Transcript An Austrian Analysis of Real Estate

The Business Cycle:
causes and remedies
Fred E. Foldvary
Dept. of Economics,
Santa Clara University
22 July 2010
Georg Wilhelm Friedrich Hegel:
Nations and governments
have never learned anything
from history.
Philosophy of History, introduction
The factors of production
• Land: all natural resources, including
space.
• Labor: human exertion that seeks to
create wealth (goods and services).
• Capital goods: goods which have
been produced but not yet consumed.
• Economic investment: capital goods.
The time-structure of capital goods
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Real estate development
New factories
Machines, durable goods
Crops
Inventory in stores
Food in your refrigerator
Time preference
• The tendency of most people
most of the time to prefer goods
in the present day to goods in the
future. Life is uncertain and short.
• The rate at which future goods
become discounted becomes the
natural free-market interest rate.
The role of interest
The interest rate has important jobs
in the economy:
• Equalize borrowing and savings
• Equalize savings and investment
• Allocate spending between
consumption and investment.
The distortion of interest
• Manipulations by a central bank
prevent interest from doing its job.
• Pushing down the interest rate
creates unsustainable and wasted
economic investment.
• Result: inflation, recession
The real estate boom
• When the central bank expands
the money, the interest rate is
pushed below its natural rate.
• The credit expansion fuels a
boom, especially the purchase
and construction of real estate.
Excessive expansion of money
• The manipulated interest rate falls.
• More investment in long-lasting
capital goods, especially real estate.
• These turn out to be bad investments
when interest rates go back up.
• Not just inflation, but also a change of
relative prices, a wasteful distortion.
The boom-bust cycle
Real estate the major player
• Real-estate construction is a major portion
of economic investment.
• Artificially low interest rates induce a
construction boom.
• Low rates also create land speculation.
• Land values rise beyond the point at which
enterprises can make a profit after paying
for rent or mortgages. The most optimistic
speculators get a winner’s curse.
U.S.: Fannie and Freddie
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Fannie Mae and Freddie Mac,
government-sponsored enterprises
buy mortgages from originators
government guaranteed
subsidize real estate, land values
generate real estate derivatives
Public Works:
the Mother of all Interventions
• Much of the value of land comes from
public works and services, paid for by
taxes on labor and capital goods.
• Adam Smith noted that "Every
improvement in the circumstances of
society tends either directly or indirectly to
raise the real rent of land,
to increase the wealth of the landlord."
The land-value subsidy
* Public works and civic services
increase the value of land.
* Little of this is paid from property
taxes specifically on land.
* So these public goods get
capitalized as higher land value
and more rent.
The US real estate cycle
land value
construction
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interval
interval
• 1818
---• 1836
18
1836 -• 1854
18
1856 20
• 1872
18
1871 15
• 1890
18
1892 21
• 1907
17
1909 17
• 1925
18
1925 16
• 1973
48
1972 47
• 1979
6
1978
6
• 1989
10
1986
8
• 2005
16
2005 19
start of depression
interval
1819
-1837
18
1857
20
1873
16
1893
20
1918
25
1929
11
1973
44
1980
7
1990
10
2008!
18!
High interest rates
and high prices
for real estate
choke off new investment.
Malinvestment falls
• The unsustainable bad investments
(malinvestments) slow down and stop.
• The collapse of economic investment
causes the rest of the economy to plunge.
• Workers in construction and other real
estate lose their jobs.
• Loans default, banks fail, the financial
system crashes.
Result: the financial waterfall
The fiscal and monetary remedy
for depressions
• The elimination of the business cycle
requires the elimination of the real
estate boom-bust cycle.
• This can be accomplished by the
provision of public goods by private
communities.
• That eliminates the implicit subsidy to
landowners.
Public Goods are effectively
provided by private enterprise by
tapping the generated site rent.
Fred Foldvary, 1994
Public Goods and Private Communities
• Market success providing public
goods, in theory and in practice.
• Demand is revealed by rent.
• No free riders: users pay rent.
• Land trusts, condominiums,
residential associations.
Private Communities
• Landowners pay for the public goods
that service their area.
• No subsidy.
• No speculative land-value boom.
• No financial crisis.
• Government can privatize or else
copy what private communities do.
Fiscal remedy
• The public goods provided by government
generate land rent.
• The collection of this rent by government
prevents the subsidy to landowners.
• The price of land falls to a small amount.
• This removes the gains from excessive
land speculation.
• A tax on land value has no excess burden.
The financial side
• To prevent the boom-bust sequence,
we also have to fix the financial side.
• The remedy for credit manipulation is
free-market money and banking
(free banking) with competitive private
bank notes.
* Provides flexibility and stability.
Free banking
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George Selgin,
The Theory of Free Banking
http://oll.libertyfund.org/title/2307
There is a base money such as gold,
and private bank notes are
convertible into gold.
No more depressions!
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Private communities, free banking.
Or, the public collection of rent.
No imposed costs, no subsidies,
Stop the fiscal and monetary subsidy
to investment and land value, and the
business cycle will go away.
• No more boom and bust!