Our land and houses based monetary standard
The monetary statistics are to quite some extent based upon the balance sheets of a particular kind of banks: the Monetary Financial Institutions (MFI’s). These banks have the legal right to accept debts which you emit and to use this as a collateral to create money legal tender. What a remarkable (and profitable) privilege do these ‘MFI’s’ have! But why should they accept your debt? Your debt is their (profitable) asset and the MFI’s of course want this asset to be save! Well, they create and lend money because they trust you. Especially when you borrow for house and land purchase and emit a mortgage based debt (table). The single largest kind of money creating debt are mortgages (table, credit to households is largely mortgage debt). It’s not completely bonkers to state that we, to an extent, have a kind of monetary ‘housing standard’. And we bail out banks instead of households when the value of land and houses goes down, unemployment goes up and households can’t pay their mortgage anymore. Weird. The lender and the borrower created the money together and the best thing to do when the value of the collateral goes down is to bail them out, together, for instance by printing vouchers which households can use to pay down (part of?) the debt. We really have to learn to talk about save debts, instead of save assets, households have balance sheets, too (as shown in the modern national accounts). These really should become part of the monetary statistics. And no. Using such vouchers won’t make the banks forego interest income – the households can’t pay anyway.
By the way – who is the legal owner of this newly created money? I’m not sure if this is the bank.
“The best thing to do when the value of the collateral goes down is to bail them out, together…” Nonsense.
Bailing out banks equals a subsidy of entities that are supposed to be commercially viable. Why do taxpayers have to subsidise banks? Why do they have to subsidise idiots who have borrowed too much? There is no excuse for that.
The “best thing” (to use your phrase) is to outlaw the Ponzi scheme that banks have run for centuries: promising to return to depositors the exact sum deposited while investing their money in loans or investments that can fall dramatically in value. And that is easily done by forcing depositors who want their money loaned on to bear the cost when it all goes wrong. In contrast, depositors who want 100% safety have their money lodged in a 100% safe way: e.g. at the central bank where it will earn little or no interest.
The latter system is called “full reserve banking”. Let’s go for it. For more details, read Laurence Kotlikoff’s works. Or see here:
http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf
Dear Ralph, I agree with you about the Ponzi financing. My remark about bailing out the banks is however a little more subtle than you might think. It is about shrinking the balance sheets of banks and households. Using vouchers to bail out indebted house owners means that (at least part) of the debt disappears, as a debt from the household balance sheets and as an asset from the bank balance sheet. These vouchers are not legal tender and will loose their value after having been used. The banks can’t trade them for legal tender – which is not any problem because the money used to finance the debts was created ‘out of thin air’ anyway and is not the property of the bank (they are part of the liability side of the balance sheet!). The loss for the banks is not money foregone but interest foregone – but as the debtors have increasing problems to pay this interest anyway (one can consult the sites of the Irish of the Spanish central banks) this interest is in fact foregone already. What we are doing at the moment, however, is bailing out the banks with huge amounts of money – without redeeming debts. We’re i.e. not shrinking the balance sheets of the banks but propping them up.
Hi Merijnknil,
I don’t think that shrinking the bank industry is an end in itself. However, a more rational banking industry would I think be smaller than the current one (basically because the current one is subsidised). I actually had a letter in the Financial Times the other day saying just that:
http://www.ft.com/cms/s/0/b18bfe1a-5b29-11e2-8ccc-00144feab49a.html
Also I’m not keen on your way of doing the “shrinking”, which is essentially a debt jubilee. There are two problems with jubilees. First, do we forgive the debt of those who have incurred million dollar mortgages so as to enable them to buy five million dollar houses? I think not. Second, take two typical people on slightly below average incomes. One might decide to rent, and the other might buy a house with the assistance of a mortgage (say a 100% mortgage). Along comes the jubilee and hey presto: the latter person is effectively given a house, while the former gains nothing. That doesn’t seem fair to me.
To summarise, I suggest we just remove all subsidies currently enjoyed by banks. The bank industry will then in time automatically contract a bit.
Bank nationalisation has been used too as an alternative to amalgamating a failing bank with another ‘going concern’. This latter preserves bad loans & other junk paper, whereas balance sheets are sunk with the former. Recapitalization is the second purpose of nationalisation. When the bank is salvaged it becomes a commercial venture again. Past experience I read, may permit the state to break even.
There are many aspects of the U.S. (and other nations) monetary systems that have contributed to periodic economic crises. In my view, the last time the world experienced non-inflationary economic activity was during the early decades of the Bank of Amsterdram. During this period the Bank served as a deposit bank and not a lending institution. The global currency (the bank-issued certificates of deposit) were fully backed by gold specie and bullion. While such a full reserve system may be impractical today (as well as environmentally destructive and a senseless diversion of resources for mining, refining, minting and storage of precious metals), allowing privately-owned central banks to issue currency at their whim and at interest has proven to be extremely volatile and corrupting.
That said, the banks as lending institutions affect property markets in one largely unrecognized way: they provide leverage that allows expanding affordability to be capitalized into higher and higher land prices. Land markets are prone to hoarding and speculation because of the very low effective rate of taxation imposed on land holdings. Thus, when credit is cheap and readily available as it was during the last 20 years up to 2007, land prices skyrocket upward putting enormous stress on affordability for those seeking homeownership or even apartments, and on the profit margins of businesses that lease space or are trying to acquire land or facilities to expand production or other activities.
Where is the outrage at the unearned profits that accrue to owners of land, as they profit from their speculations or the holding of land off the market for decades, thereby driving up the price of land made available for development?
The longer term cure for our cyclical instability is to look to the potential rental value of land in all its forms as the primary source of public revenue. As the political economists all understood (going back to Cantillon) taxing ground rents removes the profitability of investing in land for speculation purposes. Land price increases would no longer drive the business cycle.
An immediate change in regulation that should be pursued is to prohibit any financial institution that accepts publicly insured deposits from extending credit for the purchase of land or accepting land as collateral for borrowing. This one measure would go along way to protect the bankers from themselves and the taxpayer from the bankers. And, land markets would be denied an important source of fuel for their speculative fires.
Housing is a basic human need and is part of the real economy, yet economists fail to explain it or offer solutions to the problems its supply poses.
I would encourage anyone who strives for understanding to substitute “residential property” for “housing” in every context. As I am sure you agree, Carol, the property crashes that have occurred and are building to collapse are triggered by the collapse of the speculation-driven land markets. When the market (i.e., resale) value of a housing unit falls below its replacement cost less depreciation, this is a clear indication that the property market is no long functioning (i.e., is in disequilibrium).
Not just housing, rather anything that has value which has a price.
Because with the use of “CREDIT EXPANSION” the price can dramatically change (bubble)
and then burst (read since credit is not “god”, it can default).
The above proposal is very similar to the proposal that Steve Keen put forward as a modern debt jubilee. In some ways, I prefer Keen’s proposal as he advises providing funds to savers as well as debtors. A reminder that ordinary savers have lost out, not just debtors. I think a debt jubilee would be a popular proposal with many citizens. The banks would fight tooth and nail against this proposal, however, as those running the show still think they can have their cake (debt) and eat it too (interest on debt). It is pretty clear by events over the last 4 or 5 years that governments are here to serve the banks, not the people.
Re: land tax – I don’t see that the two propositions – land tax and debt jubilee are incompatable, both would be good. The debt jubilee is a one off solution to the crisis, and the land tax would be a more permanent solution to the FIRE sector’s rapacious greed.
It’s about time general commentators and the press recognize our debt-based privately issued monetary system instead of propagating the fiction still found in textbooks that it’s central bank money multiplied ten times by fractional reserve. Private banks issue M1 and M0 follows, not the opposite.
As soon a we widely recognize this it becomes obvious that allowing the MFIs to issue the monetary instrument and also recognize mortgages paid by the same instrument as assets creates a cycle and should not be allowed. It’s like allowing a bank to use gold as collateral but also issue currency for the express purpose of buying gold. Well duh. Of course that will create a bubble then.
One or the other part of the cycle has to be broken.Either take money creation out of the hands of commercial banks and give it back to central banks/treasuries (which would give governments free seignorage revenue to match GDP growth) or withdraw the guarantee on M1. Cash deposits would be limited by M0 and people would have to put substantial savings in a fund that can go down in value.
# Ralph,
I understand your objections and the short blogpost here is surely not a detailed plan. But at this moment a rapdily growing number of unemployed people evicted from their houses still have to pay back mortgages which the banks already wrote off and for which the banks received tens of billions of aid. It is time for a change in our thinking about debt – remember, these debts concern newly created money which inflated house prices! It’s not (repeat: not) the case that the banks will loose out on money when vouchers are used to redeem the debts, though they will use future interest income. But on this, see the Pavlos comment. By the way – bailing out evicted households who already lost their houses is far from radical and revolutionary, letting them pay debts which were inflated anyway to banks that are already bailed out and which are already in possession of the houses of the evicted households is radical and in a literal sense revolutionary in the sense that ‘ownership’ of the assets of a society, in this case houses, is changed not by transaction but by usurpation, rapidly destroying the social and economic fabric of our society. Yes, the banks are at this moment the true revolutionary, upsetting force in our society. But you’re right that I think that a more general debt jubilee is warranted, to prevent this kind of revolutionary turmoil.
WHAT IF……The Feds were to ” QE 4 the people” Purchase all the assets, that which are residential real estate and modify those loans as assumable mortgages at 2% for 36 years.
If commercial real estate loans were included, the purchase could be as high as $100 trillion.
What would be the consequenced of “QE 4 The People”
It would take away from the private for profit banks a revenue of $5.5 trillion a year for 36 years. A punishment that is well deserved. But more important, it could reduce federal income taxes to zero as well as FICA to zero since that “revenue” shall be turned over to the US Treasury to be used as appropriations by Congress.
HOW CAN YOU READ THIS AND NOT INVESTIGATE? Why do you not want prosperity for yourselves and your children?
The ‘good news’ (ie what UK government policy is pushing for) is that the private sector in the UK is showing signs of releveraging over the last 3 quarters. Financial sector debt levels are up, households are up, but non-financials haven’t moved much since 2011 Q3. This is an extremely worrying trend in a country that saw, at its peak, a debt to GDP ratio of around 456% in the private sector. I guess the UK government thinks more private sector debt equals a healthy economy. How stupid can you get?
See Neil Wilsons figures (based on ONS data). http://www.3spoken.co.uk/2012/12/uk-sectoral-balances-and-private-debt.html