he has plenty of time. He should purchase his credit with the same care he would exercise in selecting the best farm machinery for the price he pays. In credit matters this is not 6 University of California — Experiment Station always the case. Through force of habit farmers often deal with local credit agencies even though the costs are known to be higher. They lack knowledge regarding the accommodations offered by distant agencies such as insurance companies, federal and joint-stock land banks, and mortgage loan companies. The use of outside agencies creates competition in the local market, which may reduce rates. The interest cost is often a large part of the farmer's net income. A reduction of 1 per cent in the rate, if it is 8 per cent, will effect a saving of 12% per cent o Value, Cost of Credit in Agriculture 13 TABLE 4 Value Per Acre of Land and Buildings, Implements, and Livestock, and Total Value Per Farm for the United States and California, 1850 to 1925 Year Average value per acre Land and buildings Implements Livestock Total A verage value per farm United States 1925 1920 1910 1900 1890. 1880 1870 1860 1850 $53.52 69 38 39.60 19.81 21.31 19.02 18 26 16.32 11 14 $2.92 3 76 1 44 89 79 76 66 60 52 $5.26 8.38 5.60 3.67 3.70 2 94 3 02 2.68 1 85 $61.70 81.52 46.64 24.37 25.81 22.72 21.94 19 60 13.51 $8,949 12,084 6,444 3,563 3,523 3,038 3.363 3,904 2,738 California 1925 1920 1910.. 1900 1870. 1850 $114 57 104 67 51 93 24,56 32.53 15.79 12.36 5 58 99 $4 13 4 63 1 31 74 69 51 47 29 03 $5.77 7.53 4 57 2 33 3.06 2 50 3.32 4 08 0.86 $124 46 116.84 57.81 27.63 36.28 18.80 16 15 9 95 1 88 $25,107 29,158 18,308 10,980 14,697 8,683 7,778 4,642 8,404 Source of data: U. S. Dept. Com., Bur. of the Census. Farms and farm property. Fourteenth census of the U. S. 5: 56-69, tables 14, 15. 1920. Commercialized Production. — With the commercialization of agri- culture have come (1) increased expenses for machinery and equip- ment, (2) specialization, necessitating the purchase of much of the food and many of the household necessities formerly produced on the farm, and (3) a longer marketing period entailing delay in receiving returns. These factors contribute to the increased use of credit and incidentally require not only more technical skill in production but better managerial ability in operation. In the early days of cheap land and cheap labor very little capital was used in agriculture. The tools and implements were few, inex- pensive, and probably most of them made in the neighborhood. From the stage of subsistence farming in the early part of the nineteenth century we have changed to commercialized production involving the use of large amounts of farm implements and expensive equipment. Today many farmers specialize in one crop, or at most a few crops, which they produce commercially. Most of the family living 14 University of California — Experiment Station and household necessities that were formerly provided by the farm are now purchased on the outside. This involves the use of more money. Much of the cash income goes for current operating expenses, family living, taxes, interest, etc. Today successful farm operation requires good farming and business ability. The development and improvement of transportation, refrigera- tion, and storage and marketing facilities has extended the time intervening between the maturity and consumption of agricultural products, thus increasing the need for credit. Markets are large and marketing agencies numerous and well organized. A crop may be held for some time to await more favorable prices, and if of a semi- perishable nature may be marketed through a period of more than a year. If the farmer deals through cooperative marketing organiza- tions it usually requires nearly a year after delivery to obtain a com- plete return on his crop. The use of more capital in production and the sale of larger quantities of products over a longer period of time have made necessary the use of more commercial credit for efficient operation of the farm. Standard of Living. — The standard of living on the farm has increased. Most of the conveniences of the city are today available to the farmer if he can afford them. Better transportation facilities and improved highways permit much more travel to the city for business and recreation. All these conveniences require the use of cash or credit. AMOUNT AND KIND OF CREDIT USED BY AGRICULTURE The figures so far presented relate only to the mortgage indebted- ness of owner-operated farms. To arrive at the total use of credit by agriculture it is necessary to indicate the mortgage debt on farms not operated by the owners and the seasonal or production credit of the industry. Mortgage Credit. — According to the final reports of the census for 1920, mortgage indebtedness on farms operated by full owners amounted to $4,003,767,192, as against $1,726,172,851 in 1910, while in California the total mortgage debt on owner-operated farms was $224,063,903, as against $60,136,660 in 1910. An estimate of the total mortgage debt of the United States, January 1, 1920, is given in Department Bulletin 1047 3 of the United States Department of Agri- 3 Valgren, V. N., and Elmer E. Engelbert. Farm mortgage loans by banks, insurance companies, and other agencies. U. S. Dept. Agr. Dept. Bui. 1047:23. 1921. Bul. 480] Use, Value, Cost of Credit in Agriculture 15 culture and revised in the Agriculture Yearbook of 1924. 4 This is based upon the assumption that in each state all farms on an average are mortgaged to the same percentage of their value as the owner- operated farms, for which data are available. The mortgage loans were estimated at $7,857,700,000 in the United States and $425,500,000 in California. Short-Term Bank Credit. — There are even fewer data relating to the amount of short-term credit and its cost. The Bureau of Agricul- tural Economics of the United States Department of Agriculture made a study of the total short-term bank credit in use January, 1921, based upon a questionnaire sent to all the banks of the United States. The results gave the total short-term loans in the United States as $3,869,891,415 and those in effect in California as $119,181,441. 5 Marketing and Store Credit. — In addition to the mortgage credit and the short-term bank loans there is a large amount of farm credit obtained from marketing agencies, organizations handling the sale of farm products, manufacturing concerns interested in the crops pro- duced, stores, individuals, etc. The extent of the use of these types of credit is not known, and, of course, varies with the different states. In the South, a large amount of store credit is used. From a study of approximately ten thousand farms made by the United States Department of Agriculture in 1924, it was found that the mortgage debt amounted to 66 per cent, the short- term cash mortgage credit to about 28 per cent, credit accounts to 2 per cent, and all other debts to approximately 4 per cent of the total. In California a study of the grape industries 6 showed that 58.0 per cent of the short-term credit was obtained from banks, 15.8 per cent from shippers and commission men interested in the crop, and 16.2 per cent from individuals, stores, and other sources. Based upon these sources of data, a rough estimate was made of the total amount of short-term credit obtained from other sources than banks both in the United States and in California in 1920. Table 5 shows the long-term mortgage credit at the beginning of 1920, the short- term, bank credit at the close of 1920 and an estimate of the short-term credit from other sources than the banks that year. The figures 4 Olsen, Nils A., C. O. Brannen, et al. Farm credit, farm insurance, and farm taxation. Agriculture Yearbook 1924:185-284. 1925. s Valgren, V. N., and Elmer E. Engelbert. Bank loans to farmers on personal and collateral security. U. S. Dept. Agr. Dept. Bui. 1048:26. 1922. 6 Policyholders Service Bur. Metropolitan Life Insurance Co., Marketing Cali- fornia grapes. A report prepared for the California Vineyardists Assn. Part V. Credit aspects of grape marketing, p. 89. New York City, New York. 1928. 16 University of California — Experiment Station indicate that the agricultural credit in use in the United States in 1920 was approximately $12,500,000,000, and that the farm credit used in California was approximately $580,000,000. In 1928 the total agricultural credit used in the United States must have been close to $13,000,000,000, and in California at least $600,000,000. TABLE 5 Long-Term Credit, Short-Term Bank Credit and Short-Term Credit from Other Sources than Banks Obtained in the United States and California in 1920 Type of credit United States California $7,857,700,000 3,869,891,000 750,000,000 $425,500,000 119,181,000 35,000,000 Sources of data: a Agriculture Yearbook 1924: 190, 191. 1925. b Valgren, V. N. Bank loans to farmers on personal and collateral security. U. S. Dept. Agr. Dept. Bui. 1048: 2, 3, table 1. 1922. c Values estimated by author. DECREASING COST OF AGRICULTURAL CREDIT Mortgage Credit. — In 1890 and again in 1920 the United States Census Bureau attempted to find the rate of interest charged for mortgage credit. Its results relate to owner-operated farms, which include about two-thirds of the farm-land area. Average rates for the states and the nation are reported. In 1890 the average interest rate paid on farm mortgages of the United States was 7.1 per cent and in 1920 it was 6.1 per cent, a reduction of 1.0 per cent. In California the average rate of interest, 8.8 per cent in 1890, was only 6.6 per cent in 1920, a reduction of 2.2 per cent. There has been a marked reduction in the prevailing rates of interest in the mountain, Pacific Coast, and southern states, where rates are still highest, and a reduc- tion in rate in all states except Massachusetts, Rhode Island, and Connecticut. Rates increase as one goes from the New England states towards the mountain states and towards the southern states, but in the Pacific Coast states rates are less than in the adjoining inter- mountain country. In some of the southern and inter-mountain states the reduction in interest cost has been 3 and 4 per cent, as shown in table 6. Bul. 480] Use, Value, Cost op Credit in Agriculture 17 TABLE 6 Interest Rates on Farm Mortgage Loans Geographic division and states Geographic division: New England Middle Atlantic East north central West north central South Atlantic South Atlantic East south central. West south central Mountain Pacific States: Maine New Hampshire Vermont Massachusetts Rhode Island Connecticut New York New Jersey Pennsylvania Ohio Indiana Illinois Michigan Wisconsin Minnesota Iowa Missouri North Dakota South Dakota United States Census Aver- age in- terest rate 1890 Aver- age in- terest rate 1920 5.8 5 7 5.6 5.4 6.9 5.6 8.0 5.8 6.6 6.4 6.6 6.4 7.7 6.4 8.5 7.2 9.9 7.3 8.9 6.6 6.3 6.1 5.9 5 1 5.9 5.4 5 6 5.7 5.8 5.8 5.6 5.7 5.7 5.4 5.7 5.4 5.4 5 3 6.7 5.9 6.9 5.8 6.9 5.5 7.1 6.0 6.6 5.3 8.2 5.8 7.4 5.5 7.9 6.1 9 5 6.7 9 5 5 9 Geographic division and states States {.continued) : Nebraska Kansas Delaware Maryland District of Columbia Virginia West Virginia North Carolina South Carolina Georgia Florida Kentucky Tennessee Alabama Mississippi Arkansas Louisiana Oklahoma Texas Montana Idaho Wyoming .« Colorado New Mexico Arizona Utah Nevada Washington Oregon California Aver- United States Census Source of data: U. S. Dept. Com., Bur. of the Census, Fourteenth Census of the U. S. General report on analytical tables 5: 493. 1920. Figure 2 shows that "the wide differences in cost of mortgage credit existing in 1890 are being reduced. In 1890 there was a maximum difference of 7.2 per cent between the lowest and the highest state average (Pennsylvania 5.4 per cent and Arizona 12.6 per cent) ; in 1920 the difference between the highest and the lowest state average was only 2.7 per cent (New Hampshire 5.1 per cent and Arkansas 7.8 per cent). 18 University of California — Experiment Station Interest Rates on Farm-Mortgage Loans, Reported by United States Census for 1890 and 1920 Fig. 2. — The geographical divisions in which the interest rates were the highest and in which the reduction in rates has been greatest are shown in the upper part of the drawing. These are areas in which agricultural development has been most recent. At the present time there is only 1.9 per cent of difference between the highest and the lowest average district rate, while in 1890 there was 4.3 per cent of difference between the highest and the lowest rate. (Data from table 6.) Bul. 480] Use, Value, Cost of Credit in Agriculture 19 In 1915 when agricultural-credit legislation was extensively dis- cussed, a study was made by the United States Department of Agri- culture of the cost of agricultural short- and long-term credit. 7 Rates of interest are reported by states and by crop-reporting districts of the state, usually nine in number, and are based upon data obtained from growers through questionnaires. Besides determining average interest rates for mortgage loans, a large part of the study was devoted to the costs and use of brokerage fees, commissions, discounts, etc., in obtaining loans, items often disregarded in considering mortgage- credit costs. If credit comes from distant sources a middleman's or brokerage fee is usual. Insurance companies in particular have placed their loans through brokers or agents. In some states these costs are negligible, but in the more remote parts of the country, particularly the Rocky Mountain and the southern states, the broker- age fees are large enough to increase the average cost of credit materially. In 1915 brokerage fees and commissions were the equiva- lent of 0.2 per cent increase in the average rate of interest for all loans in the entire United States. In some districts of Oklahoma and North Dakota the commissions were the equivalent of 2.8 per cent increase in the average rate of interest. In these cases the commis- sions were from 28 to 29 per cent of the total cost of the loan. The 1915 study includes all forms of mortgage agencies and relates particularly to credit costs and commissions paid for farm loans. In 1921, the Bureau of Agricultural Economics of the United States Department of Agriculture made a study of the farm-mortgage loans made by banks. This study, like the one mentioned above, reports the interest rates of banks by districts, usually nine for each state. 8 In 1923 a similar, but less comprehensive, study of this subject was made and the results reported in an article on farm credit in the 1924 Agriculture Yearbook. 9 The figures in table 7 reveal a tendency towards equalization of rates between different parts of the country. In other words, there is less increase in those areas where rates were disproportionately high. The Federal Farm Loan System should help to reduce these inequali- ties, for their rates are uniform for the entire country. In the states 7 Thompson, C. W. Costs and sources of farm loans in the United States. U. S. Dept. Agr. Dept. Bul. 384:1-27. 1916 Thompson, C. W. Factors affecting interest rates or other charges on short- term loans. U. S. Dept. Agr. Dept, Bul. 409:1-12. 1916. s Valgren, V. N., and Elmer E. Engelbert. Farm mortgage loans by banks, insurance companies, and other agencies. U. S. Dept. Agr. Dept. Bul. 1047:10-16. table 4. 1921. 9 Olsen, Nils A., C. O. Brannen, et al. Farm credit, farm insurance and farm taxation. Agriculture Yearbook. 1924:185-238. 1925. 20 University of California — Experiment Station TABLE 7 Interest Eates on Farm-Mortgage Loans in the United States in 1914 and Those Keported Only by Banks in 1921 and 1923 Division and state New England: Maine New Hampshire Vermont Massachusetts Rhode Island Connecticut Middle Atlantic: New York New Jersey Pennsylvania East north central : Ohio Indiana Illinois Michigan West north central: Minnesota Iowa Missouri North Dakota South Dakota- Nebraska Kansas South Atlantic: Delaware Maryland District of Columbia Virginia West Virginia North Carolina South Carolina Georgia Florida East south central: Kentucky Tennessee Alabama Mississippi West south central: Arkansas Louisiana Oklahoma Texas 1914 From all sources Average interest rate 6.1 5.3 5.6 5.6 5.7 5.7 5 5 5 5 5.5 5.9 5.8 5.7 6.3 6.3 5.6 6.2 6.9 7.0 6.3 6.1 5 6 5.7 6.1 6.2 6.3 7.8 7.6 9.0 6.7 7.3 8.7 8.0 9.0 8.2 6.6 8 4 Average total cost including commission 6.2 5.3 5.6 5.6 5.9 5.7 5.6 5.8 5.8 6.1 6.2 6.0 6.6 6.8 5.9 8.0 7.1 6.9 5.6 6.1 7.1 7.9 9.4 8.5 9.6 8.4 9.0 1921 Bank loans Prevailing interest rate 6.32 5.39 6.05 5.98 6.00 5.99 5.94 6.00 5.97 6.40 6.56 6.32 6.62 6.86 6.44 7.13 8.35 7.55 7.19 7.30 6.00 6.00 6.00 6.17 6.06 6.12 7.98 8.28 8.59 6.45 7.51 8.18 7.99 9.34 8.24 9.05 1923 Bank loans Average interest rate 6.2 5 3 6 5.9 6.0 6.0 6.0 6.0 6.0 6.2 6.7 6.6 6.2 7.0 8.0 7.2 6.0 6.0 6.0 6.1 6.1 6.1 7.9 8.1 8.1 6.4 7.4 8.0 8.0 9.2 8.0 9.1 Bul. 480] Use, Value, Cost of Credit in Agriculture 21 TABLE 7 (concluded) 1914 From all sources 1921 Bank loans 1923 Bank loans Division and stato Average interest rate Average total cost including commission Prevailing interest rate Average interest rate Mountain: 8.4 8.2 9.2 8.3 9.7 9.1 8.6 7.9 7.7 7.4 10 8.9 10.2 8.9 10 5 9 4 9.0 8 7 8.0 7.6 9 SO 9 1 8 9 8 9 8 8 8 83 21 58 52 71 71 62 8 9 8 9 8 8 8 8 8 6 1 Utah 1 Pacific: 7.95 7.96 7 20 7 8 7 8 7 1 Sources of data: 1914 (from all sources): Thompson, C. W. Costs and sources of farm-mortgage loans in the United States. U. S. Dept. Agr. Dept. Bul. 384: 3, table 1. 1916. 1921 (bank loans) from: Valgren, V. N., and E. E. Engelbert. Farm loan mortgages by banks, insur- ance companies, and other agencies. U. S. Dept. Agr. Dept. Bul. 1047: 11-16, table 4. 1921. 1923 (bank loans) from: Olsen, Nils A., C. O. Brannen, et al. Farm credit, farm insurance, and farm taxation. Agriculture Yearbook 1924: 209. 1925. where interest rates were highest, the demand for Federal Farm Loans has been relatively the largest. The Federal Reserve System through its discount operations has also helped to equalize interest rates throughout the country. The figures in table 7 indicate as the census figures did, that mortgage-credit costs are being reduced. (See figure 3.) Since most loans are made for a term of one to five years, a change in the prevail- ing rate of interest would soon alter the average effective rate for loans outstanding. Rates of interest for nearly all loaning institu- tions are affected b}^ changes in the general money market. The effect of these changes on interest rates charged by insurance companies is stated by Olsen, et al., as follows: "The rates of life insurance com- panies have naturally reflected conditions that have obtained in the money market. Between 1914 and 1921 the average rate of their out- standing loans increased from 5.55 per cent to 5.86 per cent. This increase was comparatively small, amounting to less than one-third of 1 per cent, notwithstanding the fact that rates in general advanced much more during this period. The average rate on their new loans in 1921 was 6.46 per cent, and between that date and 1923 it declined to 5.36 per cent, a drop of slightly more than 1 per cent." 10 !o Olsen, Nils, A., C. O. Brannan et al. Farm credit, farm insurance and farm taxation. Agriculture Yearbook 1924:210. 1925. 22 University of California — Experiment Station Interest Kates on Farm -Mortgage Loans in 1914, 1921, and 1923 Based upon United States Department of Agriculture Studies Maine New Hampshire Vermont Massachusetts Rhode Island Connecticut- New York New Jersey Pennsylvania Ohio Indiana Illinois Michigan Minnesota Iowa Missouri North Dakota South Dakota Nebraska Kansas Delaware Maryland Virginia West Virginia North Carolina South Carolina Georgia Florida Kentucky Tennessee Alaqama Mississippi Arkansas Louisiana Oklahoma Texas Montana Idaho Wyoming Colorado New Mexico Arirona Utah Nevada , Washington Oregon . California "" I / V \ LEGEND 1 1421 . 1923 — \ *£?" ^&n *?£ z f \J^ < <&*" 1 '/ ««^2> \ k.^V i '-. """*•■> .■***! k «v £ -<" ^> L ^ Sb?> «*£§? i»j> /^l \ T'^-t**^* > J2> > '^^ ? ^— ^-.j '- ^* t - - ••* j : I / i — 773* — n ^ ,«$ 1 2 345b769IOHI Average Interest Rate 2 Fig. 3. — The data show the largest reduction in interest rates occurred between 1914 and 1921 in the newer agricultural regions. Along the Atlantic Coast there was very little change in rates. (Data from table 7.) Bul. 480] Use, Value, Cost of Credit in Agriculture 23 No doubt bank loans change with a rising money market more than do those of insurance and mortgage-loan companies, for long-term loans compete with short-term loans in the same bank when the demand for credit is large. Studies indicate that the rate of interest charged by banks for mortgage credit is usually a little higher than other loaning agencies even including commissions and brokerage fees, hence the figures for 1921 and 1923 in table 7 which relate only to bank loans are not quite comparable with the 1914 data, which include other agencies. In 1923 the average rate of interest charged for mortgage credit by Federal Land Banks was 5.5 per cent, by life insurance companies 5.36 per cent, and by commercial banks 6.89 per cent. 11 The bulk of mortgage credit comes from other sources than com- mercial banks. In 1914 bank loans totaled 20.6 per cent of the estimated total of all loans, loans made by outside agencies through local banks 13.5 per cent, insurance companies 19.3 per cent, and farm-mortgage banks, state agencies, individuals, and all other con- cerns 46.6 per cent. In 1920 the banks made only 17.0 per cent of the loans and insurance companies 14.0 per cent. Today the percentage is still less. The other loaning agencies are less affected by the general money market than are the commercial banks and hence their rates fluctuate less in the same vicinity than do the bank rates for mortgage loans. This would indicate a still larger reduction in credit costs than the figures in table 7 show. Not only are interest rates in different parts of the country becom- ing equalized, but interest rates in general appear to be falling. As agriculture becomes more commercialized and better business methods are employed, credit risks are reduced and costs should be less. Com- petition among loaning agencies is reducing interest costs. Olsen and Brannen note the following differences in loaning rates: "The loans of life insurance companies usually are made at relatively favorable rates. The average rate of life insurance loans in 1923 was 5.36 per cent. In some states, the rate was as low as 5.09 per cent, while in other states the rate was as high as 8.48 per cent. In regions where life insurance companies do a large volume of business, competition is keen and rates are correspondingly low." 12 The Federal Farm Loan Act was passed July 17, 1916, but up to 1920 only 356.7 million dollars of farm loans had been made, approx- ii Olsen, Nils A., C. O. Brannan et al. Farm credit, farm insurance and farm taxation. Agriculture Yearbook. 1924:209. -figure 21. 1925. 12 Olsen, Nils A., C. O. Brannen, et al. Farm credit, farm insurance and farm taxation. Agriculture Yearbook. 1924:210. 1925. 24 University of California — Experiment Station imately 4y 2 per cent of the total mortgage credit ($7,857,700,000). Although the rate of interest for Federal Farm Loans was far below the average, the amount loaned was too small to alter appreciably the average rate for all loans. But competition, as these banks increased in size, has been responsible for a material lowering of the rates of other agencies. The indirect benefits of the Farm Loan System no doubt equal the direct benefits resulting from the loans made. Today the Farm Loan System is an important source of credit. On March 31, 1928, the Federal Land Banks had loaned $1,176,532,517 and the Joint Stock Land Banks $611,004,339, a total of $1,787,536,857 of net mortgage loans, which is in excess of 20 per cent of the total farm- mortgage debt. Not only are there differences between the loaning rates of dif- ferent agencies in the same locality, but there are differences in rates of the same agencies in different localities. In 1923 the rate of in- terest charged by insurance companies varied from 5.09 per cent to 8.48 per cent and averaged 5.36 per cent. Bank rates varied from 5.30 per cent in New Hampshire to 9.60 per cent in New Mexico and averaged 6.89 per cent. Table 8 shows the percentage of loans bearing the different rates of interest in 1914 and 1921. TABLE 8 Percentage of Banks Reporting the Various Kates of Interest Charged for First Mortgage Farm Loans in the United States and California, Spring of 1914 and March 1921 Percentage of all banks Rate of interest United States California 1921 1914 1921 5 0.7 33.6 25.8 26.7 3.5 9.6 0.0 0.1 0.0 7.9 36.8 42.8 5.9 5.9 0.0 6 ... 3.6 7 69.3 8 26.7 9 0.0 10 0.4 11 12 0.7 Total 100 100 100 Sources of data: For spring of 1914 from: Thompson, C. W. Costs and sources of farm loans in the United States. U. S. Dept. Agr. Dept. Bui. 384: 3. 1916. For March, 1921, from: Valgren, V. N. Farm mortgage loans by banks, insurance companies, and other agencies. U. S. Dept. Agr. Dept. Bui. 1047: 20, table 5. 1921. Bul. 480] Use, Value, Cost of Credit in Agriculture 25 There is considerable variation in the average rate of interest by districts within states. Table 9 shows by district the rates of interest, commission, and effective rates of mortgage credit in California in 1914 and the high, low, and prevailing rate of interest in 1921. TABLE 9 Average Rates of Interest on Farm-Mortgage Loans in the United States and by Crop Reporting Districts in California, Reported by Banks, Spring, 1914 and March, 1921 Spring, 1914 March, 1921 Average interest Average annual commission Interest plus com- mission Low, per cent High, per cent Prevailing, per cent 6.73 6.79 6 50 6.60 7.00 6.48 6.62 6.98 6 .71 7.50 6.95 7.57 7.54 7.29 8.00 7.75 7.26 7.35 7.51 7.57 9.00 7.74 7.23 7.40 6 40 8.20 7.40 7 20 7.00 7.70 7.80 7.70 7.50 20 .10 .20 .10 .20 .30 .10 .20 0.40 7 60 6.50 8 40 7.40 7.30 7 20 8.00 7.90 7.90 7.90 7 20 6 93 District 2 7.60 7 25 6 93 6 95 7 34 7 14 8.00 District 8 7.38 * Less than one-tenth of 1 per cent. Sources of data: Data for spring, 1914 from: Thompson, C. W. Costs and sources of farm loans in the United States. U. S. Dept. Agr. Dept. Bul. 384: 6. 1916. Data for March, 1921 from: Valgren, V. N., and Elmer E. Engelbert. Farm mortgage loans by banks, insurance companies, and other agencies. U. S. Dept. Agr. Dept. Bul. 1047: 10, 16. 1921. Data for 1921 relate to first mortgage loans only. The study by Valgren and Engelbert 13 in 1921 also showed that 92.53 per cent of the bank-mortgage loans in the United States were first mortgages and 7.47 per cent were second mortgages; while in California the first mortgages amounted to 99.73 per cent and the second mortgages to only 0.27 per cent of the total. The prevailing interest rate on first mortgages for the entire United States was 7.23 per cent and for second mortgages 8.10 per cent. The prevailing rate in 1921 in California for first mortgages was 7.20 per cent and for second mortgages 7.83 per cent. Short-Term Bank Credit. — Most short-term credit comes from com- mercial banks, and rates vary between wider extremes than in mort- gage credit. The more remote sections are served by small commer- cial banks having proportionately large operating costs and doing business in a territory where loaning risks are great and competition for bank deposits keen, which results in high credit costs. is Valgren, V. N., and Elmer E. Engelbert. Farm mortgage loans by banks, insurance companies, and other agencies. U. S. Dept. Agr. Dept. Bul. 1047:10-1(5. 1921. 26 University of California — Experiment Station Short-term credit costs in 1914, 1921, and 1923 as reported by the United States Department of Agriculture are shown in table 10. TABLE 10 Average Kates of Interest on Short-Term Loans to Farmers Eeported by Banks, 1914, 1921, and 1923 States Maine New Hampshire Vermont Massachusetts Rhode Island Connecticut..- New York New Jersey Pennsylvania Ohio Indiana Illinois Michigan Wisconsin Minnesota Iowa Missouri North Dakota South Dakota Nebraska Kansas Delaware Maryland Virginia West Virginia North Carolina .... South Carolina .... Georgia Florida Kentucky Tennessee Alabama Mississippi Arkansas Louisiana Oklahoma Texas Montana Idaho Wyoming Colorado New Mexico Arizona Utah Washington Oregon California Nevada 1914 1921 6.5 6.31 6.0 5.98 5.9 6.03 6.0 6.86 6.1 7.00 5.9 6.31 5.9 6.01 5.8 6.00 5.9 6.01 6.4 6.79 6.9 7.27 6.6 6.83 7.1 6.97 6.5 7.02 8.3 8.41 7.5 7.71 7.7 7.72 11.0 9.82 9.8 9.59 8.8 8.87 7.5 8.37 6.0 6.00 6.0 6.01 6.3 6.17 6.2 6.05 6.6 6.23 8.3 8.06 9.6 8.94 9.2 8.72 7.3 6.79 8.1 7.88 10.0 8.46 8.7 8.11 9.9 9.70 9.0 8.34 12.5 9.84 10 2 9.68 11.1 9.90 10.4 9.55 10.2 9.72 10.6 9.43 11.4 10.17 10.0 9.44 8.8 9.25 9.8 8.56 8.4 8.27 8.4 7.63 8.90 1923 6.2 6.0 6.0 6.1 6.0 6.1 6.0 6.0 6.0 6.6 7.0 6.7 7.0 6.8 8.1 7.6 7.6 8.2 6.0 6.0 6.2 6.1 6.2 8.0 8.6 8.4 6.6 7.6 8.4 8.0 9.7 8.1 9.9 (Max.) 9.7 9.8 9.5 9.2 9.4 9.9 (Max.) 9.4 8.4 8.3 8.1 7.7 8.5 Sources of data: For 1914: Thompson, C. W. Factors affecting interest rates or other charges on short-time farm loans. U. S. Dept. Agr. Dept. Bui. 409: 3-6. 1916. For 1921: Valgren, V N., and Elmer E. Engelbert. Bank loans to farmers on personal and col- lateral security. U. S. Dept. Agr. Dept. Bui. 1048: 7-14. 1922. For 1923: Agriculture Yearbook 1924: 22. figure S3. 1925. Bul. 480] Use, Value, Cost of Credit in Agriculture 27 Average Kates of Interest on Short-Term Loans to Farmers Reported by Banks, 1914, 1921, and 1923 Maine Mew Hampshire Vermont Massachusetts Rhode Island Connecticut New York New Jersey Pennsylvania Ohio Indiana Illinois Michigan Wisconsin Minnesota Iowa Missouri North Dakota South Dakot-a Nebraska Kansas Delaware Maryland Virginia West Virginia North Carolina 5outh Carolina Georaia Floridfa Kentucky Tennessee Alabama Mississippi Arkansas Louisana Oklahoma Texas Montana Idaho Wyoming Colorado New Mexico Arizona Utah Washington Oregon California Nevada V ■■ — \ ^ y Legend — ^fe^ 1921 ^Sn" s 1923 / Q ^^ fff c_ .27 ,.••' *•/> ^ r — s £Z~~ m **" s> k o . ~^^—« ^??: / -S^ -»f! K^ •*»»»^s ■«-««J^H T? { ^C ^ / \ c v X V*. N > y^ .... ■^fi^ / ^ l'^^ s *x ^a»^- l z 3 A t 6 Average Interest r o £ io ii 12 is Rate Fig. 4. — The greatest decrease in rates occurred between 1914 and 1921 in the regions of recent agricultural development. The decrease in short-term rates has not been as great as that in farm-mortgage credit shown in figure 3. (Data from table 10.) 28 University of California — Experiment Station h\ order to visualize the changes, the data recorded in table 10 are presented in figure 4. Interest rates are lowest in the Atlantic Coast states and the highest in the Rocky Mountain and southern states. In the states bordering the Atlantic, rates were lowest in 1914 and highest in 1921, although in 1923 rates were very nearly as low as in 1914. In all other parts of the United States there has been a gradual lowering of interest rates. The 1921 rates were considerably lower than the 1914 rates and the 1923 rates slightly less than the rates in 1921. In those regions where the rates were highest in 1914, the reduction has been largest. The extremes in 1914 were New Jersey 5.8 per cent and Oklahoma 12.5 per cent, a difference of 6.7 per cent. In 1923 the difference between the extremes was much less. TABLE 11 Average Rates of Interest on Short-Term Loans to Farmers Reported by Banks, 1914 and 1921, for California and the United States Geographic division, state, and district Interest rate, 1914 Total cost, 1914 Prevailing rate, 1921 8.4 8.4 7.3 8.8 8 2 7.9 7.6 8.9 10.0 8.4 9.4 9.4 9.4 9.4 9.6 8.6 9.1 9.7 10.4 9.4 7.96 7.63 7.58 District 2 . . 8.00 8.00 7.32 7.36 7.76 7.67 8.50 7.75 * Data on hand not sufficient to warrant the showing of a crop-reporting district. Sources of data: Interest rate and total cost for 1914 from: Thompson, C. W. Factors affecting interest rates or other charges on short-term farm loans. U. S. Dept. Agr. Dept. Bui. 4C9: 6. 1916. Prevailing rate for 1921 from: Valgren, V. N., and Elmer E. Engelbert. Bank loans to farmers on personal and collateral security. TJ. S. Dept. Agr. Dept. Bui. 1048: table 2. 1922. Several of the New England states had a 6.0 per cent rate, wihch was the lowest at that time, while in Oklahoma and New Mexico the rate was 9.9 per cent, a difference of only 3.9 per cent. Extreme regional differences are being gradually reduced. There is much variation in the rates of interest charged in different parts of the same state. These differences are less in California than in some other states and were less in 1921 than in 1914. Table 11 shows for the United States and for California districts the average rates of interest on short-term loans to farmers in the spring of 1914 and the rates in 1921 charged by banks. Bul. 480] Use, Value, Cost of Credit in Agriculture 29 In some parts of the country the banks require a minimum deposit on commercial account of a certain percentage of the loan; the most common amounts required are 16% per cent and 20 per cent of the loan. Such a requirement operates to increase the interest rate on the loan by •one-fifth and one-fourth respectively. If 8 per cent were the nom- inal rate charged, the borrower would be paying 9.6 per cent or 10 per cent for the money he could actually use. In other parts of the country the interest for the period of the loan is deducted when the loan is made and the borrower's account is credited with the re- mainder. This increases the rate of interest. These practices are less common in California than in some other states. TABLE 12 Difference Between Average Rates of Interest to Farmers on Short-Term Loans of Less Than $100 each and on Loans of More Than $100 each Reported by Banks, March, 1921 Short-time loans of $100 or more Petty loans of less than $100 Geographic division, state, and crop Number of banks reporting Rate of interest Number of banks reporting Rate of interest estimates district Low, per cent High, per cent Pre- vailing, per cent Low, per cent High, per cent Pre- vailing, per cent United States California District 1 District 2 9,157 284 13 5 3 38 48 55 6 2 114 7.59 7.21 7.23 7.80 7.67 6.79 7 02 7.39 7.50 8.50 7.26 8.23 8.00 8.15 8.20 8.67 7.71 7.81 7.93 8.83 9.50 8.10 7.96 7.63 7.58 8.00 8.00 7.32 7.36 7.76 7.67 8.50 7.75 7,880 244 9 5 3 32 41 50 8 2 94 7.91 7.59 7.22 7.80 8.00 6.97 7.59 7.66 7.00 10.00 7.78 8.48 8.25 8.89 8.20 8.67 7.69 8.24 8.04 8.50 10.00 8.42 8.21 7.79 7.78 8.00 8.67 District 4 District 5 7.30 7.85 7.87 District 6 7 50 10.00 District 8 7.84 Source of data: Valgren, V. N., and Elmer E. Engelbert. Bank loans to farmers on personal and collateral security. U. S. Dept. Agr. Dept. Bul. 1048: 7-14, table 2. 1922. Some bankers charge a higher rate of interest for petty loans, for it costs as much to handle a small loan as a large one. The figures in table 12 show the variations in interest rate for bank loans of less than $100.00 and more than $100.00 in the United States and in California in March, 1921. The study of bank loans to farmers shows that in March, 1921, for the entire country, the banks were charging 7.96 per cent interest for short-term loans of $100.00 and more and 8.21 per cent for petty loans of less than $100.00. In California the prevailing rate for loans of more than $100.00 was 7.63 per cent and for loans of less than $100.00, 7.79 per cent. 30 University of California — Experiment Station Table 13 shows the percentage of short-term personal loans made at the different rates of interest in the United States and in California in 1914 and in 1921. TABLE 13 Prevailing Bates op Interest on Personal Collateral Loans to Farmers: Percentage of Banks Reporting Various Rates, Spring, 1914, and March, 1921* Percentage of total Rates United States, 1921 California 1914 1921 6 17.1 5.0 1.1 7 20.0 17.7 38.0 8 35.2 42.6 55.2 9 4.9 9.9 3.2 10 22.1 17.7 2.5 11 0.1 12 0.6 7.1 100 100 100 * Rates involving fractions of 1 per cent are approximated to the nearest unit. Sources of data: For spring, 1914: Adopted from hearings before the Sub-Committee of the Joint Commission on Rural Credits. 64th Congress, Part 3: 86-108. For March, 1921: Valgren, V. N., and Elmer E. Engelbert. Bank loans to farmers on personal and collateral security. U. S. Dept. Agr. Dept. Bui. 1048: 16. 1922. These variations are due to many things, among which the most important are the following : (1) Interest rates' become higher as one goes from the large cities into the country. Most credit flows from the large financial centers into the interior, and naturally the more remote the area the more hands the credit must pass through to reach the country bank. (2) Interest rates are high where the demand for credit is sea- sonal. Agricultural credit is seasonal, while commercial credit is almost constant. To take care of demands of the locality the bank must supply the peak demand. This necessitates the investment of the bank 's funds in commercial paper at a much lower rate of interest during part of the year, and naturally raises the rate of interest for local loans. (3) Physical differences in the country affect the interest rates. Where the soil is rich and production abundant rates are low. Where soils are poor, or rainfall (in an unirrigated region) is light, or the growing season short, rates are high. One-crop areas are not as safe for loaning as regions where there is a diversification of agricultural interest. Where business conditions are stable and little fluctuation occurs, interest rates are lower than where there are fluctuations, as in newly developed and remote areas far from the large cities. (4) In rural areas the banks are small and their loans concen- trated in small areas, hence the operating costs are high and the Bui* 480] Use, Value, Cost of Credit in Agriculture 31 risks large. Table 7, page 19, shows the rate of interest and the commissions or fees charged for short-term credit in 1914. In some localities the fees were more than 50 per cent of the cost of the credit. It has already been stated that short-term credit costs vary more and usually are higher than long-term mortgage credit. By referring to tables 9 (page 25) and 12 (page 29), showing by districts the rates of interest charged for long- and short-term credit in California in 1921, the amount of variation and the difference in rates between these two types of credit can be seen. It is particularly interesting to note the general lowering of interest rates for agricultural credit. Figure 4 shows the average rates by states for short-term personal credit in 1914, 1921, and 1923. 14 Marketing and Store Credit. — Very few data are available show- ing the costs of other forms of short-term credit. In California store credit is not as extensively used as in other parts of the United States, particularly in the South. But in this state a large amount of short- term credit for production and for harvesting is obtained from in- dividuals, shippers, and companies interested in the purchase of the products grown. In such transactions, the nominal rate of interest charged for the credit is far from the effective rate. Those who use this form of credit are often compelled to do so because of inability to get credit at the banks. Others use it because it is easily obtained. The credit is offered to them, and they accept it without realizing its cost. There are many reasons why this form of credit is expensive to the farmer. If credit is obtained from stores or shippers, the accommodation is granted by an organization that does not specialize in the handling of credit. Banks specialize in this sort of business, consequently their rates are less than can possibly be obtained from stores or shippers that seek their credit from the same source. To borrow of a store is like going to the drug store to get hardware. The druggist can sell hardware but may have to pay retail prices for it himself, and in addition would have to charge directly or indirectly for the incon- venience of obtaining it. The cost of handling credit is greater for the merchant than the bank, and if the farmer is so poor a risk as to be unable to obtain credit at the bank naturally the merchant must advance his credit price to avoid loss. If credit is obtained from a company to which one must sell, bargaining ability is reduced. The grower must accept what is offered him, if by the terms of the loan he is compelled under contract i* Olsen, Nils A., C. O. Brannen, et al. Farm credit, farm insurance, and farm taxation. Agriculture Yearbook. 1924:222. fig. 33. 1925. 32 University of California — Experiment Station to deliver his products to this particular concern; he is thus greatly handicapped as compared with the grower who is free to sell where and when he chooses. Where shippers are merely selling on commis- sion as agents of the farmers and obtain their credit from the local banks, the grower's bargaining ability is not impaired, but if the shipping agent is financed by wholesalers and chain stores that buy from him, the growers using this credit will not get the consideration and service that the independent growers do. The shipper, like the farmer, is handicapped in his bargaining and cannot give the grower the same service as an independent shipper. In the grape industry of California, shippers reported that 36 per cent of the growers for whom they ship obtain credit from them, some for harvesting and production purposes, others only for harvest- ing. 15 Some shippers extend credit to as many as three-fourths of their customers, while others refuse to give credit to any. Some of the credit obtained by shippers was from wholesalers and jobbers in the East who contract to purchase the products. It may, in certain instances, be desirable for the local banks to extend credit to local shippers for financing the grower, thereby greatly reducing the cost of his harvesting and production credit. The shipping companies know first-hand who grows the best quality. High-quality merchandise can always be sold even in time of a sur- plus. The banks in extending harvesting and production credit to growers through marketing agencies are secured by both the growers' assets and those of the marketing concern. There are no data on store credit costs in California. Studies have been made in Texas and in New York. In both of these states much more store credit is used than in California, Some of the findings in the two studies are presented here, however, as an indication of the cost of this type of credit. A careful study of store credit costs in Texas in 1924 and 1925, was made by the Texas Agricultural Experiment Station. Store credit costs may consist of three elements, (1) interest, (2) a higher price for goods bought on credit, and (3) the disadvantage in bar- gaining in the sale of products to the merchant extending credit. The following quotations are taken from this study : According to the reports from the 232 farmers who received merchant credit, 143, or 62 per cent, paid interest on their accounts. The average flat rate was 10.23 per cent. This amounts to a rate of 19.37 per cent per annum if 6.34 15 Policyholders Service Bur., Metropolitan Life Insurance Co., Marketing California, grapes. A report prepared for the California Vineyardists Assn. Part V. Credit aspects of grape marketing, p. 89-90. New York City. 1928. Bul.480] Use, Value, Cost of Credit in Agriculture 33 months is accepted as the average length of term of merchant credit to farms It will be noticed that the rates reported by merchants are con- siderably lower than those reported by farmers. Thus the average of the rates reported by the different types of stores is approximately 12 per cent, while the average reported by farmers is 19.37 per cent. The variance is accounted for in part by the fact that merchants reported an average length of term of these accounts about one and one-half months longer than that reported by farmers, i.e., 7.8 months as compared to 6.34 months TABLE 14 Number of Stokes Charging Higher Prices for Goods Sold on Credit; Number Charging Interest and Higher, Prices ; and Kate per Annum of Interest and Higher Price, Texas, 1924 and 1925 Kind of store Number of stores answering questions Number charging higher price Number charging both interest and higher price Rate per annum equivalent to higher credit price Annual interest price Annual rate of interest plus higher price General merchandise Hardware Grocery Dry goods Furniture Hardware and furniture. Hardware and groceiy Unclassified 14.0 10.4 16.1 0.0 20.9 9.5 13.3 11 5 12.8 9 6 11.6 0.0 11 5 10.5 14.8 10.3 26.8 20*0 27.7 32 4 20.0 28.1 21.8 Source of data: Lee, V. P. Short-term farm credit in Texas. Texas Agr. Exp. Sta. Dept. Bui. 351: 19, table 16. 1927. Another item of cost of merchant credit which is very important in some cases is the higher price which is paid for goods bought on credit. Replies received indicate that about 10 per cent of the merchants charge higher prices on credit sales than on cash sales. The increase in price ranges from 20 to 30 per cent. [Table 14] shows the number of merchants reporting on this question, the number of merchants who charge higher prices on credit sales than on cash sales, the number who charge both interest and a higher price, and the total rate per annum for interest and the higher credit price Very often the credit merchant makes his interest charges in the form of a higher price for goods sold on account, but it is evident from the data in [table 14] that about one-half of those who charge higher prices also charge interest. The figures in the third column from the last were computed by taking the percentage which the price was increased for credit sales and reducing it to an annual charge. That is, if the average length of term of accounts for a particular type of stores was six months and the price increase was 10 per cent, the rate or charge is 20 per cent. The figures in the second column from the last were computed by taking the actual interest charge and reducing it to the annual basis. 16 A similar study of store credit in New York State made in 1923 shows comparable results : 16 Lee, V. P. Short-term farm credit in Texas. 351:18-19. 1927. Texas Agr. Exp. Sta. Bui. 34 University of California — Experiment Station The annual rates of credit cost varied from 10.62 per cent for implement stores to 21.82 per cent for blacksmith shops and garages [table 15]. The average rate was 13.84 per cent, or a little more than twice the usual rate of interest. As between the different types of stores, the differences in the rate of cost are explainable mainly by the differences in the size of the credit transactions and in the relative amounts of book and note credit carried. General stores are burdened with a large number of small accounts, and their credit-accounting cost is there- fore very high in proportion to the amount of credit carried. The credit carried by implement stores is largely in the form of large book accounts and notes. This kind of credit involves much less expense for accounting and collection. 1 7 TABLE 15 Total Credit Costs Expressed as Annual, Rates on the Credit Outstanding in Certain New York Counties Kind of store Genesee county Tioga county Jefferson county All counties per cent 21.82 15.25 12.70 12.48 11.00 9.34 per cent per cent per cent 21.82 20.18 16.28 11.15 10.74 16.59 21.00 16.25 16.81 21.96 10.98 19 62 14.70 13.35 13.21 10.62 11.51 13.77 16.99 13 84 Source of data: Spencer, Leland. An economic study of rural store credit in New York. Cornell University Agr. Exp. Sta. Bui. 430: 24, 25. 1924. Much of the best available statistical data on the cost of credit, both long and short-term, has been presented in the above discussion. An estimate of the annual cost of credit for the United States based upon these figures has been made showing the amount of credit used by agriculture. (See table 5, page 16.) The estimated farm-mortgage debt in 1920 was $7,857,700,000 and the average interest rate accord- ing to the census was 6.1 per cent, making an annual interest cost of $479,000,000. For California the average interest rate was 6.6 per cent and the indebtedness was $425,500,000, making an annual interest cost of $28,100,000. The prevailing rates for short-term bank loans (table 11) give 7.96 per cent for the United States and 7.63 per cent for California. These rates applied to the short-term bank loans esti- mated at $3,869,900,000 for the entire United States, give a total annual interest payment of $308,000,000; for California, whose bank credit is $119,181,000, a total interest payment of $9,100,000. For the balance of the short-term credit merely a rough estimate can be made of interest paid. Assuming the rate to be 12 per cent, an amount 17 Spencer, Leland. An economic study of rural store credit in New York. Cornell University Agr. Exp. Sta. Bui. 430:24-25. 1924. Bul. 480] Use, Value, Cost of Credit in Agriculture 35 which is conservative when one considers store-credit costs, the annual cost of this form of credit for the United States is $90,000,000 and for California $4,200,000. The results indicate that in the United States in 1920 over $875,- 000,000 of interest was paid in the production of farm crops and in California alone the cost of agricultural credit was over $41,000,000. The year 1920 was the low point of the depression following the War, a time when nearly everyone was badly in debt as a result of over- expansion. Since 1920, the farmers have been reducing their indebted- ness, and their annual interest bill has shrunk to about $750,000,000. Short-term loans that cannot be liquidated are converted gradually into long-term financing; hence in 1925 the farm-mortgage debt was larger than in 1920, although the total indebtedness was less. TABLE 16 Annum, Interest Charge for Long- and Short-Term Credit in the United States and California, 1920 Type of credit United States California millions of dollars 479.3 308.0 90.0 millions of dollars 28.1 9.1 4.2 877.3 41.4 Source of data: Values estimated by author. The preceding discussion has shown that mortgage credit rates are usually less than short-term bank-credit costs, and short-term bank- credit costs less than those of store and marketing credit. The less the security the greater the risk, and the higher the cost of the credit. IMPORTANCE OF CREDIT COST SHOWN BY COMPARISON OF CASH INCOME WITH CASH EXPENDITURE AND WITH NET FARM INCOME The importance of credit cost is not readily realized when shown in such large sums unless compared with other farm data. In 1920 the reported value of all farm products not including livestock was $14,545,000,000 for the United States and $675,000,000 for California. The annual interest bill was approximately 7 per cent of the crop value. But this figure is small as compared with the results of a study made in 1923 by the United States Department of Agriculture. 36 University of California — Experiment Station The Bureau of Agricultural Economics studied approximately 16,000 farms to ascertain the relation of interest payments to the cash income and cash expenditures of these farms. The results appear in table 17. TABLE 17 Payment on Interest Account tor Representative Owner-Operated Farms, 1923 Geographical division Number of farms Average interest payment Percentage of net cash receipts used in payment of interest Percentage of total cash expenses paid out for interest 16,183 1,800 2,131 3,395 3.817 3,320 1,720 $230 90 100 180 380 170 390 25.8 10.1 16.9 19.8 38.4 20.5 37.5 14.6 4.8 8.3 12.2 20 3 15.5 Western 17.6 Source of data: Olsen, Nils A., et al. Farm credit, farm insurance, and farm taxation. U. S. Dept. Agr. Yearbook 1924: 188, table 1. 1925. Interest payments varied from an average of $90.00 per farm in the north Atlantic states to $390.00 per farm in the western states. In other sections of the country the average payment per farm varied between these extremes. The $90.00 interest payment was 10.1 per cent of the cash income of the farm and the $390.00 payment was 37.5 per cent. The latter was 48 per cent and the former 17.6 per cent of the total cash expenses. Agricultural conditions have improved since 1923, but in that year they were far better than during the three previous years ; hence the results shown in table 17 do not differ materially from average condi- tions. This is apparent when the ratios presented in table 18 are considered. The value of the data in this table lies not so much in the actual amounts as in the ratios that are shown to exist between them. In the table showing income and expenses of all farms the interest paid is compared with the net income and is shown in the last column. The data are taken from the United States Department of Agriculture Yearbooks, and show for several years the estimated capital invested in agriculture, the value of crops produced, the gross income, the cash income, and the division of the cash expenditures between wages, operating costs, taxes, rent of land, and interest on indebtedness. The figures in the last column showing the ratio of interest payments to net farm income appear very large. Even in 1919 the ratio was 15 per cent and in 1921, the worst year of the depression period, it was 72 per cent of the farmers' earnings. Bui* 480] Use, Value, Cost of Credit in Agriculture 37 &- - P < & p S" 3 re o — » 3 ~, C++ -•- o * r- 3- 3" p w p w ° ; z co fi. TO J- p p » 3 g 3 a; e s *:& 3-0 << 3 i p_ n\ p ffq «< a-? s ■§ 5 I? a I? ^ O P • « re" 5" S "C G-p «» 2 co >. S. ~ 3 p « s-c B TO = 3 3 V I S f I 3 & S 1 3- c 3 5 5 re re £ 3* S+ o si P • S3 9 r 3 re 3 CO r+- p U 3-a 3 jd o re S.5" & P 3 £ ST"* EL " O ft ?o 5: — o 3 re co re IS i i &- -*> 3 ri o *S "° l|? S'o ^ S- 03 p i' a a S.S" & O < e-H 38 £ »&£ |g| co re era. 5 re "3 -» g O re S- o,re -• £3- * o *T 2- "1 -) TO o re 3* co "O >— 3. » 8 '$ p-fr p — 5 TO 3 re_ re :•« 5 a 55 3 -o 3B.3. 3 «• re a- ■ re P"p «, I" re re tr | re 3,3 ^ to SO CO SO CC so CO to to li to to OS Cn 4- CO to •-* O CO 3 TO "OP--. I 1 TO 3 P ^ ^ cn cn en OS — OS ^j ^, O -1 -- ~< O g-re're EL 3 c» to 3 CO BO to ^1 "_J 4- 0. 00 *^ "rfk £ 3 2.p e 2 2. 3Tre Xi re 3 On n- 4> 3k Ed Oi to Ed to 99 CO SO c'3 G-X'o 3 g -1 ~.p ">r* 3 p 3 Ei- Gross value all farn produc tionf to OS OS ^J 9) 4- 1 - --1 4- co "to to CO ca CO O H- CO X *. O CD a> en at CO SB 4- En 1 -n 4*. 4>. to CO c 4- eo » CO OS Cn 00 CO tions fo product fed, use for seed and wastej re CO to x 09 4- ■-0 CO 3 re OS Ol CO 0O a to CT. - D-co "i to to to £ O to rs cn S 3 "0 as 8 "to CO "to OS V) 00 «j J- ex ~. 3 CO re * co 00 CT. 4k. 'CO co to to to to to to to to 3 3 3 2,<< en Cn Cd GO " H- "^ CT- CO alue food dfuel sumed farm Oi co 1— on 53 CT. CO «o cn ~J to O CO OB 00 -~1 O 10 c« :r§'o Cn n- — : -0 ^_, O 00 EL° g ^3 3 3- re 4- 00 to Oi — - 10 CO 00 CO 10 Cn Cd to - P"° ^ CT3-P to to to to "0 4- 3'aq co ^ a £ 2 CO CO CO 3.«8 00 OS ~4 CO to 10 to CO to to to to CO CO 2 re "to "0 00 -01 cn ">*k OS "co P 1 00 On OS -. O 4- ^: ~ 01 00 so OS ce 3. 3 TO OS OS OS OS Oi Cn Cn CO Taxes operat owne inves men On Cn -0 to X 4- 00 4- 4- on OS ~i to Cn 00 "70.0 7 3 co' cr 3 Rent on property rented from non- operators 4". to CO SO s as Ed 5 5' tO --J *■ #» 4^ SO CO to O re P CO Interest on debts to non- operators tr ->J ^J ■OJ - 1 CO as so On On en S - CO. 00 00 CO O ^j ^1 8 3 re to 00 CO to to h- »- en Bala avail fo livi expe eti 00 "co cn - 1 -1 to 00 -42 — CT. p 3 3 -« p 2 2 TO CTo 00 -J O OS -0 ^j re" _ to to to m CO - 1 en — atio of erest on btedness balance liable for g expense OS to 4- OS ** c; C/i >— 00 *■ OS 00 CO so CO ' X O X C3 g sc 2 W ■^ a H w > r h- 1 O ^ s > H h > I— I 2 w a g CO .t?j g rr. O H M I 2 53 > 2 s <3 P bd > fc f3 a > n X O PS O H ^> u > w m > > 7J e w r to g H oc •*i 2 p: f g a 8 M co co X Hj h- 1 S a 14 50 H g w "3 *^ > to d 5C 1 5 d to |> i 75 p 1! co ^ 38 University of California — Experiment Station Although conditions have improved, the average annual interest cost is approximately 25 per cent of the farmer's net income. Average figures are not so easy to visualize ; some farmers have no indebtedness and others very little equity in their farms. Some borrow all their operating capital while others do not depend upon credit from any source. The fact, however, that average interest costs are compared with the average income of all farms, including those which use little or no credit, emphasizes still more the importance of the cost of credit. THE DIFFICULTY OF BUILDING AN ESTATE From table 18 showing the relation between the interest paid and the farmer 's net income, it is apparent that a farmer should not expect to pay for a farm in a few years. In fact, acquiring a farm is apt to be the work of a life time. Stewart 18 took the results of farm-manage- ment studies made in 1915 and 1916 throughout the United States by the United States Department of Agriculture and from the reported average interest rate for farm-mortgage credit in these areas by the United States Census in 1919, he determined the annual installment payments necessary to pay for the farm of average value in ten years, twenty years, and thirty years. The average net income for these farms was then compared with the annual installment payments of the three amortization schedules. The farm income in only one section of the country could pay for the farms in ten years, the income in seven sections would pay for the farms in twenty years or less, and in thirteen, or half of all the sections, the income would pay for the farms in thirty years or less. The results of this study are presented in table 19. The foregoing figures representative of farming conditions in various parts of the United States relate to a time when farming was more profitable than it is now. The results may appear discouraging but they should not be if one observes the results achieved by people in building an estate in other pursuits. Figure 4 is taken from a report of the Federal Trade Commission. The data presented are based upon a study of 24 selected counties covering the period from 1912 to 1923 inclusive, and include 184,958 samples. Of these, only 43,512 were not probated. 18 A very interesting piece of work relating to this subject is reported in: Stewart, George. Can the farms of the United States pay for themselves. Jour. Farm Economics 2:181-189. 1920. Bul. 480] Use, Value, Cost of Credit in Agriculture 39 dddog p p p o ° a* a* cr eg o p 3 Hg>00&35gWW&s:0 CO CT CR TO 3 re re a- -• a* » »« 2 o'f p p » ~? g « « << << p B 2 2 o o » aaa. sssia 1 1- 1- i i 2. 2, ar 3 g 8 *g -•re < o P K\ 3 re O-P E- R' 2 < p p" £ 9 o 5 ~ p W > 1 8 S ST II 3 g > cc a: td re re 3 3 O ss W g> r ^ -1 -J P O ft -- 2 g co c 3 S 3 ~ ™ 5* * « n 3 3 > ro re O -> >-» to 00 OS OS cn co to co *■* en O 00 u (n to u S-3 5 'g > 5 3 £ ££ •-'-co a- re m « « NJ M ►— to 00 00 to cn *- to OO vl *. M to 01 I— CO tO Nl CD vl OS O OS OS OS OS -p g o oz:e.S:33P. "< as' CO 00 O CO o o o *- OS OS vl vl Cn OS *J OS OS Cn © 4». vl vl "H-OOOSCOtOO© h- to Ol vl to tO W tO CO M m CO O os h- - Cn M to OS NHCOCnCOM^ilk Oi "to CO 1— I I CO vj CO ►— O vl O ►- »J CO riii O *• M *■ * CO M M O in OS h- o 01 to CO 1-1 H- co to Cn vl CO 00 — OS OO 4» OS H- I P pJ" M g n **• ^. •* /*v ir\ 3 E.S s S re "r- 3 re re 3 ' 0) c- p 3 to co to vl CO H- to Cn 00 co Os v| o CO Cn Os>*>.cnOSO©in>4i.os OSCOCOOSvlOOlOl© i I to OS o 00 CO o CO CO o >*». ►- O OS i*>. I I I co ^ O -I H- H- O OS CD CO I I I I I to Cn to CO 1 r 1 Co to Cn >«». OS v| OS K- 00 00 Cn OS re P p'S'hh^ "£-3 S| 3,3 "3 "' -• re re re P 3 3 * 1 *< << 2- o 3 2 — 3£.g3S^ o — 3 t> n c+ p 3 re c* h- OS tO ~1 O0 O 4>- " OO O0 v| hH- CO tO M M CO M 3q£ I re P p"3- t^ _ ^-3 Z 3,3 "C -- — re re re P 5 3 «■ • rTP O co < re p3 3 P I I vl to I I OS v| O0 ►- I I I to >£» n- to CO vl v> tO vl vi I I h- cn »-> OS p— > 40 University of California — Experiment Station Of the total of 184,958 estates that were studied 147,545, or 79.8 per cent, were for less than $500.00 each. The average value was $258.00 each and they included only 5.4 per cent of the total wealth. The estates from $500.00 to $10,000 in size nmbered 27,608, or 14.9 per cent, and totaled 12.7 per cent of the wealth. That is, 94.7 per cent of the estates were less than $10,000 each and included but 18.1 per cent of the wealth, and 5.3 per cent were over $10,000 each and included 81.9 per cent of the wealth. Of this 5.3 per cent of the cases exceeding $10,000 each, 7,749 or 4.2 per cent of all the cases were between $10,000 and $50,000 each and contained 23 per cent of the wealth, while only 2,055, or 1.1 per cent of all cases exceeded $50,000 each and included 58.9 per cent of the total. These probated estates were segregated for comparison into three groups (1) those from rural or agricultural areas, (2) those from towns or suburbs, (3) those from large cities. The results are shown in table 20. The average size of estate in the cities was approximately $17,000, in the town $10,000, and in the country $14,000. Approximately 50 per cent of the estates in the country are less than $5,000 each while in the cities and towns 64 per cent of the estates are less than $5,000 each. Approximately 76 per cent of the wealth in the country is found in estates of $5,000 to $100,000 each, while in the towns 58 per cent and in the cities 36 per cent, of the probated wealth is to be found in this group. The small group of estates of over $100,000 each constitutes only 17 per cent of the wealth of the country, 31 per cent of that in the towns, and 57 per cent of that in the cities. This empha- sizes the concentration of wealth in the large estates in the cities and the large number of very small estates in the towns and cities. WHY CREDIT COSTS VARY Credit costs vary with the supply and demand for credit and according to the risk involved. They depend upon the amount and quality of the security offered, the prospective income, and the character and capacity of the borrower. Naturally, a credit institu- tion that is called upon to extend a form of credit it is not suited to provide, must charge more than the institution specializing in this particular form of credit. Some variations result from the borrower's indifference to the problem. In every community these elements affect the credit situation, though they vary in their importance. Bul, 480] Use, Value, Cost of Credit in Agriculture 41 Percentage of Total Number and Total Value of Estates fok Specified Size Groups in 24 Selected Counties, 1921-1923 Fig. 5. — Nearly 80 per cent of all estates were less than $500 each and con- tained approximately 5% per cent of the wealth, while one per cent that exceeded $50,000 each contained nearly 60 per cent of this wealth. (Source of data: U. S. Trade Comn. National wealth and income. 69th Congress, Senate Doe. 126:61. Diagram 1. 1926.) 42 University of California — Experiment Station ++ >> NiOOltDOOONOOllO^N O Is OO^HC0«OOO3O>^0500'»t 8 5 — 1 — CN > i 5 ' o o 3 o OOKOOOOmNiliOliON © H 1-1 s o >> CM'ttr-CNCMOiOCOCOOiCO © 3 3 o OOCMTt<00Oi-ie>J > >C03t^T»i-»*t-4i*> i in OS "* O CO l— 1 © OJ c too Ph 3 Nwr^ctoaoi'*'- io | o O O 115 0O « - ' CM CO CO OS © CO © 00 -3 "*£ -H -H -* — —i — HNHMOIOOMOC ^ S3 b T-HCNOO3rtt^^HCM05-HCD0C CM i fC"CiO"ONK5^ 3 *>> h N CD C S N CT ffl ifl * W OS » U5 C» f ■* M N O) » OO N OO CT5 00 CM CM CM CO * « !<) B » N H t^ c3 > 3 3 CM ^h •«* oo" O ■o o ■s O OS CO C\ (NO!!OCtO)nNK CM >> to o h a M-hNicniOOtC += £~- CO CO C U5 l> t(i 1^ IO -« CO t)i ra tfi if ■»J< CO — ^h" to CO 0) S3 to « c WHNM^N^MtO'H^- t^ "3 is ©COCO©COCJ2CO»Or^CM U0 O oo r~ u- N OS CC -h OS u o 4) H 1-1 »H 1- rt r^ s 3 # >> fc b, -H •<*< CO t^ © t^ — h ^< >C CO CM CO CO "O -J OC OO © Oi 05 *f 3 CO CO t^ CC CO OO CO r- CM 3 O ■*!< o a C 3 o gg © £ 0) © © © © o 8c g g > °- o o X w . u . O 113 O . -o - IC © © 6© «> 3 "Tooo-isiio CQ g § SJ s 3 o Eh »* o S2og o^~^ 000 © ©©©©©©. ©©OO©©©© g ©. ©. ©. © ©- © g . o * o o io 5 u . P 7 >o <-l (M •« ^ o ■ c 55 3 3 c 03 _o o ^ 3 a o a © 53 a c a 3 O Iz; s 3 5. us *-■ a; > O b9 09 a 3 c © © !-< u O 3 cu 5 u o a - o o> 03 H Tl 3 ? O o Pk p bj to -= 3 '3 a ■~ 7J -3 .3 V x; 3 d s £ iS d fl "3 o '-U ^J O d 3 3 3 3 3 J r. O O OOJ * ■*- +4 ■et 7. Bul. 480] Use, Value, Cost of Credit in Agriculture 4:J When an article that is used extensively becomes scarce, its price rises, for those who have plenty of money can still afford to buy it and these, in bidding for it, raise the price, while those of small income that cannot afford it at this higher price must go without. The price of the article is determined by the marginal buyer, that is, the price that would be paid by the purchaser that used the last unit of supply. If supply is increased, it will sell at a lower price, for the increase can only be sold at a reduced price and this determines the price paid by everyone. Credit is similar to a commodity. The banks wholesale various kinds of credit to other banks and retail them to the public. The credit supply depends upon savings of all classes of individuals, earnings of corporations, deposits of banks, etc. If these exceed the credit needs for new business, the cost of credit, that is, the interest rate, falls, but if the supply is less than the demand the bidding of business men for this credit raises the interest rate. Production of goods goes on in fits and starts. Good prices and plenty of business beget more business and better prices and in the process of increasing* the production to correspond with orders more and more credit is used. This causes high interest rates, scarcity of labor, higher wages, advancing costs of raw materials, and higher production costs. When the credit structure becomes strained the banks' refuse to loan more money and buying ceases. Then factories shut down and a period of unemployment, contracting loans, failures, and bankruptcies follows. When this has continued until the excess production has been consumed production increases again. Thus we have what is called the business cycle ; first a period of expansion which continues into a period of prosperity, then recessions in busi- ness activity, and after a period of depression, the process begins all over again. Under such conditions the supply and demand for credit varies as our production expands or contracts. Long-term credit should be adjusted to fit the cheap money markets. Corporations that expand in times of prosperity and there- fore issue bonds of high interest rate, refund as soon as money is plen- tiful and interest rates are low ; once financed at a low rate the bonds remain until the earnings from the investment pay them off. The farmer should think of his long-term credit in this way. Large cor- porations cannot afford to use straight three to five-year loans; the cost of renewal is too large and the rate of interest too high. They secure long-term financing at the cheapest possible rates for the period involved, operate an amortization scheme of yearly retiring a 44 University of California — Experiment Station definite amount of bonds, and accumulate in a sinking fund enough to retire the balance of the bond issue when due. Production credit may change from year to year depending upon general business conditions. It may be better to forego some intended improvement so as to save this capital for operating expenses and thus avoid the high bank rates for credit. Local markets vary widely. The more the local demand for money exceeds the local supply the higher the rates necessary to induce outside capital to flow in. More important than the supply and demand for credit in deter- mining its cost is the element of risk involved in loaning. Supply and demand affect the cost of credit to the government as well as to all others. There is very little probability of the Federal govern- ment failing to pay its obligations ; consequently the rate of interest it pays may be considered free from risk, or pure interest. The difference between the interest rate it pays and that paid by other organizations for the same kind of loans is due principally to the risk involved. These risks vary with the locality, with the industry or kind of business, and with the units within the particular kind of business. A high rate of interest is characteristic of new and develop- ing regions which because of their newness and lack of diversification and stability, offer less security than older and better established regions. Besides these general differences, the risk varies with the amount and quality of the security. Loaning institutions usually demand security for their loans. They desire an amount enough larger than the loan to protect them from loss in case the loan is not repaid and sale of the security becomes necessary. Evidently it is not only desirable to have ample security, but readily marketable security, for if there is a delay in disposing of it this may cause the bank consider- able inconvenience. The safety of a bank depends not alone upon its solvency but also upon its liquidity. A bank must meet its obligations when due or run the risk of ruin. This applies to long-term as well as short-term credit. While agricultural property is one of the most permanent sources of wealth and generally fluctuates less in value than other kinds of property, still it has the disadvantage of being slower to market. This element in farm credit is a problem that must be carefully considered by loaning institutions, for it has caused loss and disaster to many in times of depression when money is scarce and interest rates high, and forced liquidation of loans is necessary. In the case of two loans equally secured, the bank should charge more for the one having security that is slow to market because of the Hul, 480] jt se ^ Value, Cost of Credit i\ Agriculture 45 added risk. This is why agriculture generally pays a higher rate of interest than other industries. Farm property is not easy to evaluate because it sells slowly, the earnings therefrom are difficult to determine, the physical differences in the property are large within a short radius, and statistical infor- mation relating to yield and operation of the farm is lacking. Not only is the farmers' security slow to liquidate, but usually the security he has is inadequate in amount. The man buying a farm may have a first and second mortgage already on the farm and he needs credit at the bank for crop production. The bank obtains a crop mortgage, but there is no security unless the crop is produced. There are risks of crop failure due to frost, draught, pests, scarcity of farm labor, poor prices, etc., and, unlike other forms of business, in case of failure there is no inventory that can be salvaged. In case of crop loss all is gone. In such a case the bank may take a third mortgage but this is only secure in case the interest on the other two is paid. The bank must charge high interest rates for loans that are inadequately secured. Since credit should be used for productive purposes only, the risk involved depends very much upon how productive the venture appears to be. No matter how well the loan is secured the banks will prefer not to make it if the enterprise looks as if it would be unprofitable to the borrower. To foreclose and sell the security is not only an expense but creates ill feeling and ruins business. Since farmers' security is often inadequate in amount and of a slowly marketable type, credit has to be based very largely upon the integrity, character, and reputation of the applicant. These are highly essential, no matter how well secured a loan may be or how productive the enterprise. If the man himself is not honorable, but takes every opportunity to resort to sharp practice, he is not a de- sirable applicant. His business generally costs more than the banks get out of the loan. The cost of doing business depends upon the cooperation of the borrower with the lender. Prompt payments and adequate provisions for renewal when the time comes are of great value to the banker. It costs money to send out letters to urge the borrower to meet his obligations as promised. The cost of collection and of making loans is passed on to those who borrow. These costs, in combination with the supply and demand of credit, determine what the bank's rate of interest shall be. If the borrowers are always complaining of the service they get and do what they can to be disagreeable, their chances 46 University of California — Experiment Station of inducing new capital to come into the neighborhood are very poor. Intelligent use of credit and cooperation with the loaning agencies in supplying it will improve local credit conditions. To complain of the costs of credit without an understanding of local circumstances only increases the risk of loaning and advances the rates. Rates of interest vary with the institution from which credit is obtained. Certain institutions specialize in certain types of loans and consequently their rates are lowest for this particular service. The commercial bank is particulary suited to short-term credit. Since it loans the money of its depositors, its loans must be more liquid than those of savings banks and trust companies. Insurance companies and Federal Farm Loan banks have funds they want to invest for long periods of time, hence, if the cost of doing business is small, the rates should be low and the term desirable for mortgage credit. SUMMARY The considerations most essential to the proper use of credit by farmers are: (1) credit should be used only for productive purposes; (2) the loan should not outlast the equipment for which it was used: (3) payments on the loan should be arranged for a time when the borrower has money; (4) the lowest possible rate of interest should be obtained; (5) long-term loans should be financed when interest rates are low; (6) and the borrower should be permitted to apply payments upon the principal at any interest date or, better still, the loan should be made on the amortization plan. As a result of the commercialization of agriculture, the use of more credit has become necessary. Farmers specialize on one or two crops and obtain from outside sources the food supply of the family. Trans- portation, storage, refrigeration, and better marketing methods have increased the marketing period of perishable and semi-perishable crops. More and better machinery is used in farming. Land has increased in value, requiring a larger capital investment in farms. Besides the increased need for capital and credit due to the com- mercialization of agriculture, the standard of living on the farm has increased, so that today the farmer may have nearly all the conven- iences found in the city if he can afford them. With the increase in the use of agricultural credit, interest rates have lowered. This has been due to better business methods among farmers, more stability of income in the older agricultural regions, Bui* 480] Use, Value, Cost of Credit in Agriculture 47 and better and cheaper banking. The Federal Reserve and Federal Farm Loan systems have contributed a great deal to the reduction of costs and the equalization of rates between different localities. The difference between gross and net income of farmers emphasizes the need for careful consideration of even the smallest items of expense in farm operation. The cost of credit is still high and the interest paid annually by farmers is a large part of their net income. Credit cost is an item of expense that can be reduced by careful consideration of the problem when other problems of farm operation are less important, especially during winter months. To obtain credit at low rates of interest requires a knowledge of the principles that govern loaning operations and money costs. That is, the borrower must understand the problems and tho limitations of the bank extending the credit. To obtain cheap credit it is necessary to cooperate with the loaning agency. A poor risk that causes the bank extra labor in collection of interest and legal action to protect the security raises the cost of credit to the general public. To purchase credit cheaply requires a knowledge of the operations of different agencies selling credit. To select intelligently, one must know what is available. 15m-ll,'29