Bubble

The Georgist economic proposal insists on the primary importance of land as a factor in the economy. Many people dismiss that as a quaint, agrarian notion. "Perhaps," they scoff, "land was that significant back when most people had to work the soil for a living, but modern agriculture has moved far past that! Nowadays we deal with modern issues of technology, global markets, information -- land is no longer a big deal."
10. There's no place to dump your trash for free. ...
9. Scratch a financial crisis, find a real estate bubble. ...
8. Information (like railroads) needs routes. ...
7. Cities can no longer afford to be inefficient. ...
6. Global climate change is too likely to ignore. ...
5. The loss of biological diversity cannot be reversed. ...
4. Two out of every five people lack a safe and dependable source of drinking water. ...
3. The myth of overpopulation causes cultural sickness. ...
2. We have forgotten what nations are. ...
1. "The land shall not be sold forever, for ye are strangers and sojourners with Me." ...

YOU MAY THINK the largest category of assets in this countrly is industrial plant and machinery. In fact the US Federal Reserve Board's annual balance sheet shows real estate to be the economy's largest asset, two-thirds of America's wealth and more than 60 percent of that in land, depending on the assessment method.

This price appreciation is actually a "land gain", that is, it's not from providing start-up capital for new enterprises, but from sitting on a rising asset already in place, the land. Its value rises because neighbourhoods are upgraded, mortgage money is ample, and rezoning is favorable from farmland on the outskirts of cities to gentrification of the core to create high-income residential developments. The potential capital gain can be huge. That's why developers are willing to pay their mortgage lenders so much of their rent income, often all of it.

Of course, investing most surplus income and wealth in land has been going on ever since antiquity, and also pledging one's land for debt ("mortgaging the homestead") that often led to its forfeiture to creditors or to forced sale under distress conditions. Today borrowing against land is a path to getting rich -- before the land bubble bursts. As economies have grown richer, most of their surplus is still being spent acquiring real property, both for prestige and because its flow of rental income grows as society's prosperity grows. That's why lenders find real estate to be the collateral of choice.

Most new entries into the Forbes or Fortune lists of the richest men consist of real estate billionaires, or individuals coming from the fuels and minerals industries or natural monopolies. Those who have not inherited family fortunes have gained their wealth by borrowing money to buy assets that have soared in value. Land may not be a factor of production, but it enables its owners to assert claims of ownership and obligation, i.e., rentier income in the forms of rent and interest. ...

THE DRIVING FORCE behind the anomalies is the political lobbying eager to depict real estate gains simply as "protecting capital from inflation." In reality, it helps land owners and their creditors get a free ride out of land asset-price inflation -- that is, The Bubble. ...

In sum, just as real estate lending fuels land speculation, so the withdrawal of such credit leaves property markets to decline, sometimes with a crash, as occurred in Japan after 1990 when its financial bubble burst. Should this rise and fall be attributed to buildings or to land? It seems to me that inasmuch as the price rise and fall is homogeneous, applying to parking lots as well as to skyscrapers, we should attribute it to land. This achieves the logical symmetry of applying to the downturns as well as upturns in the real estate cycle.

One clear sign of land-price inflation is that one category of land rises or falls much more rapidly than others. A widening disparity usually reflects a financial inflation. In Japan, for instance, high rates of saving were recycled to a remarkable extent into construction and real estate acquisition. Japanese authorities produced detailed land-value statistics for each category of land, showing property values during the Bubble years 1985-90 rising at an accelerating pace until 1991, and then turning downward. The A-shaped rise and fall was steepest for the most expensive land surrounding the Tokyo palace, while land for single-story wooden residential housing rose and fell least steeply. A land-value map placing the highest values at the center and the lowest values in the outlying areas would tend to reflect a land-price bubble when price ratios steepened. On the other hand, a fairly level set of land values between the central city and its outskirts would indicate relatively less rent of location, and hence less land-value disparities. Using this analogy to examine New York City's midtown area, the steep land-value curve has been fed by credit as affluent buyers sought the most prestigious locations. Land sites have become the receptacle of the economy's surplus savings. ...

REAL ESTATE LOBBIES recognize that what is not seen is less likely to be taxed. What is not quantified for public policy-makers to see clearly may avoid taxes, leaving property owners with a larger after-tax return. They prefer land-residual's capital gains statistics at the national level, even as individual investors seek site-value gains at the local level.

This explains the seeming irony that investors in an industry dealing primarily with the development of land sites have campaigned to minimize the statistical treatment of land. Relegating land to merely secondary status enables the real estate industry to depict its "capital" gains as resulting from cost inflation and hence the reproduction costs of buildings -- whose value is allowed to be depreciated and re-depreciated at rising values over time. The free lunch of land-price gains is unseen as attention is diverted from the real estate bubble and land-price inflation to building costs. These fiscal considerations help to explain why it has been so hard to get Washington to produce national land value statistics. ...

THE FREE LUNCH:
Its cost to citizens
The recycling of savings into new mortgage lending has fueled an economy-wide inflation of asset prices for land, homes, and commercial properties, as well as stock market and bond prices. If what rises in value is mainly the land site, then the property owners appear as passive beneficiaries enjoying a free lunch. The property is their major asset and the mortgage their major debt. While doing little to increase the value of the building beyond having picked a good location and making the normal maintenance, they ride the crest of asset-price inflation of land . Indeed, take-home earnings have drifted down over the past two decades, but house prices have soared.

These "capital gains" for households are part of the new phenomenon that has been popularized as "labor capitalism." As Margaret Thatcher's crowd has put it, "Sorry you've lost your job; I hope you've made a killing on your Council House or home in the real estate market." The free lunch.

For the two-thirds of America's and Britain's populations who are home owners, this free lunch from asset-price inflation of land has proved to be a silver lining in the post-industrial economy. For the remaining third of the population, however, the price of access to home ownership is receding rapidly. Today it hardly is possible for most renters to earn the money to acquire their own homes. The entry price has been bid up too high by those hoping to gain from asset-price inflation even as labor's earnings have been declining.

Its cost to the economy
Once a building has taken all its depreciation, investors have a tax motive to sell the property and buy another. The sales price obviously will be higher if the new buyer can begin depreciating the building all over again, for the property will yield more after-tax revenue. This financial trick turns the real estate sector into a game of musical chairs, while enabling property owners to avoid income taxation. The end result is to free more of their cash flow to pledge to mortgage lenders as interest, in exchange for loans to buy more and more property that is rising in price. This is the anatomy of the dramatic increase in land-prices, called the real estate bubble. The tragedy of modern economies is this divergence of saving away from financing new direct investment and employment, to inflate a financial and real estate bubble. When the bubble bursts there will be little new tangible wealth creation to show for it, only a wave of insolvency, bankruptcy and foreclosures as the Western economies begin to look more like that of Japan since its bubble burst a decade ago. America's and Europe's largest economic expansion may similarly give way to a long depression. Its cause will remain invisible as long as the politically powerful real estate interests keep getting land undevalued and its income masked as capital gains on the national income and product accounts.

SUMMARY

For hundreds of years property's value has been calculated by discounting its flow of rental income at the going rate of interest. The lower the interest rate, the higher the price a given rental stream will justify -- or as property owners express it, the more years' rent a property will bring. What is so striking about land values today is that they are rising for reasons independent of their earnings stream. The major new consideration is their prospect for future "capital" (that is, land-price) gains. In sum, the ultimate aim of real estate investors no longer is so much to seek income -- most of which is pledged to their bankers as interest payments on the property they acquire -- as much as to seek property gains. Politically opportunites abound. Merely changing zoning in New York City in the 1980s to allow using commercial loft spaces for residential purposes had the effect of multiplying asset values five or tenfold.

Whether the gains come from selling the property or from borrowing more money against it, the essential phenomenon is the rapid growth in asset values and real estate's uniquely favored tax treatment. That's why investors choose real estate instead of bonds or stocks, and much of the strategy underlying corporate takeovers has followed the strategies they developed over the past half century.

Nationwide the capital-gains dimension needs to be incorporated into the rental revenue statistics to measure real estate's total returns. This sector's nearly complete success in escaping the tax collector has placed an enormous tax burden on everyone else. Read the whole article

What’s bubbling, and until when?

Sellers are happy. So are developers and speculators. Real estate has gone all bubbly, and that bubble has gone ballistic. What goes up, however, must soon do something else. ...

Actually, it’s not housing whose price has entered the stratosphere. Buildings age – get older, more worn out. What’s getting more valuable is the land, the location – whether it has a building on it or not. Buildings you can make more of, but land you can not, especially locations along the coasts or on the good side of town. None of that would matter if you could ever get buildings to hover around in the air. Meanwhile however, speculators are happy.

... What’s seemingly good for landowners is not necessarily good for the economy. As people spend more on land, something nobody produced, they spend less on output, things people do produce. As producers get less money spent on their products, eventually they take the hint and produce less. "Produce less" is another way of spelling recession.

Plus, more expensive land means heavier borrowing to buy it. More debt means more inflation and less stability. When producers cut back, borrowers have a much harder time paying back their debts. As people go bankrupt, they drag others down with them. A collapsing house of cards is another way of spelling depression.

Preventing bubbles?

If land values didn’t get inflated, of course they would not have to get deflated.Call it mutual compensation for deprivation from part of our common natural heritage. While in rhythmic systems, prices must rise and fall, but they need not boom then bust; they could climb then glide. What would temper economies, preventing bubbles? Rather than let a few lucky owners collect land values, neighbors would have to recover land values for themselves. Nobody made land, and no lone owner made its value; the presence of society in general did that. Plus, for excluding everyone else from their sites, owners owe everyone else, as each one of us owes everyone for excluding them.

To recover land value, government could either transform the property tax into a land tax or replace it and other taxes with land dues or land use fees or an annual deed fee. ...

To pay the land dues, owners use their land efficiently; owners who had been speculating get busy and develop. No longer allowed to tax anything that moves, local governments, too, which presently let acres of abandoned urban land and buildings lie fallow, get busy, too, and make sure to get those acres into the hands of ambitious owners who’ll pay land dues. More locations put to use and more buildings put up increases supply, which dampens price.

Better still, as government recovers land rent, that leaves owners with less land rent to capitalize into land price. Hence buyers need not borrow so much. ...

Land would still rise in value. With every discovery of a nearby natural resource. With the opening of every new bridge. With every techno-advance, as silicon wafers did for Silicon Valley. With every jump in income and drop in crime, land value rises. But no longer into a bubble. Because every rise would find its way – via land dues and rent dividends – into everyone’s pockets. ...

If the 18-year average holds for this cycle, then real estate still has a few more years of sucking all the investments and purchasing power out of the rest of the economy. Land is still able to soak it all up, and lenders are still willing to pump more in. So despite the premature panic (markets almost never do what everybody says they’re going to do), Mankiw’s 2007 would be the earliest that the current bubble would burst, and 2008 is just as likely.

Then land prices will fall for a few years. Since the run-up was steep, the drop will be, too – after correcting for inflation, maybe as much as 50%. Which will be an enormous relief for the economy – just what the doctor ordered. With land affordable again, a new cycle can get under way. Whether the new one will be boom and bust or climb and glide is up to us, whether we’re willing to practice geonomics, to forego taxes and subsidies in favor of land dues and a Citizens Dividend.

While I don’t mind the current gambling, I do mind the widening of the cavernous gulf between haves and have-nots, and I boil over while workweek grows more onerous, and just seethe watching vacant lots and abandoned buildings push development out from urban cores to sprawl on suburban farmland. To reverse that, let’s let go of the individual owner’s hold on land rent and share Earth’s worth equitably among us all. We’ll all be glad we did. ... Read the whole article

Failure to collect land rent leads to speculation and the resulting boom-bust economic cycles that are so destructive to the general economy.67 Henry George in Progress and Poverty (Bk V, Ch1) identified the "speculative advance of land values" as the "great initiatory cause of industrial depressions." Economic cycles can be linked to just about every downturn over the course of two centuries, the more so as the economy has come to be monetized. Frederick Lewis Allen, the great journalist gives a compelling account of how the Florida land boom (and later bust) antedated the Great Depression.68 More recently a similar speculative bubble explains the Asian economic crash, particularly in Thailand.69 When the Japanese economy was at its peak, the value of land in Tokyo alone exceeded that of the entire United States, and the appraised land value under the Imperial Palace was as great as all the real estate in California.70 The most convincing study of the relationship between land value cycles and more general economic cycles is one done for Australia by a contemporary Georgist economist.71 There are some students of the American economy that believe that we are the cusp of a crash in land values that have been bid up over decades, and that this could well precipitate a market downturn that could be long-enduring. 72... read the whole article

We surely agree with Roberts et al. that domestic capital formation is a crying current need; and the means is to foster saving and investing (but properly defined, as below). We also agree there is a strong, bi-partisan case for raising investment flows of the income-creating, work-activating kind. Here, however, we meet the problem of distinguishing new capital from old assets, especially land.

Land is not formed, like capital, by saving and investment; land is not reproducible. For that very reason land tends to appreciate, and therefore has to be a major source of what are misleadingly called "capital" gains. Again for that very reason, there is no supply-side kick in untaxing gains. Most of them are land gains, and should be called that. To use land as a store of value is macro-economically unproductive at best, and on balance counterproductive and destabilizing (considering its effect on financial institutions like the S&Ls).

To handle this matter we need two semantic distinctions which often are lost in the word-fencing of debate. Walter Heller, whose policies still enjoy bi-partisan support, thought and spoke in a Keynesian framework where "investment" means "investing," an affirmative, job-making action. It is a process, not a store of value; an economic flow, not a fund. It is not the asset held: this "investment" is a noun, macro-economically static and sterile. [Land may appreciate, and one may call this "investment," but the appreciation employs no one and creates no new wealth (although it may reflect the externalities of wealth created by others).]

To signalize these differences I use the present participle "investing," rather than the ambiguous noun "investment." [Webster's 9th New Collegiate defines investment both ways: it is an action, (the Keynesian usage); it is also an asset being held, a store of value. Such a two-faced word is a natural medium for double-talk, and has been so exploited, to the detriment of general understanding.]

Every Keynesian also knew in 1961 that investment means net, positive-sum investing. It does not include buying and selling existing assets like land: these are zero-sum transactions, macro-economically non-functional and barren. [Keynes, although careless of consistency, generally took care to distinguish old and new assets. " ... the competition of a high interest-rate on mortgages may well have had the same effect in retarding the growth of wealth from current investment in newly produced capital-assets as high interest rates on long-term debts ... " [General Theory, 1936, p. 241.] The old macro-economists generally refer to investing in newly produced assets as "income- creating expenditure," which is clear and correct, but too much of a mouthful.]

I use "investing" only in the sense of net, income-creating, job-making spending. [Note the difference between real turnover and mere ownership turnover. Ownership turnover generates no income (except for brokers and M&A personnel) and creates no capital. Real turnover also creates no capital, but does forward supplies of goods to consume, and flows of investing to produce replacement goods. Most of gross investing is reinvesting funds received or anticipated from sales of old capital (including inventories, which turn fast, and "fixed" capital which turns slowly as it depreciates and the funds are reinvested).]

As to borrowing on land, that can be worse than barren when the financial system rises and falls on a land bubble, as it has and is. ... read the whole article

... In our economy, land is a ready object of speculation, and its value is constantly reflecting this evil. What happens in a rising market, the up side of a business cycle, is that investors see rising prices in land as indicative of a boom. Thereupon, they try to increase their holdings in such land, only to discover that their present returns will not pay for the present costs of land; the current price of land is not based on what the yield of that land is today, but on what it is projected to be two or three years from now. The difference tends to increase until a point is reached where the imarginal buyer of land suddenly finds himself unable to meet the rising costs to which he has subjected himself. With bankruptcy threatening him or having already been forced upon him, the land passes from his hands, and the market temporarily becomes overpriced. The bankruptcies increase, and ultimately land values are brought back to levels which represent current productivity, at which point the new boom will have started. ... read the whole essay

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