Officials of the Farm Credit System, faced with a deteriorating farm economy and the likelihood that loan losses will mount sharply, decided that they had to go public with the system's plight, although in the short run it would undermine investor confidence in their securities and increase the cost of raising funds in the market.
Analysts said the system was forced to take the risky step because obtaining federal help is likely to be a difficult and lengthy political process that must be begun now.
The Farm Credit System, like other financial institutions, lives on investor confidence, a confidence that is being shaken by publicity about large potential loan losses.
The $74 billion system, a decentralized network of locally controlled lending organizations funded through a dozen Federal Intermediate Credit Banks, provides more than one-third of the money borrowed by farmers.
The system raises all its loan money by selling securities; no federal funds are involved.
Should investor confidence be shaken enough, the system could find itself unable to raise money to pay off maturing securities, some financial analysts warned yesterday.
Such a development, still regarded by analysts as a remote possibility, could produce financial chaos in the farm sector and huge losses for investors holding the system's securities and for farmers who, as a condition of getting credit, bought stock in the system.
So far, the system has absorbed its losses and maintained a substantial net worth, estimated at more than $10 billion at the end of March by the Farm Credit Administration, a federal agency that oversees the system. Meanwhile, dividends are still being paid on the stock.
However, the system may have $11 billion in uncollectable loans, possibly more, according to estimates by sources in the system.
Only about $1 billion has been set aside to cover possible losses, the FCA's March report said.
Most of the securities issued by the system are held by both domestic and foreign institutional investors such as commercial banks, insurance companies, savings and loan associations and corporations. Some are also held by individuals.
The securities have no federal guarantees, but investors have treated them as if there were guarantees.
Normally, the system has raised money by paying only about 10 or 15 basis points above the yield on regular U.S. Treasury securities of similar maturities. A basis point is one-hundredth of a percentage point.
Because of looming problems, the spread had risen to 25 to 50 basis points. Publication of a Wall Street Journal story Wednesday saying system officials were going to seek some form of direct federal assistance raised that spread further to 50 to 75 basis points and reduced the number of transactions in the securities, said one trader at a New York bond dealer.
The dealer said that investors regard the system's securities has having a "moral obligation" type of government guarantee even if there is no legal guarantee. Foreign investors, he added, are even more confident than American investors that the U.S. government would not let the system collapse.
At the moment, no one knows how much of a rescue package might be needed, except that FCA Governor Donald E. Wilkinson said it will have to be "multibillions of dollars."
But while the Farm Credit System is facing losses, so are many agricultural banks -- those with more than one-fourth of their loans in agriculture -- and a number have failed in the last two years. The Federal Deposit Insurance Corp. has more than 400 such banks, mostly small, on its list of problem banks. Assisting the Farm Credit System without helping the banks, too, could be politically difficult.
Public disclosure of the system's plight will have an impact on the entire farm credit issue, and officials avoided it as long as possible. Last month, the system chose to use cash on hand to pay off some maturing notes rather than make the disclosures that would have to accompany a new securities issue. By late this month or early next month, the system normally would be bringing another new issue to market.
If the present holders of the system's securities were to decide to sell them, buyers would have to be found for those securities as well as any new ones. "It could be hard to find buyers, and there could be a liquidity problem," said one dealer. "It could be a real mess."
However, he added, "there are investors who think this thing will be solved" as was a problem a few years ago at another government-sponsored agency, the Federal National Mortgage Association, also known as Fannie Mae. The problem at Fannie Mae was not loan losses but that the cost of the short-term money being borrowed by the agency was costing more than it was making on the long-term mortgages it had in its portfolio.