Over the course of the 19th century, banking services were extended to rural parts of America. This trend continued into the next century. Compared to urban banks, those in small towns in rural parts of the country had exposure only to a narrower array of economic activities requiring their services, these regions being mostly agrarian. These banks and their mortgage lending helped propel land prices higher during a farmland boom in the 1910s. When this crashed in the 1920s, it took down many small-town banks.
Banks located in small towns, serving agrarian communities, began to emerge in the United States in the early 1800s. At the time, the urban banks mostly focused on serving the needs of merchants and were less interested in financing farms. The small rural banks intended to fill the apparent void in agrarian finance. They were capitalized with local money, much of it raised from farmers themselves; shareholders were essentially part borrowers and part bankers, or at least bank proprietors. The capital was accumulated over time as shareholders paid for their share subscriptions in installments.
In the early 20th century, the overall number of American banks ballooned, more than doubling from under 14,000 to over 30,000 between 1900 and 1920. The largest concentration of banks per capita were in the rural states of the West and Midwest United States.
Many small banks had been formed. Bankers in small towns had a supposed advantage in their lending given the local knowledge they possessed, which an out-of-town lender could not replicate. In an era before automobiles and telephones especially, this was a robust competitive advantage. However, a rural bank could not finance such a vast array of activities as urban banks since their local economies were agrarian, with very little trade or industry. As a result, they focused mostly on agriculture finance.
First World War
One of the most disruptive events in world food supplies during the 20th century was the First World War. Together with the Russian Revolution of 1917, the war years disrupted agricultural output in Europe. Wheat prices rose as did those for other agricultural commodities. Though the war ended in 1918, many expected that European food output would take a long time to recover.
By contrast, conditions were great for American farmers since their production was not impacted by the war though they still received the benefit of higher prices. Given the pessimistic forecasts for European output, farmers in America expected their incomes to keep rising even after the war ended. This was easier to believe because it would have been a continuation of conditions that pre-dated even the war’s start; farm incomes and land values had generally risen since the late 1890s. Indeed, appreciation in farm values had become an important source of profit to the farmer.
American farmland values rose 68% between 1914 and 1920 after a 22% rise in 1919 alone. This is only an average; some areas saw larger jumps. Rural areas in central and southern parts of the country saw a doubling of land values during and immediately after the war. Also, areas with greater credit availability, estimated by the number of competing banks in a county, saw a larger increase in land values even after controlling for a myriad of other factors. Thus, the expansion in rural lending in the 19th and early 20th centuries played a role in this boom.
It makes sense that greater credit availability can make land more valuable and credit was in fact widely available. The local banks were one contributor but so too were life insurance companies and some urban banks active in agriculture finance, though the local banks were the most important. Their presence was critical. The more banks in operation in a rural county, the lower the level of local interest rates and the higher the level and rate of increase in farmer indebtedness.
Newly created federal land banks, supervised by the Federal Farm Loan Board, were required to lend conservatively but most other lenders were not bound by such requirements. Rising land values themselves made most lenders more comfortable.
A typical farm mortgage had no amortization of principal over its life; borrowers only had to make interest payments until they refinanced the loan after one to five years, which should be easy provided farm prices kept rising. Farmers selling their land also provided buyers with seller financing, often in the form of a junior mortgage at a favorable rate, in order to facilitate a sale at a high price.
Junior mortgages became more common, forming 18.7% of all farm mortgage debt in 1921 as compared to 11.3% in 1915, often extended by private non-bank lenders or the smaller local banks. This meant that the more conservative lending of big banks, which may have only lent 50% of the value of a property, was no longer a constraint to borrowing.
From 1910 to the beginning of 1918, American farm mortgage debt rose at a rate of just under 9% per year. From 1918 through the start of 1921 though, it rose at an annual rate of over 15%. Thus, mortgage debt per acre rose 135% between 1910 and 1920, roughly matching the increase in land value over the same years. Would farm incomes keep up?
As it happened, European agriculture recovered quickly after the war’s end and Russia became, once again, a large net exporter of grain. Agricultural commodity prices began to fall and, without sufficient improvements in productivity (whatever the impact of growing adoption of tractors), so too did farm incomes. Farm incomes fell 60% from 1919 to 1921 but then recovered, returning to at least their 1916 level by the end of 1922. However, farms were now leveraged with more debt relative to their incomes and farm land values had not mostly recovered as farm incomes had.
The temporary shock to farm incomes, the longer-term depression in farm values, higher farm mortgage debt, and tighter financing conditions led to more farm foreclosures. Foreclosures rose from an average of 0.3% per year from 1912 to 1920 to 1.7% per year in the late 1920s. Again, these are averages; certain areas were worse afflicted. The local banks struggled to sell the property without incurring a loss and many failed. Bank failures were most numerous in areas with greater credit expansion during the boom years.
In all, 5,000 banks failed between 1920 and 1929 or about 16% of the total in existence at the decade’s start. Small town banks made up most of the failures, and in larger proportion than their share of the total banking market would suggest. Regions with the largest increases in debt per farm acre during the boom years saw more bank failures than others.
Still, agricultural incomes kept rising as the decade went on, but in the years after the agricultural recession, the hardest hit areas continued to have depressed land values, fewer banks, and a more concentrated banking sector. This trend continued into the Great Depression, when farm incomes fell once again, delaying the day when farm values would finally turn the corner. The effects of the two decades of slump in the agrarian economy were measurable even decades after the 1920s bust.
In the 1980s, another boom and bust in agricultural land values took place. It too was the result of inflation, rising commodity prices, and growing farm mortgage indebtedness. Eventually inflation rates dropped but interest rates remained high, destroying land values. Many large urban banks left rural lending altogether but the small local banks, of the sort that had become common a century earlier, remained and were judged to be more accommodating of distressed borrowers.
In the aftermath of this second crisis, many of the surviving banks were by now over a century old, dating to the 19th century boom in rural banking and surviving two financial crises in rural banking that saw the end of many of their peers and the exit of banks less focused on agrarian markets.
All in all, the 1920s should have been a prosperous decade for American farmers, as those years were for other parts of the economy. The shock to incomes in the early part of the decade was substantially reversed in just a year. They then kept rising. However, a farmer expanding his operation at the start of the decade was buying new land on borrowed money at peak prices. New arable land cannot be made, at least not quickly; its supply is fixed. So, the response to a promising new future for farm incomes shows up in land prices quickly and intensely, but so too does the end of such dreams.
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Read about the German rural credit union movement led by Friedrich Raiffeisen and the role of an agricultural crisis in sparking France’s Revolution of 1848, which changed the nature of French finance. Consider subscribing to this blog’s newsletter here.
1. Graham, Kathleen A. “The Role of the Town Bank in the Agrarian United States.” Financial History, 2004.
2. Johnson, H. Thomas. “Postwar Optimism and the Rural Financial Crisis of the 1920’s.” Explorations in Economic History, vol. 11, no. 2, 1974, pp. 173–192.
3. Rajan, Raghuram, and Rodney Ramcharan. “The Anatomy of a Credit Crisis: The Boom and Bust in Farm Land Prices in the United States in the 1920s.” American Economic Review, vol. 105, no. 4, Apr. 2015, pp. 1429–1477.