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Savings & Loan Crisis of the 80's

Michael Hudson: The Lies of the Land: How and why land gets undervalued

As noted, the anomaly occurs when real estate prices fall. Real estate prices are volatile, while construction costs rarely dip more than slightly, if at all. When real estate prices turn down, they often plunge below the reproduction cost of buildings. Hence, the residual ("land") rises and falls much more sharply than do building replacement costs (which are estimated as rising at a fairly steady pace) and overall property values.

The result is a curious asymmetry. Building prices seem to be responsible for the rise in real estate prices, while land prices are held responsible for their decline. When the fall in property values intersects the rising reproduction-cost trend, the land residual turns negative.

Because this land value often represents the owner's equity, this decline may prompt heavily indebted owners to default on their loans or even to walk away from their property, which reverts to the bank or other mortgage holder. In this sense the financial system itself is based largely on real estate, as the economy learned in the savings and loan (S&L) deposit insurance crisis of the late 1980s. Real estate prices reflect the supply of property (including a fixed supply of land) as compared with the fluctuating supply of mortgage credit, which tends to be a function of the economy's overall liquidity.  Read the whole article

Mason Gaffney:   Privatizing Land Without Giveaway (1990)

Credit follows collateral. In periods of high and rising land prices, borrowers get used to pledging land to secure loans, and lenders get used to demanding it. Socializing land rent, as proposed herein, lowers or eliminates the value of land as loan collateral.

On the good side, this lack of land collateral would stop lenders' discriminating in favor of landowners, as they do now. It would remove a major cause of the concentration of economic power and control, that is the clustering of credit around original nuclei of large, superior landholdings. The credit is often used to buy still more land, to reserve for possible future use and at the same time to withhold from competitors. Such concentration and market control form the ugly side of extant Western "capitalism," when enterprise degenerates into greed and acquisitions supplant innovations.

As Rainer Schikele wrote, "the basis of credit is not marginal productivity but collateral security." He meant that lenders are concerned not with the productive use of their loans, but with the security provided by borrowers' ownership of old wealth.

As Keynes put it in his General Theory, there are two kinds of risks: investment risk proper, and lender's risk. "Investment risk" depends on the productivity of new capital; "lenders' risk" depends on borrowers' old collateral, like land. The social purpose of investing is to create capital; the individual purpose is to buy income with security. The second purpose leads lenders to lend to the rich in preference to the productive. The principles are at odds; the productivity principle is clearly better from the viewpoint of basic micro efficiency.

The marginal productivity basis of lending is also better in terms of macro stability. Flows of credit dominated by cycles in the land market are highly unstable. The current S&L calamity in the U.S. exemplifies and should settle the point. It has many precedents, going back at least to the Dutch Tulip Bubble of 1634 and the French-English Mississippi and South Sea Bubbles of 1720. The rule has been that following each collapse the hung-over lenders woke up penitent. Reacting to the excesses they adopted something like the English Banking School philosophy of avoiding real estate loans and sticking with self-liquidating commercial loans, only to fall off the wagon in the next land boom, repeating the cycle. How easily one generation forgets the hard lessons life taught the one before. "When will they ever learn?"

In the absence of land booms, however, bankers would have to stay on the wagon. On the bad side, low land prices raise new problems of how to transfer funds to builders. If the free market is to provide ample flows of investment, the credit system must adjust to life without land values. Actually, however, it has often done so anyway, following the periodic collapses of land markets such as those already cited, plus those of 1798, 1819, 1837, 1857, 1873, 1893, and 1929, to mention only the extreme cases. In those periods of atonement credit systems worked quite well without depending on real estate as collateral. We would be much better off to keep them working that way permanently.

Many particular lenders practice the arts of lending without land collateral. Factoring inventories is a thriving business. Building on leased land is commonplace, with both private lessors like the Wrigley Company of Catalina Island and the Irvine Company of Orange County, California; and public lessors like the Crown Provincial of British Columbia, the County of Los Angeles, The Port of San Francisco, the State of Alaska, and countless others. Chattel mortgages are common, secured by movable capital. Even construction loans are secured mainly by capital, not land, because new buildings normally outvalue their sites, even on dear land and more so on cheap land. Some developers borrow on the security of signed leases.

As credit follows collateral, so it flees taxes. The policy proposed here is not just to tax land, but to untax capital, and untax profits drawn from skill in management, and untax wages and salaries generally. That which is less taxed becomes more creditworthy. The flow of credit will turn away from those with accumulated wealth and monopoly towards those with skill and daring to use it better. The result is to make capitalism work as advertised, not in the decadent way as charged.... read the whole article


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Wealth and Want
... because democracy alone hasn't yet led to a society in which all can prosper