Federal banking regulators began warning of a farmland price bubble early in 2011.

Thomas Hoenig, then president of the Federal Reserve Bank of Kansas City, testified in February before the U.S. Senate Agriculture Committee that distortions in capital markets, including historically low interest rates, could lead to a farmland price bubble that could damage the U.S. economy when it collapses.

He warned that farmland prices could drop as much as a third if interest rates return to historic averages.

Since then, the Farm Credit Administration, the Federal Deposit Insurance Corporation (FDIC) and the Kansas City Fed all have hosted sessions addressing a potential farmland price bubble. Federal Reserve regional bank examiners and the FDIC are focusing more on lending standards and risk-management practices at rural banks.

Ag economists who follow farmland price trends acknowledge there is reason for concern if farmland prices continue to heat up, but they argue that current price levels aren’t in bubble territory.

“There is a bubble somewhere, but it is not farmland,” says Gary Schnitkey, an ag economist at the University of Illinois. “I can see why they are concerned about asset prices going up, but they have picked the wrong market.”

Schnitkey says that current Illinois farmland values are roughly in line with capitalization values, which are calculated by dividing average land rent by long-term interest rates.

Rabo Agrifinance reached the same conclusion in a July report that evaluated farmland values across the U.S. It said that recent land price increases are not linked to speculation or other factors that traditionally lead to a bubble and that strong crop prices and low interest rates support recent price gains.

“Our definition of a bubble is an asset that is not supported by a fundamental value,” says Sterling Liddell, vice president for food and agribusiness research for Rabo Agrifinance.” With the dramatic increase in commodity prices, land values are supported by fundamental values.

“What we are saying from an asset value perspective is not that there is no risk,” Liddell says. “There clearly is risk. But we do not see this as a classic bubble.”

However, if the hot land market continues into 2012, prices could reach speculative heights, Schnitkey says. “If we have another year of 20% increases, you are getting into the speculative area,” he acknowledges.