YOU’VE GOT TO ACKNOWLEDGE THE PROBLEM IF YOU WANT TO FIX IT! (Originally Sun 1 Feb 2009)

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WORLD ECONOMIC FORUM – DAVOS

Early this  morning (Sunday), I listened as the BBC World Service featured a well-credentialled panel commenting on the World Economic Forum in Davos. Of course it was discussing the GFC. No one on the panel had a workable solution, as they hadn’t ‘seen the cat’, the real estate bubble that precedes every recession. This one, too, was apparently painted in camouflage against the background of the global economic meltdown.

Each of them nevertheless provided useful insights: Nouriel Roubini merited a congratulatory pat on the back for having called the downturn.  Laura Tyson, an advisor to Barack Obama, made sense when she said it’s pointless seeking scapegoats when there’s a systemic problem that needs to be urgently addressed. But no effective solution was provided, because participants wouldn’t get to the root cause of this unfolding economic depression.

They generally accepted that central banks failed us by not turning back the credit spigot before the real estate bubble began to develop. And, by golly, if we had our time over again we’d soon fix that! That’s nonsense, of course, because easy credit may have exacerbated the real estate bubble, but it certainly didn’t create it. It would have occurred even under a tighter credit regime – because that’s where the capital gains and tax advantages are to be found, the cost of money notwithstanding.

They skimmed over the real problem, our double standard on real estate monopoly and speculation. Although property bubbles precede and underpin virtually each and every crash, politicians know that many of us get a warm inner glow when the value of our property increases – so they’re not about to interfere by telling us there’s a line to be drawn in connection with rapidly escalating land prices: at least, until it self-corrects in a recession or depression. After all, a man’s house is his castle, right?

Real estate monopoly, speculation and rampantly escalating land price increases may only be condemned by politicians and economists after the event.  Even at that point nothing must be put into place to ensure that these events will never occur again!  Why not go for regulation and interest rates, instead?

It is not only politicians and economists who praise property price increases as one of the ‘benefits of home ownership’ while condemning the lack of affordable housing out the other side of their mouths. Most people have also now come to regard real estate as ‘private property’, and charges on the value thereof as something akin to blue murder.

Even the law used to distinguish freehold land from ‘private property’ (produced by individuals) and ‘quit rents’ paid on freehold titles. But our laws seem to have experienced a one hundred and eighty degree turnabout: black has become white, and both the monopoly of land and the pathology of the creation of bubbles in land prices is rarely questioned.

The vagaries of the role and responsibility of landholding, speculation and monopoly in modern society are compounded by the theory of real estate valuation having been written out of the study of economics so that we don’t become too condemnatory about the excesses of real estate markets. Devastating boom/bust cycles have come to be regarded as ‘the natural business cycle’ about which we can do nothing substantial – ‘cept the ever reliable ‘regulation’ and ‘central bank interest rate policy’, that is!

It is not generally understood that the value of a piece of real estate may be established by capitalizing its net rent at the yield (rate), indicated by the market. Were valuation theory widely understood, it would be known that a market return of 3% or often less (that is, greater than 33 years’ purchase) on residential property is entirely speculative at any location. It follows therefore that a bursting must necessarily follow such a bubble in the capitalised price in order for returns to resume commercial viability.

In valuing real estate over 38 years, I’ve noted that many real estate agents and valuers (assessors) will develop a feeling about an impending economic recession well before economists will. Whereas real estate professionals have some understanding of the theory of valuation, most economists don’t, because it’s no longer part of their neo-classical training. More than a few real estate people will have had an ironic guffaw at last week’s announcements from the IMF and Access Economics that economic growth might tail off during the course of 2009! That was some ‘prediction’!

Adam Smith’s once formidable Science of Political Economy has been reduced to the modern embarrassment, ‘Economics’. Chaos rules, as individuals and the various schools of economics drag out their latest ‘solution’ or the latest form of tax. Throughout this chaos, every government remains assured and confident that recovery is ‘ just around the corner’. Why, just look at all those stimulus packages they’re rolling out for us! None of them perceive that they’re slavishly following the ineffectual 1930s script.

But we can’t expect salvation from within the real estate industry.  As long as real estate professionals’ fees are based upon the value of properties with which they deal, they’re unlikely to blow the whistle on the destructive effects of real estate bubbles on the economy either.  You’d think that an ongoing healthy and vibrant real estate market would be more preferable to them than one characterised by repetitive boom and bust conditions. Valuers and real estate agents pose the defensive question whether it’s their role to second-guess our economic ‘experts’ anyway – and “our professional institutions shouldn’t get ‘political’ [read ‘honest’?] about real estate’s effects on the wider economy?”

Politicians, policymakers and theologians need to find the gumption to get out of the pockets of landed interests because the tax privileges dispensed to real estate monopoly and speculation have harmed societies since the days of ancient Rome. (Latifundia perdidere Italiam.)  Until they do so, the chances of remedying the current economic depression are zero. Taxing thrift and industry and inflating land price bubbles have created recessions and depressions over the millennia, and Fred Harrison’s “The Power in the Land” provides data confirming this thesis over the last two centuries . So, it’s beyond time, instead of sweeping the issue under the carpet, they acknowledged it.  From whence in their ranks shall emerge the next Richard Cobden, the next William Wilberforce?

Utilising land rent as an alternative to taxation – the one thing necessary for a swift recovery from the GFC – remained a remote possibility as I listened to the BBC’s expert panel in Davos this morning. They were still dutifully playing the game of avoiding the real problem.