A default by the $70 billion Farm Credit System on its outstanding bonds would be such a shock to the nation's financial system that interest rates would jump by up to 3 percentage points and the economy would lose 1.5 million jobs, according to a study by Chase Econometrics released yesterday.
Holders of Farm Credit System bonds would lose about $28 billion in a default, the study estimated. Banks holding about half the bonds would lose $14 billion, followed by additional loan losses as the value of farm real estate plummeted.
The study was commissioned by the Farm Credit Council, a lobbying organization for the Farm Credit System, which is seeking federal help to avoid a possible default sometime in the future.
However, the study is based on the assumption that the Federal Reserve would not respond fully to the "extreme liquidity pressures" that might follow a default on Farm Credit bonds. Interest rates would be allowed to rise because of the Fed's "long-term goal of controlling the growth in the money supply" in order to hold down inflation, the study said.
Some analysts questioned whether the Fed, in fact, would allow interest rates to rise in such a situation. In the past, the analysts noted, the Fed has responded to any such actual or potential liquidity crisis by making available whatever resources were needed to head it off.
For instance, in 1973 when bankruptcy of the Penn Central Railroad threatened to disrupt the national market for commercial paper -- unsecured promissory notes issued by corporations -- the Fed stepped in. Then-Federal Reserve Chairman Arthur F. Burns called major banks across the country assuring them that the central bank stood ready to lend them whatever money might be needed to allow the banks to advance money to corporations that were unable to issue new commercial paper. The assurances from Burns of unlimited access to money through the Fed's so-called discount window halted the potential liquidity crisis in its tracks.