Review of the Book
Boom Bust: House Prices, Banking
and the Depression of 2010,
by Fred Harrison
Edward J. Dodson
[June 2005]
For more than a century now, colleges and universities around the
world have awarded doctorate degrees in economics. And yet, economics
was described by one of its members as the "dismal science"
because of the apparent inability to explain with any certainty what
is happening in the world and why. Theories continue to compete with
one another for dominance among economics professors. Most seriously,
to the extent the public policy recommendations of economists have
been followed, they have failed to solve the most serious "economic"
problems plaguing every society - widespread generational poverty and
the recurring impact of the business cycle.
Socialists, supported by the interpretation of political economy
provided by Karl Marx, hoped to solve these problems by state
ownership and management of "the means of production."
Instead, "state socialism" proved to foster corruption and
bureaucratic elitism, while destroying individual initiative. In the "social-democracies,"
several generations of economists pursued the type of training
required to assist businesses penetrate and secure markets, respond to
competitive pressures and lobby government for privileges and
subsidies. In the era before John Maynard Keynes, the economists
concentrated on monetary and credit questions -- such as the need for
"gold" to back national currencies, the virtues of fixed
versus floating exchange rates, and to what extent banks should be
required to hold reserves to protect against runs by fearful
depositors. Keynes recommended that government create new powers over
the economy designed to mitigate the highs and lows of the business
cycle. With Keynes came the era of "demand management" and
the "mixed economy." Others followed with their particular
insights and policy recommendations: the monetarists, the
supply-siders, and the rational expectationists.
In a paper I wrote back in 2003 titled "Pseudo-Scientific
Economics: The Business Cycle and a Neo-Classical 'Mystery'," I
expanded on the criticisms of economics and economists offered in two
books published in 1994. The first book,
The Corruption of Economics, examined the development of
economics as a weapon in the arsensal of vested interests determined
to protect privileges they enjoyed under existing socio-political
arrangements. This book was co-authored by economics professor Mason
Gaffney (University of California, Riverside) and Fred Harrison, a
London-based economics writer. The second book, Lost Prophets,
came from the former economics editor of the Wall Street Journal,
Alfred L. Malabre, Jr. In this book, Malabre essentially detailed the
failures of economists from Keynes on without making any connection
with the arguments raised by Gaffney and Harrison.
Fred Harrison now offers us Boom Bust: House Prices, Banking and
The Depression of 2010, published as a direct challenge to
conventional economic wisdom and the policies currently guiding the
economies of Britain, the United States and other developed nations.
What I have to say about this book is less a review than an addendum.
Over the last few years, I sent to Fred a continuous stream of data
and analyses on the U.S. economy and responded to his requests for
specific information. I have few arguments with his presentation of
the causes of the business cycle and the measures he states are
required to achieve sustained economic growth as well as the full
employment society. The historical record affirms his observation that
"[s]elf-censorship has damaged governance to the point where
central bankers and finance ministers have imposed on us a crude tool
of economic management - the rate of interest, the cost of borrowing
money."[1] Our political leaders have given central bankers and
finance ministers little choice, however, by repeatedly reducing the
amount of public revenue raised from those whose personal wealth is
derived from activities that produce neither goods nor services. In
the United States and in Britain, the trend over the last quarter
century has been to greatly reduce the portion of tax revenue coming
from the highest marginal incomes and the estates of the wealthiest
citizens. Fred's book examines the history of how this has occurred
and warns that the list of victims is about to become even longer:
"The failure to eliminate or control the business
cycle, despite repeated attempts to do so, suggests that the
received wisdoms do not lead governments to remedies that work. A
second reason is that economics, as it is employed today, is
seriously prejudiced by the dilution of some of its key concepts.
Economists routinely work with economic models that treat the world
as if it were composed of two factors - labor and capital - instead
of the three-factor model favoured by the classical economists. This
disembodies the economy from its spatial context. That, especially
when we are concerned with the impact of the housing market on
people's lives, creates analytical problems. For land is the key
piece of the jigsaw that is the complex economy."[2]
What then follows is the historical evidence Fred has brought
together from researchers who either failed to grasp the importance of
their own compiled data or were ignored because their findings
conflicted with conventional wisdom. "The need for the long-term
perspective is crucial," he writes, "for we are dealing with
events that recur time and again."[3] Therefore, the causes must
be the same across time and for different regional and national
economies:
"If the business cycle is characterized by a
pattern that is regular in its periodicity and scale, the
probability is that we are searching for a single, or a very few
related, causes, and that those causes are embedded in the
foundations of the system."[4]
However, to examine the system's socio-political foundations is a
task most economics professors have decided is outside the scope of
their work. Challenging the status quo belongs in the realm of the
political philosopher and moralist, not the economist. And yet,
virtually every government (and almost every agency within government)
has economists on staff charged with gathering and analyzing data,
evaluating existing public policies, and - at least at the higher
levels - recommending policies they believe will move their society in
the direction of stated political objectives. Fred reminds us that the
classical political economists approached the world in what we would
today call an interdisciplinary manner. Many were not at all averse to
advancing moral arguments to defend or attack the status quo. What
they all agreed on was that nature (i.e. in the language of the
political economist, land) functioned as a unique factor in
the production of wealth. As Harrison reminds readers, land and land
markets are very different from labor and capital goods and the
markets for these two other factors of production:
"The land market - where the supply of the raw
material is in fixed supply - has the characteristics of a natural
monopoly. Contrast this with the markets for labour, capital and
consumer goods, where - if prices and profits rise - the supply is
increased and prices and profits return to their competitive levels."[5]
He might have also pointed out that land has a zero cost in terms of
labor and capital goods. Land exists independent of labor and capital.
While the supply of land may not be absolutely inelastic (i.e., the
supply curve for land appearing vertical on an economic chart with "price"
on the vertical axis and "quantity" on the horizontal axis),
the near-inelasticity of the supply of land in any market is part of
the equation. As land prices have increased over time, we have become
remarkably adept at more intensive use of locations in order to
maximize the ratio between revenue generated and costs incurred.
New building methods and technologies have made the high-rise office
building the norm in cities and even most suburban business districts
where land costs are a major component of the costs of doing business.
Before many civic leaders introduced codes to protect the historic
quality of residential neighborhoods adjacent to or within downtown
business districts, many dwellings were demolished and replaced by
huge apartment buildings or condominiums. In a sense, this type of
land-intensive development creates locations by taking advantage of
air space. Even so, almost every new residential building contains
what are termed "studio" or "efficiency" units to
meet the need (and demand) for housing that is affordable to people
with a range of household incomes.
One of Fred's insights regarding the present is that, "[f]or
most people the occupation of smaller spaces is not a lifestyle
choice; it is a survival response to the prospect of becoming
homeless."[6] In city neighborhoods close to restaurants, shops,
museums, theatres and other amenities, the trade-off between living
space and convenience might be a lifestyle choice. However, for
millions of families whose incomes are falling or are unstable, the
choice may be living with relatives, in housing of marginal quality,
or becoming homeless.
In the United States, we have experienced a continuing expansion in
the size of our metropolitan regions. Somewhat unexpectedly, new "edge
cities" have developed with their own sizeable employment base,
stimulating even more spread out residential and retail development
into what until recently were rural and thinly-populated parts of the
region. Total population in the metropolitan areas is often stable, or
even declining, but people are spreading out further and further from
the historical center. Initially, this migration of people left many
cities with emptying downtowns and many decaying residential
neighborhoods. That trend now seems to be reversing itself. A
combination of demographic, lifestyle and political factors are
bringing higher income households and real estate developers back into
the cities.
Three of the original reasons why suburban communities blossomed in
the first place - low land prices, minimal local taxes, and
newly-constructed affordable housing - are things of the past. As city
neighborhoods are cleared of decaying and abandoned buildings, the
opportunity to reshape city landscapes with amenity-laden housing
choices is a powerful magnet for re-population of our urban centers.
For much of the duration of the business cycle, those who profit most
from all of this development are those who have control over land:
"The land market is a giant sponge. It soaks up the
value that is not taken by people in the labour and capital markets.
The speed and the scope by which revenue is transformed into net
income (that is, after paying for the use of labour and capital) and
paid as rent to the owners of land and natural resources depends on
particular circumstances."[7]
Economists refer to these "particular circumstances" as
externalities. What gives even the least doctrinaire analyst headaches
is the complex web of externalities that must be considered in any
economic analysis or forecast of the future. One such externality is
the absence of up-to-date and complete data on land markets.
Economists cannot analyze what they do not have. Yet, as Fred has
documented, several generations of economics professors have simply
accepted on blind faith the wisdom of those who wrote land out of the
economic textbooks. As economic theorists retreated early in the
twentieth century to the safety of the two-factor model, their success
denied students with the theoretical mandate to ensure data on land
markets was pursued. The results, he concludes, have been
catastrophic:
"[E]conomic theory, as it is applied by its
practitioners, fails to treat rental income as the economy's
pressure gauge. As a consequence, the mightiest economies
periodically collapse into a mess because the experts at the
steering wheel turn Nelsonian blind eyes to the vital information
that is registered on that gauge."[8]
The needle on today's gauge is well into the danger zone. A clear
indication is what Fred refers to as "the tragedy of house price
trends that [are] eclipsing people's ability to afford shelter for
their families; of progress with poverty."[9] In the United
States, there are still many parts of the nation where land prices
have not yet driven the majority of renters out of the housing market.
The problem is the greatest in the coastal cities. Housing prices have
been and are continuing to increase wherever the population and
employment are reasonably stable. The response to higher housing
prices by financial institutions and investors in mortgage loans has
been to reduce the need for savings in order to purchase a home.
Borrowing 100 percent of the purchase price is no longer unusual.
Funds to cover transaction costs frequently come from a combination of
gifts from family members and either grants or forgivable loans from
government agencies or foundations. Millions of existing homeowners
have borrowed against the "equity" in their homes to obtain
cash for needed repairs, for the costs of college for their children,
to cover uninsured medical expenses, and - in the worst cases - to
provide needed cash to live on during periods of prolonged
unemployment. A huge market has developed for "reverse mortgages"
that supplement the monthly income of seniors in return for housing
equity. Many elderly homeowners and the financially naïve are
being victimized by "predatory" loan terms that make it
almost impossible to repay the debt incurred. Thousands and thousands
of homeowners have lost their homes to foreclosure after defaulting on
these second or third mortgage loans. With notable exceptions, state
and federal government agencies have been slow to respond to this
crisis.
An added externality has re-emerged in the United States to worry
those of us who have resisted becoming economic "true believers."
After a brief period of stability, the national debt incurred by the
U.S. government has skyrocketed under Republican Party stewardship.
When President Bush leaves office at the end of 2006, the national
debt is likely to exceed $10 trillion. If the average rate of interest
paid to bondholders is just 5 percent, the U.S. government will need
to raise $500 billion each year just to service this debt. How this
revenue will be raised and who is holding all of this debt is - or
ought to be - a subject of primary importance to U.S. citizens. As
housing costs - whether rents for apartment units or the monthly cost
of ownership (i.e., mortgage payments, plus escrows for property
insurance and taxes, and utility costs) - continue to rise, household
savings for the bottom half of the population are fast disappearing.
Escalating property taxes are actually forcing households living on
fixed incomes to sell their homes and move to other communities,
competing with other low-income households for a dwindling stock of
available affordable housing. In the face of this reality, those
supposedly in charge of economic policy have sent out the message that
all is well and that people should not be overly concerned. In the
United States, these messages continue to come from Alan Greenspan,
long-time Chairman of the Federal Reserve System:
"The Greenspan model of the economy was fatally
flawed because it excluded the one variable that featured in every
boom bust over the past 200 years in the United States: the land
market. In every significant economic collapse, the central
operating mechanism was the land market. People experienced the
helter-skelter prices through the value of their homes. But
according to Greenspan, in congressional testimony to a House of
Representatives Committee: 'The type of underlying conditions that
create bubbles are very difficult to initiate in the housing
market'. In fact, far from fearing the inflation of residential
assets, he was confident that robust gains in this sector would
offset the weakening effect of a declining stock market on the
nation's consumption habits. In that testimony on Capitol Hill, the
one man on whom a nation relied for economic wisdom betrayed a
cavalier attitude that would guarantee the destruction of people's
hard-earned wealth."[10]
If Fred's analysis is correct, age-old dynamics will overcome the
illusion of "the New Economy." He reminds readers that land
markets arose as the control over land was gradually privatized by Old
World monarchies more in need of hard currency than the pledge of
loyalty from grateful land barons. Commerce in land made possible the
speculative acquisition and holding of land for resale rather than
improvement. Thus began the business cycle, at the center of which was
a cyclical land market characterized by frequent recessionary crashes
- and sometimes depressionary collapses. "This review of the
historical evidence confirms the theory that economic activity is most
fruitfully analysed in terms of 18 year segments,"[11] writes
Fred. There is no secret to the nature of this cycle. All one needs is
a clear understanding of what motivates our behavior:
"The periodicity is linked to the construction
cycle, which is shaped by the financial mechanisms and the pursuit
of windfall gains from the rents of land and nature's resources."[12]
These same observations for a very long time have been made by a
small group of writers trained in economics, individuals such as Harry
Gunnison Brown in the U.S., who fought against the trend in their
field to write "land" out of economics by declaring that
land, labor and capital are inputs without distinction to the
productive process, and that the markets for land, labor and capital
are each subject to "the price mechanism" (i.e., the supply
of each factor will be offered for use at a price determined by
competitive forces). The fact that land responds to increasing prices
in a direction opposite to labor and capital is something land
speculating investors rely on but the majority of economists have
ignored. In the real world, as land prices increase, owners profit by
reducing supply - by hoarding land in anticipation of even higher
prices.
Some economists have even written favorably on the benefits of land
speculation, suggesting that speculators hold land in reserve for high
value development when the market justifies paying the price asked by
the land owner. Neither Harry Gunnison Brown nor Fred Harrison would
find this argument convincing. Whatever minimal benefit might appear
to exist in individual cases, the impact of land speculation on a
society's well-being is intensely destructive. Land speculation is the
most entrenched form of "rent-seeking" behavior we endure
and have been forced to endure since privatization nurtured the first
land markets and the ability of land owners to capitalize land rent
income into a selling price. Industrialization and the increased
productivity of labor and capital merely intensified the economic and
political power of land owners because not only was land ownership
privatized but land rent as well. Fred's description of mid-nineteenth
century Britain could be used to describe what occurred nearly
everywhere and is occurring today in places such as India and China:
"Britain's burgeoning industrial centers needed
investment in infrastructure, to make life tolerable for urban
dwellers. An improvement in the quality of life, for which people
were willing to work, would have increased their ability to generate
even greater income. But that would also have raised the rents of
land. This was a two-edged sword. If rental income was public
revenue, it would have provided for resources to make communities
more habitable. But because rent was privatized, its owners could
extract wealth out of the working population and diminish the
quality of their lives - for, instead, they had to bear the cost of
public services out of taxes on their earned incomes."[13]
This perspective has always seemed to me to be perfect common sense.
And yet, very few of my own professional colleagues working to
revitalize communities or expand the supply of affordable housing
grasped its significance. Those of us who completed one or more
college level economics courses come away feeling there are so many
variables involved in markets, in regional and national economies, and
in the global economy that understanding what might happen and when is
an impossibility. Given our capacity to capture market data for
analysis using powerful computer software, the objective of economists
- and policy analysts - ought to be to study all markets, and study
land markets in particular.
A year or so ago, I engaged one of the economists on the research
staff of the Federal Reserve Bank in Philadelphia in a conversation
about why his economic model did not track land markets. His response
was that he would love to have the data but it just was not being
captured by anyone. This gap could be narrowed - at least where
residential land values are concerned - if mortgage lenders and the
appraisal industry would add this data element to what they capture
during the mortgage loan approval process. The standard residential
appraisal report assigns a separate value to property improvements and
to the underlying land parcel. Delivering this information to a
central repository for compilation and analysis would provide
government, university and industry analysts with extremely valuable
information on land market trends.
In the arena of public policy, we have abandoned any hope for
solutions (i.e., for the economic nirvana of "full employment
without inflation") and keep trying strategies of mitigation.
And, as Fred concludes, the landed are more than content to put some
of their resources at work in defense of the status quo:
"
to concede that damaging turning points in
economic activity can be forecasted entails an obligation to change
the rules of the game. Those who benefit from the current system
would not favor such changes. Thus, it is convenient to conclude
that we cannot anticipate the future."[14]
And yet, anticipating the future - and gambling on the accuracy of
that anticipation - is what motivates a huge portion of the "investment"
activity driving the markets for shares in newly-formed corporations.
The opportunity to profit extravagantly has caused some people to put
their entire savings at risk in the hands of what too often are
unscrupulous manipulators. In describing two of the great historic
economic "bubbles" - tulips in the 17th century and the "South
Sea" scheme to monopolize trade in precious metals in the 18th
century - Fred reminds us of how easily people are taken in by dreams
of wealth without work. And, because "rent" remained almost
exclusively privatized rather than captured for the public purposes,
paying for government and infrastructure imposed heavy burdens of
taxation on those actually producing goods and services. Weighed down
by heavy land costs and heavy taxation, producers eventually find
themselves unable to compete; the bubbles inevitably burst:
"The formula was unbelievably simple. You sell,
today, company shares at prices that capitalize the future stream of
rental income from natural resources. That rental income is
securitized and traded on the stock exchanges, which at the time
were in an embryonic form. An essential step was persuading
prospective investors that the companies held the leases to valuable
natural resources from which they would extract the rents.
"
"The trick was to capture the rents immediately. The laborious
task of extracting and transporting the natural resources to market
would take time. If investors could be persuaded that the companies
would one day be profitable, they would buy the shares today at
tomorrow's prices. That would enable the original speculators to
take cash upfront and run. Shareholders would be left with the
business of having to deliver a value to customers, if they wanted
to recover their capital."[15]
Come forward to the late twentieth century and this first decade of
the twenty-first and the big stories around the world have been the
crash of Japanese land markets and the resulting bank failures, the
large numbers of internet start-ups failing to produce a profit after
raising millions from venture capitalists and others, and the long
upward spiral in land prices in many regions of the world. As Fred
Harrison warns us, neither the experts nor the politicians see in all
of this any systemic problems. Despite the record of recurring periods
of high unemployment - during which a large number of working families
lose everything and increasingly end up homeless - we are told "booms
and busts are characterized as the failures of frail individuals from
business and politics."[16] In the financial services sector,
where I spent nearly my entire professional life, these failures have
been exacerbated by a complex legal, accounting and regulatory
environment unable to adequately keep pace with the introduction of
dubious "financial products" that have nothing to do with
expanding the supply of material wealth and everything to do with tax
loopholes and subsidies.
Detailing the history of how economics displaced political
economy, how pseudo-science displaced science, Fred eventually
gets to the role of John Maynard Keynes. Keynes, it turns out, was
quite frank about his objectives in writing The General Theory on
Employment, Interest and Money (1936). He stated with great
certainty that "the Ricardian foundations of Marxism will be
knocked away."[17] Marx, for all his clouded polemics, wrote in
the tradition of political economy. On the land question, Marx said
little that Richardo, Smith and Turgot had not already said (or
Proudhon for that matter). What they all acknowledged as true and
fundamental to an understanding of political economy Fred recaptures:
"Rent was the transfer of part of the income of the
nation to people who, as land owners, added nothing to the sum total
of wealth."[18]
Keynes closed his eyes to the historical record and even to the
observable trends occurring during his own life. He had virtually
nothing to say about land markets in any of his writings. Land had
been important in the agrarian age, but Keynes accepted the idea that
technological advances combined with financial innovations would
continue to produce what people needed at lower and lower prices -
regardless of what it cost to access land. Fred notes that Keynes
totally ignored the rising prices for land in the world's great
financial centers, apparently oblivious to the fact "that land is
in fixed supply in the desired locations."[19] In the end, writes
Fred, "Keynes' theory of how to maintain full employment
converted governance into the art of perpetual crisis management
rather than crisis resolution."[20] So much for Keynesian "demand
management" embraced by U.S. economists such as Alvin Hansen,
Paul Samuelson and a generation of theorists who looked to a
combination of credit management, government spending and targeted
subsidies to keep inflation and unemployment within tolerable
political limits. Keynesians paid no more attention to the land
question or to land markets than other Neo-Classical professors.
Not every economist over the last century has traveled down the
two-factor road without voicing concern or opposition. I have already
mentioned the name of Harry Gunnison Brown. However, the list of those
who have held positions of significant influence over government
policy is rather short. Joseph Stiglitz, Herman Daly and William
Vickrey come to mind. From Stiglitz came the observation that "[u]surious
rent is the cause of worldwide poverty." Interviewed upon winning
the 2001 Nobel prize in economics, Stiglitz commented on his reasons
for leaving the World Bank:
"If you challenge [land ownership], that would be a
change in the power of the elites. That's not high on their agenda."[21]
Herman Daly added in a speech delivered at the World Bank in April of
2002:
"Rent is by definition a payment in excess of
necessary supply price, and from the point of market efficiency is
the least distorting source of public revenue."
Fred mentions another economist, Lawrence H. Summers, who served as
Secretary of the Treasury in the Clinton administration. Although I
can find no evidence that Summers has recognized the insufficiency of
the two-factor economic model, he has at least acknowledged the
serious shortcomings of the policy work performed by economists. A
study he co-authored reported that nearly 70 percent of all wealth
acquired by individuals in the United States over the first
three-quarters of the twentieth century was inherited or transferred
from one generation to the next, rather than earned by the recipients.
This analysis directly challenges the idea that "America is the
land of opportunity." Increasingly, opportunity in America is
opportunity for fewer and fewer people. At the heart of the matter are
what Fred describes as destructive "revenue-raising policies of
government."[22] He calls for a new "Theory of Public
Property" that recognizes "rent" for what it is - a
claim on production that arises in the market due to aggregate public
and private investment, independent of what the legal owner of
locations in cities, natural resource-laden lands, the broadcast
spectrum or the world's seas and seabeds does or does not to. Reason
dictates, then, what I call a new "Labor and Capital Goods Theory
of Private Property" under which legitimate claims to ownership
require the expenditure of labor and/or the investment of capital
goods.
Globalization has now reached the point where the flaws in existing
socio-political arrangements expose us to previously unheard of risks.
"The distinctive development, today," Fred writes, "is
the synchronization of cycles into a single gigantic trend."[23]
Until the mid-twentieth century, the Western hemisphere provided an
essential safety valve for the migration of people and investment in
productive capital. Despite intense speculation and widespread
corruption, land costs were low enough to nurture the growth of new
towns and cities. In the United States, there has always been a
constant movement of people from one region to another in search of
better opportunities. Today, states compete with one another to
attract businesses by offering extensive subsidy packages. Often these
packages include land assemblage and long-term tax abatements. Despite
these measures, every year sees the departure of goods-producing jobs
to China and other locations where very low labor costs, minimal
environmental regulations, low taxes and - for the most part - lower
land costs more than make up for the cost of transporting goods across
the Pacific Ocean. Not unexpectedly, the businesses and workers
directly impacted seek protection from what they perceive to be unfair
competition (e.g., dumping of products at below production cost in
order to drive domestic producers out of the market). Yet, as Henry
George wrote more than a century ago:
"
that violation of natural rights which
imposes tariff duties is inseparably linked with that violation of
natural rights which compels the masses to pay tribute for the
privilege of living. The one cannot be abolished without the other."[24]
George recognized that the benefits of commerce - of free trade
between peoples - would emerge only when the land question was
justly resolved. And, a just solution to the land question
demands a new theory of public revenue. Nothing else will strike at
the heart of the problem. None of the technological or financial
innovations of the last half century have really changed fundamental
economic and social relations. Social democracy has armed nations with
mitigating safety nets, necessary to prevent political upheavals where
out-migration of the disfranchised is no longer a viable option.
"The New Economy of the 1990s did not alter the
historic trends. Millions of people in the richest nation on earth
were institutionalized into poverty, and there was little they could
do about it. The situation was similar in Europe."
"
The rules were functionally designed to mass produce
social exclusion; rules with which no one had tried to tamper for
more than 50 years. Transferring income between winners and losers
had not worked, and something new was needed. Cross-pollinating two
antithetical philosophies - socialism and capitalism - would merely
perpetuate the history of failure."[25]
What Fred refers to here is the slogan of the "Third Way"
championed by Britain's "new" Labour government and adopted
by Bill Clinton during his Presidency. What these left-of-center
politicians had come to appreciate during the Reagan-Thatcher
experiment with a partial program of supply-side economics was that
government must allow people to produce wealth in order to maximize
employment while also raising enough revenue to preserve the social
welfare state. Clinton was fortunate enough to take office just as the
U.S. economy was poised to rebound - and its most competitive trading
partner, Japan, was still absorbing the pains of a collapsed land
market. Fueled by easy access to credit from Japanese banks, Japanese
investors had driven up the price of land and commercial real estate
well beyond a prudent capitalization of actual cash flows. As they
defaulted on mortgage debt, the banks foreclosed and dumped these
assets on the market. Many were sold at half the price originally paid
- to wiser investors who had cashed out of the market and waited for
what they were certain would be an inevitable result. Japanese workers
and taxpayers absorbed the social costs.
One of the other great ironies of the Japanese economic story is the
failure of Japan to provide decent, affordable housing for its growing
population. For more than thirty years after the end of the Second
World War, the Japanese contented themselves with rebuilding their
nation's infrastructure with revenue raised from exported goods. The
democratic institutions imposed on the Japanese during MacArthur's
reign as military governor failed to solve the land question
in Japan, although the number of land owners was more than doubled.
Initially, this allowed farmers to keep all of their incomes from
production rather than passing on a third or more to absentee
landlords. However, as Japanese cities were rebuilt, the absence of an
annual tax on the rental value of land created a new privileged class
of landowners. Capitalization of rising land rents - fueled by credit
- drove Japanese land prices up to the point where Japanese businesses
were forced to move production facilities out of Japan in order to
remain competitive. For the first time during the post-war era,
unemployment faced Japanese workers. Elderly and poor Japanese without
the support of family networks found themselves homeless. There are
today in the neighborhood of 50,000 homeless Japanese, despite the
fact that housing construction (now that land prices have dropped
significantly) has been stable at more than 1 million units annually.
Analysts report that the Japanese recession has not yet ended and that
land prices have continued to decline across much of Japan. The
insight is that Japan's land market remains fundamentally
dysfunctional, so much so that its crash in 1990 has not yet worked
its way to a market equilibrium under which Japanese producers can be
competitive and profitable. Just how far out of equilibrium the
Japanese land market had gone by 1990 is demonstrated by one almost
unbelievable statistic: the land occupied by the Imperial Palace in
the center of Tokyo had an estimated market value greater than all of
the land in the entire state of California.
Throughout history banks have provided the credit to fuel speculative
investment behavior. Thousands have paid the price when borrowers
defaulted, insolvency occurred and they were forced to close their
doors. Fred warns that the expansion of credit to marginally-qualified
borrowers to purchase homes or refinance existing debt is pulling the
major developed nations rapidly towards the next land market crash and
into deeper recessions than would otherwise be the case. Of equal or
even greater concern, I suggest, is the enormous amount of bank credit
utilized by investors to acquire income-producing properties - whether
individual residential properties leased to tenants, apartment
buildings, or office towers. The prices paid over the last few years
for these properties has been well above the cost to service debt,
management and maintenance expenses, based on existing revenue
streams. It is one thing if investors are putting their own financial
reserves at risk. It is quite another thing if banks are supporting
these transactions with high levels of credit. An important - and
unknown - variable is how the banks are establishing appraised values
for these properties. Are they using data on comparable sales, or are
they using a capitalization of the actual income stream? If they are
using the latter valuation method and also requiring purchasers to
make a significant equity contribution, the potential for a widespread
crash is lessened; and, if it does occur, the number of resulting bank
failures would be far lower than in the past.
With regard to that portion of the residential housing market
involving owners of primary residences, the U.S. experience is that
homeowners will continue for some years to make mortgage payments even
when housing values fall below their level of outstanding mortgage
debt. The most important variable is employment. Prolonged
unemployment triggers default and foreclosure for those who have
purchased homes with financing as structured by the secondary market
investors - Fannie Mae and Freddie Mac. Default rates are much higher
for mortgage loans made by lenders utilizing criteria established by
the Federal Housing Administration. Banking deregulation has resulted
in the creation of international super-banking entities that compete
aggressively for market share in the United States, Britain and
elsewhere. They have formed mortgage banking subsidiaries charged with
generating transaction-related revenue rather than whole loan assets
subject to interest rate and credit risks. Depending on the interest
rate environment (and investor expectations of the direction of future
"yields"), mortgage loans are then sold into the secondary
market directly or pooled as collateral for "mortgage-backed
securities," sold to individual, institutional, corporate and
government investors. A mortgage-backed security is nothing more than
an amortizing bond. Mortgage companies take in an origination fee and
charge the investor a monthly fee for servicing the loan. Investors
mitigate their own risk by requiring borrowers who make a down payment
of less than 20 percent of the purchase price to pay for private
mortgage insurance. Thus, if the borrower defaults and foreclosure
results in a loss, the mortgage insurer absorbs most of the loss.
Defaults on conventional mortgage loans are historically low and have
remained so for the last decade. On the other hand, defaults on
government-insured mortgage loans have always been high and continue
to be high.
For those who read Fred's book and begin to ask themselves what
action to take, if any, to protect themselves from the coming bust,
the decision is one of timing. The stresses on our economies created
by land rent privatization are real. The social democracies have
constructed an elaborate complex of agencies and programs to respond -
without thought of permanent solution -- to the consequences of
entrenched socio-political arrangements. Will these externalities
delay the inevitable or help to bring about a soft landing, as many
housing analysts have been forecasting? We do not have that long to
wait.
FOOTNOTES AND REFERENCES
Except where otherwise noted, all
quotations referenced are from Boom Bust: House Prices, Banking
and the Depression of 2010, by Fred Harrison (London:
Shepheard-Walwyn Publishers Ltd., 2005).
[1] x
[2] 21
[3] 25
[4] 25
[5] 34
[6] 35
[7] 50-51
[8] 55
[9] 62
[10] 66-67
[11] 109
[12] 109
[13] 111
[14] 116
[15] 122
[16] 131
[17] 135
[18] 135
[19] 143
[20] 143
[21] Greg Palast. "The globalizer who came in from the cold,"
The Observer, London, 10 October, 2001. [22] 164
[23] 169
[24] Henry George. Protection Or Free Trade (New York: Robert
Schalkenbach edition, 1980. Originally published 1886), p.331 [25] 208
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