Why is a house important to my economy?

Another way of looking at how the 2008 banking crash happened

honestaphronesis

How did the crash in 2008 happen?

The complexity of the system makes dialogue on the subject difficult but we will try to describe what happened that resulted in the housing and financial crisis by focusing on the key players.

( When you see a link it’s there to offer more information and sometimes links to an explanation of other important parts of the system.)

Player 1: A teacher named Paul gets married to Phillipa in the summer. They decide after the honeymoon a house is needed as the family is growing so they apply and are granted after much paper work a mortgage for a house in a leafy suburb an hour outside the city. The house is worth just 1 million but Paul and Phillipa are both working teachers and have a joint yearly income of 75000. Phillipa works out that with yearly repayments of 20000 it will take them 50+ years…

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Steve Keen responds to a recent blog from Paul Krugman.  He paraphrases Paul Krugman’s post as:

No need for change, boys and girls: main­stream eco­nom­ics has every­thing under con­trol. We missed the cri­sis just because we failed to observe the shenani­gans in the shadow bank­ing sys­tem. Once we realised our obser­va­tional errors, we had all the nec­es­sary tools and knew what to do (oh, and what the rebels said would hap­pen didn’t any­way, so there!). The sta­tus quo is fine: move along folks, noth­ing to see here…

For a more complete look at the arguments (and the full blog from Paul Krugman) go to the full Australian Business Spectator article Why Krugman needs a new school of thought

Debt is a bad thing – HIRC

I may have coined a FLA (four letter acronym) in my white paper.  “HIRC” is short for “Highly indebted Rich Country.”

Greece  –     is the answer to the obvious question (what country is a HIRC?).

How did it get that way?

If I have understood the situation properly – the government spent money it did not have in the expectation that this would generate an economic upturn which would increase government revenues to pay for the spending.  This is the recommended response advocated by economists such as Keynes and followed by Gordon Brown and others following the global financial crisis of 2008.

Another way of describing this policy is “spend now and pay later” and is the opposite of the austerity measures being used by the current UK government in dealing with UK debt.

A particular problem that Greece faces is that it is within the Eurozone which means that it cannot realign its national currency to reflect its poor status – it does not have a national currency but is tied to stronger economies such as Germany and France.  As a result, the only way it is allowed to deal with the problem is the sort of austerity budgetting we are seeing in the UK.  And austerity bugdetting is not popular because it means fewer state-funded jobs, which means higher unemployment and therefore lower living standards.

Could this situation have been avoided?

Under my proposal that commercial debt is outlawed, governments would not be able to issue debt so, yes, this particular problem could not have arisen.

The big question is can governments operate without the flexibility that borrowing gives them.  Should Keynesian solutions be allowed to governments?

And if governments cannot borrow, how are cash flows managed?  The UK cycle involves payments going out throughout the year but a large proportion of tax revenues (income and corporation tax) coming in in January.  Would we need to change tax payment dates?  Or change the fiscal year so that the largest inflow of money came in at the start of the and set an automatic limit on what could be spent?

 

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Keen on mortgages

The day before my post on house borrowing, Steve Keen posted this article.  In summary he is saying that in Australia there is a much closer link between the availablility of finance and house prices (his view) than between earnings and house prices (the main view held before the global debt crisis.

I have linked to his summary blog – if you want more detail he links through to a more detailed article in the Australian Business Spectator, which includes more figures and graphs.

Debt is a bad thing – but what about mortgages

If I have understood the situation correctly, one of the root causes of the global financial crisis was to do with house lending (which is what I will call mortgages in this post).  I have added a separate post explaining how.

If we are to get rid of commercial debt, this will include mortgage lending.

So the question is what effect will this have.

I do not support the government’s Help to buy scheme because in my view it perpetuates the problem of inflating house prices by making borrowing too easy.  However, I do recognise that people do want to buy houses.

By taking away the ability to borrow to buy houses, house prices will go down.

Lower prices will mean that people will (at least to start with) feel poorer, because they no longer have the same equity in their houses.  And initially there may be problems over negative equity (owing more on the mortgage than the value of the property).

But my plan of phasing out commercial lending over an extended period (probably set at the length of the longest commercial debt plus a little) should mean that, when the day comes, mortgages will already be a thing of the past.   Over that period the mortgage should have been repaid anyway.

House-building companies with large land banks may find it more difficult to make a profit.  But again the time taken to phase out commercial lending should provide a period to come to terms with a new way of operating.  As with private landowners, the biggest problem might be negative equity – if the land bank is financed by significant borrowing.  This is going to be more difficult than private borrowing as the finance is short-term rather than long-term which means that the drop in value will need to be dealt with sooner.  This could lead to company failures so is there a need for some form of government support?

Might landlords have a similar problem?  They should not as borrowings should be covered by rental income, but a fall in the underlying property value might create problems with some lenders.

Looking at the situation positively, lower house prices will mean that they are more affordable for everyone.

And in the long term, the absolute price of a house is meaningless.  What is more important is the ability to buy and sell – and pay a higher price if you are moving “up” the market or withdrawing money to spend on something else if you are moving “down” market.

THE BIG QUESTION

Is there something we would need to do to replace mortgages?  This is a really difficult question and I have not come up with a workable answer.  I have tried to imagine a system of “instalment payments” being available to house-buyers but the mechanism seems to be far too complicated.

If someone has an idea please post it here so I can incorporate it in my white paper.  I will check all posts before they appear on the site so I can keep it anonymous if you tell me to.

The problem with mortgages

As I understand it the problem with mortgages which lead to the global financial crisis was not that people were borrowing money on mortgage.

The mortgages themselves were “high risk” – the amount lent was very high compared to the value of the property and the people who were borrowing had poorly paid jobs, which meant they were less likely to be repaid in full – but that was not the problem either.

The problem was that the mortgages were wrapped up as a package to be sold on to other banks – but that was not the problem.

The problem was that the package was rated as “lower risk” by the clever people who work out risk for financial institutions.

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Why the US can’t escape Minsky

Steve Keen’s view of debt is that, now that we are moving out of recession, we are setting ourselves up for another crisis.  We need to rethink international debt instead of doing it all the same way – or we will end up with the same answer,

Here is how his article starts:

My call a few weeks ago that the global financial crisis is over was very much an Anglo-centric one, and a US-centric one in particular (Closing the door on the GFC, March 10).

Europe’s continuing own goal from the euro and austerity, and credit excesses in emerging economies, could still derail a global recovery. But the epicentre of the crisis was the US, and the indications are solid there that this particular ‘Minsky moment‘ is behind it.

It might be felt that Minsky is irrelevant, now that the economy has begun its recovery from this crisis. But in fact this period — in the immediate aftermath to a crisis, when the economy is growing once more, and debt levels are only just starting to rise — is precisely the point from which Minsky developed his explanation of economic cycles.

In his own words: “The natural starting place for analysing the relation between debt and income is to take an economy with a cyclical past that is now doing well.

Debt is a bad thing – personal debt

My grandfather was a milkman.  My mother (the milkman’s daughter) was very cautious about money and my father still is.  I remember when the bank sent us a credit card through the post and my father cut it up.  He had not asked for it and he did not want it.

I was taught that buying goods on hire purchase was buying on the “never never” and was something we should never do.

I now have 2 credit cards which I use regularly and have had for years.  When I bought my second car I took out a bank loan (please dont tell my father).  My first car was so cheap you couldnt borrow that little!

When I went to university I got a grant and came out debt free.  My children had to take out student loans.  Most students these days also end up with large overdrafts.

When I finished at university I chose what job I wanted.  I was chatting to a barman the other evening and he said that he had just finished his degree and that jobs were hard to come by.

Why am I saying all this?  Because it shows how the world has changed over a relatively short period of time – within my memory.

In particular attitudes to debt appear to have changed radically.  My mother’s background was to be careful with money.  Today’s attitudes seem to be “borrow now pay later” and TV adverts are now offering “payday” loans with interest rates measured in thousands of percent compared to a bank base rate of only ½%.

This must be a bad thing because politicians are talking about what they should do about it – should they introduce a limit on interest rates which can be charged.

If my idea of introducing a ban on commercial lending is brought in, then all payday loans, credit cards and other forms of debt will be outlawed.  This will remove the problem of high interest debt, but will it create other problems?

I can see that there are reasons why people may want to borrow – a crisis when the car breaks down perhaps.  So the big question is – can we come up with alternatives?  Or are there circumstances when only a commercial loan will do?

So please comment on the sorts of circumstances when money is needed (and might now be borrowed) and what alternatives you can think of to commercial lending.