Popular Science Monthly/Volume 82/March 1913/How European Agriculture Is Financed

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By Professor H. C. PRICE


THE American farmer is ahead of the European in many things, particularly in the use of labor-saving machinery. But in the application of business principles in their financial operations, the European farmers have perfected systems that are in advance of anything yet attempted in America. This has been largely brought about by the force of circumstances necessitating an economic transformation. During the last century the competition of new countries with immense areas of virgin soil flooded the European markets with agricultural products and forced the European farmers to reorganize their business methods.

As a result they have organized to make available abundant credit at low rates of interest and on favorable terms of repayment. By credit, it is not meant that the farmer gets everything he buys on time without paying anything on it, and that he is in debt on every hand, but just the reverse. It means he has money available at all times, so that he may pay cash for everything he buys, thus getting the benefit of the lowest cash prices and discounts. His credit is at the bank and not at the store, and through the bank he gets the loans that he needs at rates of interest just as low and in many cases lower than secured by other industrial enterprises, no difference how large or how much business they do. But to accomplish this the farmers have had to take a hand in the banking business themselves. They have organized on a cooperative basis to secure the credit they need and to supervise its distribution rather than leaving it to private interests to supply the same. By so doing they have reduced rates of interest, lengthened the time for which loans are made, provided for the repayment of loans by annual installments, and they keep the money in the rural districts and prevent its accumulation in the large cities.


Sources of Capital

The sources from which the capital is drawn that is thus made available to the use of the farmers may be classified under three heads: (1) subvention from the government, (2) savings deposits of the farmers and rural population, (3) from the sale of bonds secured by mortgages on farm land.

The relation of the governments in furnishing agricultural credit has varied greatly. In France the rural banks have been established for the most part on funds advanced by the government without interest. This policy was begun in 1894 and in 1910 the working capital at the disposal of the rural banks which had state aid amounted to 71 million francs (between 14 and 15 million dollars), of which 40 million francs had been advanced by the government. In Austria the provincial governments have actively assisted in the establishment of rural banks to furnish credit for farmers and have advanced loans without interest to them. In Germany the government has indirectly aided the rural banks by establishing central banks founded on capital advanced by the government, in most cases at 3 per cent, interest. The central banks in turn furnish credit to the rural banks and the rural banks to the farmer. The Prussian Central Bank at Berlin now has a capital of 75,000,000 marks from the Prussian government. However, its business is not confined to agricultural banks, but is open to all kinds of industrial cooperative associations. It receives deposits and makes loans to the cooperative banks throughout the kingdom of Prussia, and serves as a compensating medium between the different cooperative institutions. For example, if a rural bank has large deposits and a surplus of funds, it deposits them in a central bank to be loaned to some other bank in need of funds.

The desirability of government subvention is a disputed point, and in Germany which has the best developed system of agricultural credit in the world, many are opposed to it as being entirely unnecessary and think that a better system can be developed without it.

The second source of capital, savings and deposits of the farmers and rural population, is the most important. It has the advantage of developing the habit of saving among all classes in the country and it keeps the money in the rural districts in which it is earned. In Germany alone there are over 16,000 rural savings and loan banks with one and one half million members and deposits of over $250,000,000. Instead of being deposited in savings banks to be loaned out in the cities, as is the case in America, or deposited in post-office savings banks to be loaned to city banks, the money is kept in the rural districts and loaned out at a rate of interest that the farmer can use it to advantage.

The third source of capital, obtained by the sale of bonds secured by mortgages on farm lands, was the first form of cooperative agricultural credit established in Europe and was begun in Germany in 1770. Its most rapid development, however, has been within the last thirty years, and at the present time the German farmers have over $1,000,000,000 borrowed in this way, none of it costing them more than 4 per cent, interest and in some cases it is as low as 3 per cent.


Agricultural Credit in the Province of Saxony

The agricultural credit institutions of the province of Saxony in the kingdom of Prussia are as highly developed as in any place in Europe and are typical of the German system. The province of Saxony lies in central Germany, contains an area of 9,750 square miles and in 1910 had a population of 3,088,000, equal to 315.7 per square mile. The largest cities in the province are Halle and Magdeburg with 180,000 and 280,000 population, respectively. It is the heart of the sugar-beet district of Germany and the richest agricultural section of the entire empire. It contains 97,000 farms of over five acres in size. The estimated worth of the land per acre is $300 (for the whole of Germany it is $150 per acre). It is a typical agricultural province, in which the most intensive systems of agriculture have been developed, necessitating the investment of a large working capital per acre, which has been made available through the development of agricultural credit institutions.

These may be divided into two classes: (1) the institutions furnishing real credit, that is, loans secured on farm mortgages made through the public land mortgage bank—the so-called Landschaft of the province of Saxony, (2) institutions for furnishing personal credit, that is, working capital on short time loans and on personal security which is provided through the farmers' cooperative banks.


The Land Mortgage Association

The German Land Mortgage Association (Landschaft) was first established in 1770 by the nobility of eastern Germany, with the approval of Frederick the Great, for the purpose of securing loans on their farm real estates. Instead of borrowing individually they organized an association and issued a common mortgage bond against all of the real estate owned by the members of the association. Furthermore, the management of the association was under the direct control of the government and the officers were quasi-public officials. Other similar institutions were soon established, but confined their members to the nobility and large landowners. However, the results secured were so satisfactory, the rates of interest so low and terms of the loans so favorable that the plan extended and the farmers of the middle classes organized in a similar manner.

The province of Saxony, in which the farmers of the middle class predominate, did not organize a land mortgage association until 1864. A few years later came the war between France and Prussia (stopping industrial development) so that in reality the association did not make real progress before 1880. To-day the total mortgage indebtedness of the province is 830,000,000 marks, and over 220,000,000 marks of these loans have been made through the Provincial Land Mortgage Association. The proportion of the loans made through the association is constantly increasing and within the last six months they have increased 10,000,000 marks, but the time probably will never come when all of the outstanding mortgage loans will be made through the land mortgage associations, as in many cases mortgages are given by members of families in settlements of estates, loans are made within families and through other private interests, so that in no case is it likely that over two thirds of the mortgage indebtedness of a province will be made through a public credit institution.


The Business of the Land Mortgage Association

The Land Mortgage Association of the province of Saxony, which is typical of all other similar institutions in Germany, is a cooperative union of the landowners of this province for the purpose of securing loans for its members on their land by issuing bonds (Pfandbriefen) against the same. The association is not a stock company. No profits are declared to individuals, but go to the reserve funds of the association. Any one may become a member who is a landowner in the province and pays a land tax of at least 90 marks per year, which means owning from 10 to 25 acres of land, depending upon its value.

The articles of the incorporation for the association were approved by the Prussian government and the oversight of the business is under the direction of the Minister of Agriculture of the kingdom of Prussia. The association is independent to conduct its own affairs and to elect its own officers, but the election of the higher officers must be approved by the government. A farmer wanting to borrow through the association makes his application. After examination of the title of his farm and finding it satisfactory he has the privilege of borrowing to two thirds the assessed value of his farm for taxation by giving first mortgage to the association for the amount he borrows. The association does not have the money on hand to make the loan, but secures the same, not by selling the mortgage, but by issuing what is known as a Pfandbrief or mortgage bond of equal amount to the mortgage and selling the bond. There are several features of the Pfandbrief that are characteristic. First, it is not secured alone by the mortgage of the farmer for whom it was issued but by all the mortgages and property of the land mortgage association. Second, it is transferable without endorsement at any time and is an impersonal security payable to bearer. Third, it is not a bond in the sense that it runs for a definite length of time, for there is no fixed time at which it matures. Fourth, the holder does not have the right to demand payment of the face of the bond—that is, to call in the loan—but the issuer—the land mortgage association—has the privilege of paying it at any time. For example, the bond may be called in and paid six months after it is issued or fifty years, at the pleasure of the land mortgage association. But under no conditions is the amount of bonds outstanding permitted to exceed the amount of mortgages held by the land mortgage association.

The business of the land mortgage associations has been done so conservatively that their bonds are regarded as the very best of security and are favorite investments for trust funds, savings banks and any capital seeking a perfectly safe investment negotiable at all times. In fact, these bonds sell next to government bonds, and in case of war, or even threatened war, they sell better. The government may be overthrown or compelled to suspend payment of interest, but the farm real estate that secures the bonds can not lose its value.

The rate of interest the bonds bear is 3 per cent., 31/2 or 4 per cent., at the option of the farmer securing the loan, but the price at which they sell depends upon the condition of the money market. At the present time (July 1, 1912) 3 per cent, province of Saxony Pfandbriefen are selling at 81.00, 31/2 per cent, at 90 and 4 per cent, at 99.80, while the 4 per cent, national bonds of Germany are selling at 100. In case a farmer borrowing $1,000 chooses a 3 per cent, interest rate and the 3 per cent, bond are only selling for 81.00, he gets only $810 and pays $30 per year interest, that is, 3 per cent, on the face of the bonds, and gives his note and mortgage for $1,000. But on the other hand, if 4 per cent, bonds are selling at par and he chooses a 4 per cent, loan, he gets his $1,000 in cash for his Pfandbrief and pays $40 per year interest and gives his mortgage and note for $1,000. It is always regarded as the best policy for the borrower to choose the class of bonds selling nearest par, unless they are selling above par, in which case the farmer securing the loan gets a premium over and above the amount of his liability and it is to his advantage to take such loans. When the bonds go above par they are called in and paid off by the farmers refunding their debts at lower rates of interest. Here comes the advantage that the farmers reserve for themselves in the privilege of paying off the bonds at will. Just such a thing happened when in the seventies the rate of interest advanced to 5 per cent., due to the scarcity of money and the enormous demand for it in building railroads on the continent and ten years later the rates of interest sank until 3 per cent, bonds sold close to par and the farmers rapidly paid off their loans made at the high rate of interest by using new bonds at the lower rate of interest and selling them to pay off the old ones.


Central Land Mortgage Association

In order to widen the market for the Pfandbriefen a central land mortgage association was established in Berlin in 1873. By this means it was thought to make them an international security and to give them a larger market. The bonds of the central association are secured by all the mortgages of the provincial associations belonging to the central association. The results attained through the central association, however, have. not fulfilled expectations. The Pfandbriefen in no considerable extent have found their way into the international money markets. The offering of them in such large quantities on the Berlin Bourse reduced the price below what they could be sold for in home markets through the local banks. Furthermore, there is a sentiment among investors buying bonds that as long as the provincial bond is equally as secure as the central they prefer to invest in Pfandbriefen of their own province. In the province-of Saxony, with its 220,000,000 marks of Pfandbriefen outstanding, the director of the Landschaft estimates that 75 to 80 per cent, of the total amount invested in them is capital of the province of Saxony. So far as security was concerned, nothing was to be gained by consolidation into a central association, since the provincial association bonds are as secure as bonds can be made.

Of the total amount of bonds in circulation at the present time only about 10 per cent, of them are central association bonds. The latest statistics show that the provincial and central association of Prussia have the following amounts of outstanding bonds.

Land Mortgage Association of Prussia

Association Founded Outstanding Bonds
East Prussia 1788 426,152,350 M.
West Prussia 1787 123,074,405 M.
New West Prussia 1861 186,278,210 M.
Berlin 1868 449,563,500 M.
Pomerania 1781 252,007,525 M.
New Pomerania 1871 19,006,900 M.
Posen 1857 301,525,300 M.
Silesia 1770 608,634,180 M.
Saxony 1864 126,675,600 M.
Celle 1790 15,579,100 M.
Hanover 1825 24,706,650 M.
Bremen 1826 10,360,425 M.
Westphalia 1877 74,554,300 M.
Central 1873 433,255,000 M.
Total 3,093,493,545 M.
Mark equals 23.8 cents.

Amortization of Loans

One of the most valuable features of the loans made through the land mortgage associations from the standpoint of the farmer is the gradual amortization through annual payments made with the interest. This is obligatory on the part of the borrower and usually is 1/2 per cent, to 3/4 per cent, of the face value of the loan. In the land mortgage association of the province of Saxony the amortization is 3/4 per cent, per year. On a loan made at 4 per cent, is added the 3/4 per cent, amortization and 1/4 per cent, to cover the operating expenses of the association, making a total of 5 per cent., and by paying this amount annually for between forty to forty-five years the loan will be paid off. The farmer in the meantime also has the privilege of paying it all or in part at any time. After the loan has been made the rate of interest can not be raised or the loan called in, so if the farmer has secured his loan at a low rate of interest he can carry it until it has been amortized by his annual payments. The Saxon farmers who in the nineties borrowed at 3 per cent, and got par for their bonds are relishing this feature now that the rate of interest has advanced to 4 per cent.

However, many of the better farmers make no attempt to pay off their loans any faster than is required through the annual amortization payment, finding that they can get their credit cheaper in this way than any other and can make more interest on the money used in their business than they have to pay for it. The association also has the provision that when 10 per cent, of the original loan has been paid an additional loan can be made and in this way a farmer can continue to carry indefinitely practically the same amount of loan on his property if he finds it advantageous to do so. The average length of time loans run in Saxony is about twenty-five years.

By this method the farmer gets all the advantages of the money market if money is tight—the rate of interest goes up and the price of the Pfandbriefen go down when money is abundant and interest rates low the price of Pfandbriefen go up. The farmer through his bank watches the money market and takes advantage of the low points in interest rates to secure his loan, and once made he is safe from having his loan called in or his interest rate raised.


Decentralizing the Business

A practical point in the operation of such a business is to make it as convenient as possible for the farmer to do business with the land mortgage association. The province of Saxony is a territory nearly 100 miles square and the association is located in Halle, a relatively large city. For all of the farmers to come to the central association to negotiate their loans would be impracticable and would diminish the business very much. This problem has been solved by dividing the province into districts 10 to 15 miles square and in each district is a local officer of the association elected by the members in their annual meeting. This officer assists the members in getting their loans, sends in their applications, gives information concerning the association and looks after the business in his district. When property is appraised for loans, he is chairman of the committee making the appraisement. When interest is not paid or a member is neglecting his farm, the local deputy, as he is called, serves as the medium between the association and the delinquent member. In this way the advantages and economy of a centralized organization and at the same time the benefits of a decentralized association—that is, one close to the individual farmer—are secured.


Personal Credit

While the land mortgage association is sufficient to provide the long-time credit that is needed by the landowner, it does not suffice to furnish the short-time loans that are needed to supply working capital, to buy seeds, fertilizers, livestock to be fattened, to pay for labor to grow crops and such operations as require capital for six to nine months. To the farm renter or any farmer who does not own land, the land mortgage association has nothing to offer.

To meet this need the rural banks have been established. The work of this class of banks had its beginning particularly with William Raiffeissen among the peasant farmers of western Germany about the middle of the last century. Raiffeissen saw the dire straits of the small-farmers who were without credit and at the mercy of the usurer. He began by establishing cooperative associations to do their own banking, and there were four fundamental principles that he insisted upon that have been retained in the true Raiffeissen banks of the present time. First, unlimited liability of the members. This was necessary in the beginning in order to get any credit at all. All the members were practically without means and the question of limited or unlimited liability was of little moment to them.

Second. A restricted area of operation for the bank. This was confined to the district in which the members were all personally acquainted with one another. In European farming it is customary, especially for the peasants, to live together in small villages and not on single farms as in America, so that the boundaries for the operation of the bank were generally confined to a single village.

Third. No dividends to members. A low rate of interest, usually 4 per cent., was paid on the capital stock each member had invested in the bank, but all profits made over that amount were set aside in a reserve fund.

Fourth. No salaried officers were employed in the banks except the bookkeeper. The management of the bank was made a matter of honor, the work to be done without any mercenary compensation. The business was done in the most democratic manner possible. Every member was given a voice and made to feel he was personally responsible for the success of the business. Loans were made for specific purposes, for example, to drain a field. The committee considered the advisability of the proposed expenditure in making the loan, the members of the bank all knew the plan of the member and were interested in his success, because in case the member failed and was unable to repay his loan to the bank they would all be losers.

Raiffeissen did another thing that is of utmost importance in rural banking. He adjusted the loans of the bank to meet the needs of agriculture. The farmer needs a longer time loan than the merchant or manufacturer. City loans for three and four months do not fit the business of farming. With the farmer 6 to 9 months is the shortest time for which he needs a loan. The time from planting a crop till it is harvested and ready to market is at least six months. The city merchant will turn over his money four or five times during the year but the farmer only once, so that the rural banks must make the loans for longer periods than is customary in the city. In case of crop failure in bad seasons loans must be allowed for still longer periods and in Raiffeissen banks these provisions were made.

From their beginning in the Rhineland the Raiffeissen banks have spread not only over all rural Germany, but almost all rural Europe. They have been modified to meet local conditions but with it all have kept in view the purpose of serving the needs of the farmer.

In studying the agricultural banking or credit system of a country the condition of the individual farmer must be taken into consideration. A system applicable to peasant farmers with small holdings, such as are found in many parts of Europe, is not likely to offer much of value for American farmers. But in a section in which the average wealth and stand of the farmers is on the same level as in America, a system that is proving successful may afford some good lessons.


Rural Banks in the Province of Saxony

Such a section is to be found in the province of Saxony where the rural banks are splendidly organized and doing a business of $100,000,000 per year.

The first striking difference between these rural banks and the original Raiffeissen banks is that they are organized on a limited liability basis. The farmers of Saxony for the most part are well to do, but they vary greatly in their financial worth. The man whose property is worth a hundred thousand marks is not willing to become a member of a rural bank or a cooperative association of any kind with members who are worth only five thousand marks and agree to an unlimited liability for its members. Consequently the Saxon banks are organized limiting the liability of the members in proportion to the interest they have invested in the bank. The fundamental object of the rural banks is to furnish credit to their members for working capital at the lowest rates of interest possible and not to make a profit on their business. In the province of Saxony there are 660 rural banks. These are small village savings banks with an average membership of about 100 farmers. They are the units of the farmers' cooperative organizations of the province. At Halle there are three central cooperative organizations, with all of which the local banks stand in relation and are members: (1) The Central Cooperative Bank, which does nothing but a banking business and whose members are cooperative associations instead of individuals. (2) The Central Cooperative Association for the purchase and sale of agricultural products. This, like the central bank, has for members associations instead of persons and does a wholesale business in buying and selling agricultural products. (3) The Union of Cooperative Societies, which oversees the management of the local societies, audits their books, furnishes uniform systems of bookkeeping and looks after the organizing of new societies and does the propaganda work in promoting agricultural cooperative work in the province.

In order to become a member of the Central Bank at Halle the local association or bank must take a share in it which is 300 marks. The number of shares that the local bank or association hold is in proportion to the amount of business it does. By virtue of holding shares in the central association it is entitled to make loans from it. The farmer goes to his local bank, of which he is a member and to whom he is known, and makes his application for a loan. The bank in turn applies to the Central Association with which it has credit and secures the money and it costs the farmer 1/2 per cent, more interest than the local society pays the Central in order to cover the local costs of the society. The average interest rate charged by the Central Bank in 1909 was 3.92 per cent., in 1910 it was 4.34 per cent, and in 1911 was 4.39 per cent. The rate of interest paid for deposits is 3 to 31/2 per cent., depending upon the current interest rate.

Credit is the first requisite of successful cooperation. When a country has a well-established system of agricultural credits it is almost certain to be thoroughly organized on a cooperative basis in other lines. This is the case in the province of Saxony, particularly in the purchase of agricultural supplies, such as fertilizers, feeding stuffs, coal, seeds and agricultural machinery.

The local banks serve the farmers both as the societies through which the purchases are made and furnish the credit for making the purchases. In this way there is a saving in the cost of doing the business and the bank knows how the money is spent.


Moral Effect of Cooperation

The development of the cooperative credit systems among the farmers of Europe has had an important influence on their social life. Aside from the independence gained in their business affairs by being freed from the money-lenders which for the most part were usurers, they have been united in a community of interest that has widened their circle of acquaintance, given them a sympathetic interest in each other's welfare and has largely displaced the jealously so commonly existing in rural communities.

Among the peasant classes where the Raiffeissen savings and loan banks were established with unlimited liability of the members, ministers have frequently testified that they have been as important factors in the moral life of the people as the church itself. Intemperance and immorality is not permitted among the members. If a farmer takes to intemperate drinking his loan is called in by the bank. If he is neglecting the work on his farm the loan is called in. So that every farmer feels he is under the constant watch of the other members and since they are united together in a cooperative association, where if one man fails the others must pay his losses, they are all interested in each other and anxious to see every one succeed.

The application of the cooperative principle of "one for all and all for one" serves as an incentive to the individual farmer and inspires him to do his best.


Need in the United States

The farmers of the United States as yet have not appreciated the value of organizing to improve their credit. In the southern states the cotton crop must be marketed as soon as harvested to meet outstanding loans that the farmers have made at exorbitant rates of interest. The grain dealers throughout the central states know that they will be flooded with wheat and corn just before tax-paying time by farmers who are compelled to sell in order to raise money to pay taxes. Intensive systems of farming that must be adopted to adjust American agriculture to present needs means a larger working capital for the farmer, he must use more labor, more commercial fertilizers, better seed and he must drain his land. The European farmer gets twice as large a crop yield per acre as the American farmer because he spends twice as much capital in producing it. He cultivates better, fertilizes better and he takes better care of his land.

Interest rates in general are lower in the United States than they are in Germany and yet the German farmer is able to secure his credit through his cooperative organizations at two thirds the rate of interest ordinarily paid by the American farmer. In addition the loans are made on much more favorable terms and the times and methods of repayment are adjusted to suit the business of the farmers.

The advantages of the farmers organizing to sell their credit for what it is worth are not all on the part of the farmer. But for the capitalist seeking a safe investment for his money they offer a security that can be bought at any time and is always negotiable. Such organizations serve as an economic saving between borrower and lender. The man in America at the present time who wishes to invest his money in farm mortgages must seek out such loans personally or through an agent. The punctuality with which the interest will be paid and the loan when it falls due will depend upon the personality of the farmer. But such is not the case when the loans are made through a land mortgage association and the investor instead of lending direct to the farmer buys the bonds of the association; he then knows that his interest will be paid as punctually as on a government bond; that his security has a market value and can be sold for cash any clay through his bank. The establishment of the land mortgage association and selling its bonds on the open market opens up a field for investment that is now practically closed to a large class of investors.

One thing to be emphasized in regard to the success of the European systems is the fact that it has been largely due to the direct oversight that the governments have had over them. Without this government relationship they could not have commanded the confidence of the public that they have. It is hopeless to expect an equal degree of success for similar institutions in America unless they are also organized under government control, at least to the extent that the public will have absolute confidence in their solvency.