Review of the Book

Boom Bust: House Prices, Banking
and the Depression of 2010,

by Fred Harrison

Edward J. Dodson

[June 2005]

For more than a century now, colleges and universities around the world have awarded doctorate degrees in economics. And yet, economics was described by one of its members as the "dismal science" because of the apparent inability to explain with any certainty what is happening in the world and why. Theories continue to compete with one another for dominance among economics professors. Most seriously, to the extent the public policy recommendations of economists have been followed, they have failed to solve the most serious "economic" problems plaguing every society - widespread generational poverty and the recurring impact of the business cycle.

Socialists, supported by the interpretation of political economy provided by Karl Marx, hoped to solve these problems by state ownership and management of "the means of production." Instead, "state socialism" proved to foster corruption and bureaucratic elitism, while destroying individual initiative. In the "social-democracies," several generations of economists pursued the type of training required to assist businesses penetrate and secure markets, respond to competitive pressures and lobby government for privileges and subsidies. In the era before John Maynard Keynes, the economists concentrated on monetary and credit questions -- such as the need for "gold" to back national currencies, the virtues of fixed versus floating exchange rates, and to what extent banks should be required to hold reserves to protect against runs by fearful depositors. Keynes recommended that government create new powers over the economy designed to mitigate the highs and lows of the business cycle. With Keynes came the era of "demand management" and the "mixed economy." Others followed with their particular insights and policy recommendations: the monetarists, the supply-siders, and the rational expectationists.

In a paper I wrote back in 2003 titled "Pseudo-Scientific Economics: The Business Cycle and a Neo-Classical 'Mystery'," I expanded on the criticisms of economics and economists offered in two books published in 1994. The first book, The Corruption of Economics, examined the development of economics as a weapon in the arsensal of vested interests determined to protect privileges they enjoyed under existing socio-political arrangements. This book was co-authored by economics professor Mason Gaffney (University of California, Riverside) and Fred Harrison, a London-based economics writer. The second book, Lost Prophets, came from the former economics editor of the Wall Street Journal, Alfred L. Malabre, Jr. In this book, Malabre essentially detailed the failures of economists from Keynes on without making any connection with the arguments raised by Gaffney and Harrison.

Fred Harrison now offers us Boom Bust: House Prices, Banking and The Depression of 2010, published as a direct challenge to conventional economic wisdom and the policies currently guiding the economies of Britain, the United States and other developed nations.

What I have to say about this book is less a review than an addendum. Over the last few years, I sent to Fred a continuous stream of data and analyses on the U.S. economy and responded to his requests for specific information. I have few arguments with his presentation of the causes of the business cycle and the measures he states are required to achieve sustained economic growth as well as the full employment society. The historical record affirms his observation that "[s]elf-censorship has damaged governance to the point where central bankers and finance ministers have imposed on us a crude tool of economic management - the rate of interest, the cost of borrowing money."[1] Our political leaders have given central bankers and finance ministers little choice, however, by repeatedly reducing the amount of public revenue raised from those whose personal wealth is derived from activities that produce neither goods nor services. In the United States and in Britain, the trend over the last quarter century has been to greatly reduce the portion of tax revenue coming from the highest marginal incomes and the estates of the wealthiest citizens. Fred's book examines the history of how this has occurred and warns that the list of victims is about to become even longer:

"The failure to eliminate or control the business cycle, despite repeated attempts to do so, suggests that the received wisdoms do not lead governments to remedies that work. A second reason is that economics, as it is employed today, is seriously prejudiced by the dilution of some of its key concepts. Economists routinely work with economic models that treat the world as if it were composed of two factors - labor and capital - instead of the three-factor model favoured by the classical economists. This disembodies the economy from its spatial context. That, especially when we are concerned with the impact of the housing market on people's lives, creates analytical problems. For land is the key piece of the jigsaw that is the complex economy."[2]

What then follows is the historical evidence Fred has brought together from researchers who either failed to grasp the importance of their own compiled data or were ignored because their findings conflicted with conventional wisdom. "The need for the long-term perspective is crucial," he writes, "for we are dealing with events that recur time and again."[3] Therefore, the causes must be the same across time and for different regional and national economies:

"If the business cycle is characterized by a pattern that is regular in its periodicity and scale, the probability is that we are searching for a single, or a very few related, causes, and that those causes are embedded in the foundations of the system."[4]

However, to examine the system's socio-political foundations is a task most economics professors have decided is outside the scope of their work. Challenging the status quo belongs in the realm of the political philosopher and moralist, not the economist. And yet, virtually every government (and almost every agency within government) has economists on staff charged with gathering and analyzing data, evaluating existing public policies, and - at least at the higher levels - recommending policies they believe will move their society in the direction of stated political objectives. Fred reminds us that the classical political economists approached the world in what we would today call an interdisciplinary manner. Many were not at all averse to advancing moral arguments to defend or attack the status quo. What they all agreed on was that nature (i.e. in the language of the political economist, land) functioned as a unique factor in the production of wealth. As Harrison reminds readers, land and land markets are very different from labor and capital goods and the markets for these two other factors of production:

"The land market - where the supply of the raw material is in fixed supply - has the characteristics of a natural monopoly. Contrast this with the markets for labour, capital and consumer goods, where - if prices and profits rise - the supply is increased and prices and profits return to their competitive levels."[5]

He might have also pointed out that land has a zero cost in terms of labor and capital goods. Land exists independent of labor and capital. While the supply of land may not be absolutely inelastic (i.e., the supply curve for land appearing vertical on an economic chart with "price" on the vertical axis and "quantity" on the horizontal axis), the near-inelasticity of the supply of land in any market is part of the equation. As land prices have increased over time, we have become remarkably adept at more intensive use of locations in order to maximize the ratio between revenue generated and costs incurred.

New building methods and technologies have made the high-rise office building the norm in cities and even most suburban business districts where land costs are a major component of the costs of doing business. Before many civic leaders introduced codes to protect the historic quality of residential neighborhoods adjacent to or within downtown business districts, many dwellings were demolished and replaced by huge apartment buildings or condominiums. In a sense, this type of land-intensive development creates locations by taking advantage of air space. Even so, almost every new residential building contains what are termed "studio" or "efficiency" units to meet the need (and demand) for housing that is affordable to people with a range of household incomes.

One of Fred's insights regarding the present is that, "[f]or most people the occupation of smaller spaces is not a lifestyle choice; it is a survival response to the prospect of becoming homeless."[6] In city neighborhoods close to restaurants, shops, museums, theatres and other amenities, the trade-off between living space and convenience might be a lifestyle choice. However, for millions of families whose incomes are falling or are unstable, the choice may be living with relatives, in housing of marginal quality, or becoming homeless.

In the United States, we have experienced a continuing expansion in the size of our metropolitan regions. Somewhat unexpectedly, new "edge cities" have developed with their own sizeable employment base, stimulating even more spread out residential and retail development into what until recently were rural and thinly-populated parts of the region. Total population in the metropolitan areas is often stable, or even declining, but people are spreading out further and further from the historical center. Initially, this migration of people left many cities with emptying downtowns and many decaying residential neighborhoods. That trend now seems to be reversing itself. A combination of demographic, lifestyle and political factors are bringing higher income households and real estate developers back into the cities.

Three of the original reasons why suburban communities blossomed in the first place - low land prices, minimal local taxes, and newly-constructed affordable housing - are things of the past. As city neighborhoods are cleared of decaying and abandoned buildings, the opportunity to reshape city landscapes with amenity-laden housing choices is a powerful magnet for re-population of our urban centers. For much of the duration of the business cycle, those who profit most from all of this development are those who have control over land:

"The land market is a giant sponge. It soaks up the value that is not taken by people in the labour and capital markets. The speed and the scope by which revenue is transformed into net income (that is, after paying for the use of labour and capital) and paid as rent to the owners of land and natural resources depends on particular circumstances."[7]

Economists refer to these "particular circumstances" as externalities. What gives even the least doctrinaire analyst headaches is the complex web of externalities that must be considered in any economic analysis or forecast of the future. One such externality is the absence of up-to-date and complete data on land markets. Economists cannot analyze what they do not have. Yet, as Fred has documented, several generations of economics professors have simply accepted on blind faith the wisdom of those who wrote land out of the economic textbooks. As economic theorists retreated early in the twentieth century to the safety of the two-factor model, their success denied students with the theoretical mandate to ensure data on land markets was pursued. The results, he concludes, have been catastrophic:

"[E]conomic theory, as it is applied by its practitioners, fails to treat rental income as the economy's pressure gauge. As a consequence, the mightiest economies periodically collapse into a mess because the experts at the steering wheel turn Nelsonian blind eyes to the vital information that is registered on that gauge."[8]

The needle on today's gauge is well into the danger zone. A clear indication is what Fred refers to as "the tragedy of house price trends that [are] eclipsing people's ability to afford shelter for their families; of progress with poverty."[9] In the United States, there are still many parts of the nation where land prices have not yet driven the majority of renters out of the housing market. The problem is the greatest in the coastal cities. Housing prices have been and are continuing to increase wherever the population and employment are reasonably stable. The response to higher housing prices by financial institutions and investors in mortgage loans has been to reduce the need for savings in order to purchase a home. Borrowing 100 percent of the purchase price is no longer unusual. Funds to cover transaction costs frequently come from a combination of gifts from family members and either grants or forgivable loans from government agencies or foundations. Millions of existing homeowners have borrowed against the "equity" in their homes to obtain cash for needed repairs, for the costs of college for their children, to cover uninsured medical expenses, and - in the worst cases - to provide needed cash to live on during periods of prolonged unemployment. A huge market has developed for "reverse mortgages" that supplement the monthly income of seniors in return for housing equity. Many elderly homeowners and the financially naïve are being victimized by "predatory" loan terms that make it almost impossible to repay the debt incurred. Thousands and thousands of homeowners have lost their homes to foreclosure after defaulting on these second or third mortgage loans. With notable exceptions, state and federal government agencies have been slow to respond to this crisis.

An added externality has re-emerged in the United States to worry those of us who have resisted becoming economic "true believers." After a brief period of stability, the national debt incurred by the U.S. government has skyrocketed under Republican Party stewardship. When President Bush leaves office at the end of 2006, the national debt is likely to exceed $10 trillion. If the average rate of interest paid to bondholders is just 5 percent, the U.S. government will need to raise $500 billion each year just to service this debt. How this revenue will be raised and who is holding all of this debt is - or ought to be - a subject of primary importance to U.S. citizens. As housing costs - whether rents for apartment units or the monthly cost of ownership (i.e., mortgage payments, plus escrows for property insurance and taxes, and utility costs) - continue to rise, household savings for the bottom half of the population are fast disappearing. Escalating property taxes are actually forcing households living on fixed incomes to sell their homes and move to other communities, competing with other low-income households for a dwindling stock of available affordable housing. In the face of this reality, those supposedly in charge of economic policy have sent out the message that all is well and that people should not be overly concerned. In the United States, these messages continue to come from Alan Greenspan, long-time Chairman of the Federal Reserve System:

"The Greenspan model of the economy was fatally flawed because it excluded the one variable that featured in every boom bust over the past 200 years in the United States: the land market. In every significant economic collapse, the central operating mechanism was the land market. People experienced the helter-skelter prices through the value of their homes. But according to Greenspan, in congressional testimony to a House of Representatives Committee: 'The type of underlying conditions that create bubbles are very difficult to initiate in the housing market'. In fact, far from fearing the inflation of residential assets, he was confident that robust gains in this sector would offset the weakening effect of a declining stock market on the nation's consumption habits. In that testimony on Capitol Hill, the one man on whom a nation relied for economic wisdom betrayed a cavalier attitude that would guarantee the destruction of people's hard-earned wealth."[10]

If Fred's analysis is correct, age-old dynamics will overcome the illusion of "the New Economy." He reminds readers that land markets arose as the control over land was gradually privatized by Old World monarchies more in need of hard currency than the pledge of loyalty from grateful land barons. Commerce in land made possible the speculative acquisition and holding of land for resale rather than improvement. Thus began the business cycle, at the center of which was a cyclical land market characterized by frequent recessionary crashes - and sometimes depressionary collapses. "This review of the historical evidence confirms the theory that economic activity is most fruitfully analysed in terms of 18 year segments,"[11] writes Fred. There is no secret to the nature of this cycle. All one needs is a clear understanding of what motivates our behavior:

"The periodicity is linked to the construction cycle, which is shaped by the financial mechanisms and the pursuit of windfall gains from the rents of land and nature's resources."[12]

These same observations for a very long time have been made by a small group of writers trained in economics, individuals such as Harry Gunnison Brown in the U.S., who fought against the trend in their field to write "land" out of economics by declaring that land, labor and capital are inputs without distinction to the productive process, and that the markets for land, labor and capital are each subject to "the price mechanism" (i.e., the supply of each factor will be offered for use at a price determined by competitive forces). The fact that land responds to increasing prices in a direction opposite to labor and capital is something land speculating investors rely on but the majority of economists have ignored. In the real world, as land prices increase, owners profit by reducing supply - by hoarding land in anticipation of even higher prices.

Some economists have even written favorably on the benefits of land speculation, suggesting that speculators hold land in reserve for high value development when the market justifies paying the price asked by the land owner. Neither Harry Gunnison Brown nor Fred Harrison would find this argument convincing. Whatever minimal benefit might appear to exist in individual cases, the impact of land speculation on a society's well-being is intensely destructive. Land speculation is the most entrenched form of "rent-seeking" behavior we endure and have been forced to endure since privatization nurtured the first land markets and the ability of land owners to capitalize land rent income into a selling price. Industrialization and the increased productivity of labor and capital merely intensified the economic and political power of land owners because not only was land ownership privatized but land rent as well. Fred's description of mid-nineteenth century Britain could be used to describe what occurred nearly everywhere and is occurring today in places such as India and China:

"Britain's burgeoning industrial centers needed investment in infrastructure, to make life tolerable for urban dwellers. An improvement in the quality of life, for which people were willing to work, would have increased their ability to generate even greater income. But that would also have raised the rents of land. This was a two-edged sword. If rental income was public revenue, it would have provided for resources to make communities more habitable. But because rent was privatized, its owners could extract wealth out of the working population and diminish the quality of their lives - for, instead, they had to bear the cost of public services out of taxes on their earned incomes."[13]

This perspective has always seemed to me to be perfect common sense. And yet, very few of my own professional colleagues working to revitalize communities or expand the supply of affordable housing grasped its significance. Those of us who completed one or more college level economics courses come away feeling there are so many variables involved in markets, in regional and national economies, and in the global economy that understanding what might happen and when is an impossibility. Given our capacity to capture market data for analysis using powerful computer software, the objective of economists - and policy analysts - ought to be to study all markets, and study land markets in particular.

A year or so ago, I engaged one of the economists on the research staff of the Federal Reserve Bank in Philadelphia in a conversation about why his economic model did not track land markets. His response was that he would love to have the data but it just was not being captured by anyone. This gap could be narrowed - at least where residential land values are concerned - if mortgage lenders and the appraisal industry would add this data element to what they capture during the mortgage loan approval process. The standard residential appraisal report assigns a separate value to property improvements and to the underlying land parcel. Delivering this information to a central repository for compilation and analysis would provide government, university and industry analysts with extremely valuable information on land market trends.

In the arena of public policy, we have abandoned any hope for solutions (i.e., for the economic nirvana of "full employment without inflation") and keep trying strategies of mitigation. And, as Fred concludes, the landed are more than content to put some of their resources at work in defense of the status quo:

"…to concede that damaging turning points in economic activity can be forecasted entails an obligation to change the rules of the game. Those who benefit from the current system would not favor such changes. Thus, it is convenient to conclude that we cannot anticipate the future."[14]

And yet, anticipating the future - and gambling on the accuracy of that anticipation - is what motivates a huge portion of the "investment" activity driving the markets for shares in newly-formed corporations. The opportunity to profit extravagantly has caused some people to put their entire savings at risk in the hands of what too often are unscrupulous manipulators. In describing two of the great historic economic "bubbles" - tulips in the 17th century and the "South Sea" scheme to monopolize trade in precious metals in the 18th century - Fred reminds us of how easily people are taken in by dreams of wealth without work. And, because "rent" remained almost exclusively privatized rather than captured for the public purposes, paying for government and infrastructure imposed heavy burdens of taxation on those actually producing goods and services. Weighed down by heavy land costs and heavy taxation, producers eventually find themselves unable to compete; the bubbles inevitably burst:

"The formula was unbelievably simple. You sell, today, company shares at prices that capitalize the future stream of rental income from natural resources. That rental income is securitized and traded on the stock exchanges, which at the time were in an embryonic form. An essential step was persuading prospective investors that the companies held the leases to valuable natural resources from which they would extract the rents. …"

"The trick was to capture the rents immediately. The laborious task of extracting and transporting the natural resources to market would take time. If investors could be persuaded that the companies would one day be profitable, they would buy the shares today at tomorrow's prices. That would enable the original speculators to take cash upfront and run. Shareholders would be left with the business of having to deliver a value to customers, if they wanted to recover their capital."[15]

Come forward to the late twentieth century and this first decade of the twenty-first and the big stories around the world have been the crash of Japanese land markets and the resulting bank failures, the large numbers of internet start-ups failing to produce a profit after raising millions from venture capitalists and others, and the long upward spiral in land prices in many regions of the world. As Fred Harrison warns us, neither the experts nor the politicians see in all of this any systemic problems. Despite the record of recurring periods of high unemployment - during which a large number of working families lose everything and increasingly end up homeless - we are told "booms and busts are characterized as the failures of frail individuals from business and politics."[16] In the financial services sector, where I spent nearly my entire professional life, these failures have been exacerbated by a complex legal, accounting and regulatory environment unable to adequately keep pace with the introduction of dubious "financial products" that have nothing to do with expanding the supply of material wealth and everything to do with tax loopholes and subsidies.

Detailing the history of how economics displaced political economy, how pseudo-science displaced science, Fred eventually gets to the role of John Maynard Keynes. Keynes, it turns out, was quite frank about his objectives in writing The General Theory on Employment, Interest and Money (1936). He stated with great certainty that "the Ricardian foundations of Marxism will be knocked away."[17] Marx, for all his clouded polemics, wrote in the tradition of political economy. On the land question, Marx said little that Richardo, Smith and Turgot had not already said (or Proudhon for that matter). What they all acknowledged as true and fundamental to an understanding of political economy Fred recaptures:

"Rent was the transfer of part of the income of the nation to people who, as land owners, added nothing to the sum total of wealth."[18]

Keynes closed his eyes to the historical record and even to the observable trends occurring during his own life. He had virtually nothing to say about land markets in any of his writings. Land had been important in the agrarian age, but Keynes accepted the idea that technological advances combined with financial innovations would continue to produce what people needed at lower and lower prices - regardless of what it cost to access land. Fred notes that Keynes totally ignored the rising prices for land in the world's great financial centers, apparently oblivious to the fact "that land is in fixed supply in the desired locations."[19] In the end, writes Fred, "Keynes' theory of how to maintain full employment converted governance into the art of perpetual crisis management rather than crisis resolution."[20] So much for Keynesian "demand management" embraced by U.S. economists such as Alvin Hansen, Paul Samuelson and a generation of theorists who looked to a combination of credit management, government spending and targeted subsidies to keep inflation and unemployment within tolerable political limits. Keynesians paid no more attention to the land question or to land markets than other Neo-Classical professors.

Not every economist over the last century has traveled down the two-factor road without voicing concern or opposition. I have already mentioned the name of Harry Gunnison Brown. However, the list of those who have held positions of significant influence over government policy is rather short. Joseph Stiglitz, Herman Daly and William Vickrey come to mind. From Stiglitz came the observation that "[u]surious rent is the cause of worldwide poverty." Interviewed upon winning the 2001 Nobel prize in economics, Stiglitz commented on his reasons for leaving the World Bank:

"If you challenge [land ownership], that would be a change in the power of the elites. That's not high on their agenda."[21]

Herman Daly added in a speech delivered at the World Bank in April of 2002:

"Rent is by definition a payment in excess of necessary supply price, and from the point of market efficiency is the least distorting source of public revenue."

Fred mentions another economist, Lawrence H. Summers, who served as Secretary of the Treasury in the Clinton administration. Although I can find no evidence that Summers has recognized the insufficiency of the two-factor economic model, he has at least acknowledged the serious shortcomings of the policy work performed by economists. A study he co-authored reported that nearly 70 percent of all wealth acquired by individuals in the United States over the first three-quarters of the twentieth century was inherited or transferred from one generation to the next, rather than earned by the recipients. This analysis directly challenges the idea that "America is the land of opportunity." Increasingly, opportunity in America is opportunity for fewer and fewer people. At the heart of the matter are what Fred describes as destructive "revenue-raising policies of government."[22] He calls for a new "Theory of Public Property" that recognizes "rent" for what it is - a claim on production that arises in the market due to aggregate public and private investment, independent of what the legal owner of locations in cities, natural resource-laden lands, the broadcast spectrum or the world's seas and seabeds does or does not to. Reason dictates, then, what I call a new "Labor and Capital Goods Theory of Private Property" under which legitimate claims to ownership require the expenditure of labor and/or the investment of capital goods.

Globalization has now reached the point where the flaws in existing socio-political arrangements expose us to previously unheard of risks. "The distinctive development, today," Fred writes, "is the synchronization of cycles into a single gigantic trend."[23] Until the mid-twentieth century, the Western hemisphere provided an essential safety valve for the migration of people and investment in productive capital. Despite intense speculation and widespread corruption, land costs were low enough to nurture the growth of new towns and cities. In the United States, there has always been a constant movement of people from one region to another in search of better opportunities. Today, states compete with one another to attract businesses by offering extensive subsidy packages. Often these packages include land assemblage and long-term tax abatements. Despite these measures, every year sees the departure of goods-producing jobs to China and other locations where very low labor costs, minimal environmental regulations, low taxes and - for the most part - lower land costs more than make up for the cost of transporting goods across the Pacific Ocean. Not unexpectedly, the businesses and workers directly impacted seek protection from what they perceive to be unfair competition (e.g., dumping of products at below production cost in order to drive domestic producers out of the market). Yet, as Henry George wrote more than a century ago:

"…that violation of natural rights which imposes tariff duties is inseparably linked with that violation of natural rights which compels the masses to pay tribute for the privilege of living. The one cannot be abolished without the other."[24]

George recognized that the benefits of commerce - of free trade between peoples - would emerge only when the land question was justly resolved. And, a just solution to the land question demands a new theory of public revenue. Nothing else will strike at the heart of the problem. None of the technological or financial innovations of the last half century have really changed fundamental economic and social relations. Social democracy has armed nations with mitigating safety nets, necessary to prevent political upheavals where out-migration of the disfranchised is no longer a viable option.

"The New Economy of the 1990s did not alter the historic trends. Millions of people in the richest nation on earth were institutionalized into poverty, and there was little they could do about it. The situation was similar in Europe."

"…The rules were functionally designed to mass produce social exclusion; rules with which no one had tried to tamper for more than 50 years. Transferring income between winners and losers had not worked, and something new was needed. Cross-pollinating two antithetical philosophies - socialism and capitalism - would merely perpetuate the history of failure."[25]

What Fred refers to here is the slogan of the "Third Way" championed by Britain's "new" Labour government and adopted by Bill Clinton during his Presidency. What these left-of-center politicians had come to appreciate during the Reagan-Thatcher experiment with a partial program of supply-side economics was that government must allow people to produce wealth in order to maximize employment while also raising enough revenue to preserve the social welfare state. Clinton was fortunate enough to take office just as the U.S. economy was poised to rebound - and its most competitive trading partner, Japan, was still absorbing the pains of a collapsed land market. Fueled by easy access to credit from Japanese banks, Japanese investors had driven up the price of land and commercial real estate well beyond a prudent capitalization of actual cash flows. As they defaulted on mortgage debt, the banks foreclosed and dumped these assets on the market. Many were sold at half the price originally paid - to wiser investors who had cashed out of the market and waited for what they were certain would be an inevitable result. Japanese workers and taxpayers absorbed the social costs.

One of the other great ironies of the Japanese economic story is the failure of Japan to provide decent, affordable housing for its growing population. For more than thirty years after the end of the Second World War, the Japanese contented themselves with rebuilding their nation's infrastructure with revenue raised from exported goods. The democratic institutions imposed on the Japanese during MacArthur's reign as military governor failed to solve the land question in Japan, although the number of land owners was more than doubled. Initially, this allowed farmers to keep all of their incomes from production rather than passing on a third or more to absentee landlords. However, as Japanese cities were rebuilt, the absence of an annual tax on the rental value of land created a new privileged class of landowners. Capitalization of rising land rents - fueled by credit - drove Japanese land prices up to the point where Japanese businesses were forced to move production facilities out of Japan in order to remain competitive. For the first time during the post-war era, unemployment faced Japanese workers. Elderly and poor Japanese without the support of family networks found themselves homeless. There are today in the neighborhood of 50,000 homeless Japanese, despite the fact that housing construction (now that land prices have dropped significantly) has been stable at more than 1 million units annually. Analysts report that the Japanese recession has not yet ended and that land prices have continued to decline across much of Japan. The insight is that Japan's land market remains fundamentally dysfunctional, so much so that its crash in 1990 has not yet worked its way to a market equilibrium under which Japanese producers can be competitive and profitable. Just how far out of equilibrium the Japanese land market had gone by 1990 is demonstrated by one almost unbelievable statistic: the land occupied by the Imperial Palace in the center of Tokyo had an estimated market value greater than all of the land in the entire state of California.

Throughout history banks have provided the credit to fuel speculative investment behavior. Thousands have paid the price when borrowers defaulted, insolvency occurred and they were forced to close their doors. Fred warns that the expansion of credit to marginally-qualified borrowers to purchase homes or refinance existing debt is pulling the major developed nations rapidly towards the next land market crash and into deeper recessions than would otherwise be the case. Of equal or even greater concern, I suggest, is the enormous amount of bank credit utilized by investors to acquire income-producing properties - whether individual residential properties leased to tenants, apartment buildings, or office towers. The prices paid over the last few years for these properties has been well above the cost to service debt, management and maintenance expenses, based on existing revenue streams. It is one thing if investors are putting their own financial reserves at risk. It is quite another thing if banks are supporting these transactions with high levels of credit. An important - and unknown - variable is how the banks are establishing appraised values for these properties. Are they using data on comparable sales, or are they using a capitalization of the actual income stream? If they are using the latter valuation method and also requiring purchasers to make a significant equity contribution, the potential for a widespread crash is lessened; and, if it does occur, the number of resulting bank failures would be far lower than in the past.

With regard to that portion of the residential housing market involving owners of primary residences, the U.S. experience is that homeowners will continue for some years to make mortgage payments even when housing values fall below their level of outstanding mortgage debt. The most important variable is employment. Prolonged unemployment triggers default and foreclosure for those who have purchased homes with financing as structured by the secondary market investors - Fannie Mae and Freddie Mac. Default rates are much higher for mortgage loans made by lenders utilizing criteria established by the Federal Housing Administration. Banking deregulation has resulted in the creation of international super-banking entities that compete aggressively for market share in the United States, Britain and elsewhere. They have formed mortgage banking subsidiaries charged with generating transaction-related revenue rather than whole loan assets subject to interest rate and credit risks. Depending on the interest rate environment (and investor expectations of the direction of future "yields"), mortgage loans are then sold into the secondary market directly or pooled as collateral for "mortgage-backed securities," sold to individual, institutional, corporate and government investors. A mortgage-backed security is nothing more than an amortizing bond. Mortgage companies take in an origination fee and charge the investor a monthly fee for servicing the loan. Investors mitigate their own risk by requiring borrowers who make a down payment of less than 20 percent of the purchase price to pay for private mortgage insurance. Thus, if the borrower defaults and foreclosure results in a loss, the mortgage insurer absorbs most of the loss. Defaults on conventional mortgage loans are historically low and have remained so for the last decade. On the other hand, defaults on government-insured mortgage loans have always been high and continue to be high.

For those who read Fred's book and begin to ask themselves what action to take, if any, to protect themselves from the coming bust, the decision is one of timing. The stresses on our economies created by land rent privatization are real. The social democracies have constructed an elaborate complex of agencies and programs to respond - without thought of permanent solution -- to the consequences of entrenched socio-political arrangements. Will these externalities delay the inevitable or help to bring about a soft landing, as many housing analysts have been forecasting? We do not have that long to wait.


Except where otherwise noted, all quotations referenced are from Boom Bust: House Prices, Banking and the Depression of 2010, by Fred Harrison (London: Shepheard-Walwyn Publishers Ltd., 2005).
[1] x
[2] 21
[3] 25
[4] 25
[5] 34
[6] 35
[7] 50-51
[8] 55
[9] 62
[10] 66-67
[11] 109
[12] 109
[13] 111
[14] 116
[15] 122
[16] 131
[17] 135
[18] 135
[19] 143
[20] 143
[21] Greg Palast. "The globalizer who came in from the cold," The Observer, London, 10 October, 2001. [22] 164
[23] 169
[24] Henry George. Protection Or Free Trade (New York: Robert Schalkenbach edition, 1980. Originally published 1886), p.331 [25] 208