A Real Estate Fueled Boom

Recently, economist Michael Hudson visited Vancouver to speak on the issue of housing and the ‘Junk Economics‘ (the title of his most recent book) behind our apparent good times.  The substance of his observations is presented in a readable article in this week’s Common Ground.  Hudson spoke at an event sponsored by the Centre For Policy Alternatives.

At the risk of misrepresenting him, these are the key insights that I take from what I have read.  Notably, the analysis is not particular to Vancouver, Hudson clearly sees the real estate ‘debt’ model for economic growth as being a feature of our North American economy generally.

  • Most real estate investment is based upon the investor deriving earnings from capital gains; rent collected from occupants is only used to service debt and cover operating costs.
  • Lenders feed the investment by providing mortgages based upon ‘predictable’ rents from residents and assumed increases in the value of the underlying asset.
  • Lenders benefit by the increasing values, and the consequential demand for loans upon refinancing.
  • To ensure the system does not stumble (‘bust’), incremental changes are introduced to ensure borrowers qualify; for example the acceptable percentage of household income used to service mortgage debt goes from 25% to 30% to 35%, down-payments are reduced from 25% to 20%, unqualified borrowers are given government guarantees, the maximum amortization periods for mortgage loans is increased for 25 years to 30 years, to 35 years.
  • Huge amounts of income are ignored for tax purposes;  these include capital gains on a principal residence and select tax dodges available to developers.
  • Banks collect handsome returns, and bankers pay themselves well.
  • Debts accumulate (banks portfolios grow) far faster than the economy generally, and more and more household earnings are diverted to servicing debt; leaving other parts on the economy to shrink – retail, hospitality, etc.
  • The distorted real estate based economic growth hits a wall, the borrowers are ‘maxed out’.
  • Contraction in other sectors triggers income stresses in some households and delinquency on some mortgages.
  • Loan defaults grow in numbers the banks suffer losses, and property values decline so that the security on loans may become questionable.
  • Government is forced to intervene to ‘backstop’ banks.  In 2008, the US decided that the cost was to be covered by taxpayers – principally working people who pay a disproportionate share of taxes.
  • The property owning class accumulates great earnings (net of modest losses upon the crash), renters are ‘disinherited’ because they get no share of the capital gains over time, and the resulting burden is unfairly borne by workers, the young, immigrants, and renters (substantially, those who may not benefit from parents who saw a big gain in the value of their homes). We have two distinct ‘wealth’ classes.

Hudson notes that the debt fueled cycle is nurtured by tax policy, regulatory policy, and the self-interests of the FIRE sector (finance, insurance, and real estate).  The FIRE sector has substantial influence (with our money) in the political arena.  The FIRE sector will push the ‘good times’ for as long as possible, but the bust will come.  How the cost is distributed is subject to political action and debate.  The ‘correction’ is not really that; it is not simply a matter of markets doing their ‘magic’, it is a game – a debt based model of development – through which some bankers can become very wealthy.

Image from Common Ground May 2017



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