from Merijn Knibbe
There seems to be a debate about why house prices in the USA rose (and fell). House prices did not only rise in the USA (table 1). An explanation for the rises can’t, therefore, be confined to the USA. An explanation also has to take into account that there were some countries were prices did not increase (Japan, South Korea, Germany). Rising household incomes do explain part of year to year changes but as real household income did hardly increase in the long term, it’s not a good explanator for long term increases.
Table 1. Real prices of houses, different countries, 1970-1974 = 100. Bank of International Settlement data spliced to deflated Eurostat data.
| |
1990-’94 |
2006 |
2010 |
| USA |
122 |
205 |
135 |
| GERMANY |
102 |
84 |
78 |
| GREAT BRITAIN |
152 |
318 |
318 |
| SPAIN |
199 |
363 |
350 |
| NETHERLANDS |
130 |
289 |
281 |
| SWEDEN |
86 |
144 |
167 |
| BELGIUM |
141 |
343 |
372 |
| DENMARK |
85 |
206 |
169 |
| NORWAY |
99 |
217 |
249 |
So, what caused the differences? Interest rates? These were low (and even lower) too in Germany and Japan. The IMF answer is, however, clear. Summarized: reckless lending. In IMF parlance:
” In the United States, Canada, and Australia, the share of the total household sector’s outstanding loans issued by nonbanking financial institutions (read: shadow banking, do not read: organisations like Fannie Mea and Freddie Mac, M.K.) had doubled by 2005 compared with the 1980s …. This shift was accompanied by the introduction of new mortgage instruments and easier lending policies, and all these changes contributed to the rapid growth of mortgage credit in these countries. By contrast, in some continental European countries (read: Germany and Italy, M.K.) and in Japan, the reform process was slower and/or less comprehensive…. public sector financialinstitutions (read: institutions like Fannie Mae and Freddie Mac, M.K.) continued to dominate the residential mortgage market in these countries, and this constrained the forces of competition: on average in these countries, nonbank financial institutions accounted for about 1 percent of total outstanding loans to the household sector in 2005 (up only slightly from the mid-1990s), compared with about 30 percent in the United States.”
The IMF report continues like this: the more deregulation, the higher the debt level. They do not call it ‘reckless lending’. I do. Why this difference? The IMF does not use the right variable to estimate the private debt level. The level of mortgage debt should, of course be expressed as a percentage of disposable household income (better even: of disposable house owning households income) instead of as a percentage of GDP, as the IMF does. Using the right variable, as the banks should have done and still should do, would often double the estimated total debt level, to percentages of 100% or even 200% of disposable income. That does feel reckless.
http://imf.org/external/pubs/ft/weo/2008/01/pdf/c3.pdf; http://www.huizenmarkt-zeepbel.nl/tag/merijn-knibbe/
Which goes to show you that numbers are just as much loaded with political/philosophical bias as words are.
The message depends on the numbers you choose and the assumptions they rest on.
In practice you choose the message first and then pick the numbers that support
that message.
For most of their history, banks were managed by people who understood the banking business to be that of an intermediary between lenders and borrowers. People who enjoyed incomes greater than their immediate needs deposited surplus cash with the bank. The bank created an account for the depositor and permitted the depositor to write checks against the account balance. The bank charged for this service when the depositor did not keep in the account an amount that enabled the bank to cover its own expenses by investing the cash elsewhere or making loans to borrowers. The bank would actually share its investment revenue by paying interest when the depositor agreed to open a savings account with more restricted access for withdrawal of funds. The bankers knew what their cost of funds was, knew what their expenses were to operate the bank, knew what market forces would permit as a profit margin, and charged borrowers interest accordingly.
What makes this rather straightforward model of the banking business more complicated is the process of evaluating risk. And, for bankers there are several important risks to consider. First, there is duration risk; that is, the risk that an unstable interest rate environment will jeopardize profit margins when rates on deposits are rising while rates on loan assets are not. Second, there is default risk, where the creditworthiness of a borrower has been incorrectly analyzed or has materially deteriorated while a loan is outstanding. And, third, there is business environment risk. To the extent possible, banks try to engage third parties to mitigate these risks, which adds another layer of complexity to the business model.
The current problem for banks of widespread defaults by borrowers who were given loans for the purchase of residential properties occurred because they ignored everything their predecessors had learned about risk. Instead, they accepted the dubious idea that government planners and central bankers had successfully developed the fiscal and monetary tools to achieve sustained economic conditions. And, they felt very protected by what almost everyone accepted as a positive economic indicator: rising property prices. With property as collateral for loans, losses due to defaults and foreclosures would be minimal or even non-existent. So confident were some bankers that they did not even require borrowers to pay for mortgage insurance when they could not make the traditional 20 percent down payment.
We are now in the midst of a global economic meltdown, and many banks are in danger of closing their doors. Failing to understand the cyclical nature of the land markets that drive property markets, they have watched helplessly as the value of their collateral has fallen and continued to fall. To save the surviving banks from themselves, this is an opportune time for new regulation that greatly restricts or prohibits banks whose depositors are protected by government insurance from accepting land as collateral for future loans. This one measure would remove a significant portion of the accelerant from the next credit-fueled upward movement in the land market cycle.
But also; GDP per head in US doubled between 1960 and 2005, but wages only increased by 15%. What hapenned to the rest? Figures from Australia show that while the share of wages decresed, the share of taxation and rent increased, enormously.
My bet is that it was the same in USA. The information revolution has only rewarded a few. Now these few, holding rents, do not need much of it to live on,
so they invest in assets. The asset prices rose. The banks climbed on the band wagon, their best clients needed credit to buy land.
So the root cause of the asset price hike is the mal-distribution of the result of work. The only way to correct this is to apply the principles of Henry George, and finance the state from rental values, which we all create. Then taxation becomes not needed. The reward for work is the product of work.