Bank Profits and House Prices
So, here’s a starter for ten. What’s the connection between the ANZ Bank’s recently announced $655 million half-yearly profit and the growing crisis of housing unaffordability in Auckland?
It’s a question that is rarely asked. All sorts of answers are proffered to explain Auckland’s housing crisis, but almost all are answers to the wrong questions. No one bothers to ask the obvious and central question – where does the money to fund the rise and rise in house prices actually come from?
Instead, the explanations offered generally reflect the political prejudices of those providing them. The government is anxious to blame a shortage of supply and – since this failure of the supposedly infallible market to achieve equilibrium cannot be admitted – it must be attributed to “rigidities” that prevent the market from operating properly.
Those “rigidities” can easily, it seems, be identified. They arise, it is argued, because of local government bureaucracy and the requirements of the Resource Management Act. The answer is to remove these impediments and free up more land so that private developers can build more houses for profit.
This supposed remedy has the great advantage of not only cutting local government down to size, but also of providing valuable profit-making opportunities to the government’s supporters in property development.
The Opposition agrees that market failure and a shortage of supply are to blame and that the remedy is to build more houses; but, instead of waiting for property developers to sniff out profit-making opportunities, their answer is to use the power of government, both central and local, to ensure that the required houses are built at affordable prices.
Yet others take a more technical and less political approach, pointing to failures in planning and transport policy and bemoaning the irrationality of waiting for the “free market” to do its irresponsible and inadequate best to resolve the problems.
Most are agreed that those problems are the result of market failure. No one, it seems, bothers to ask whether the housing market is really just another market, operating according to the normal laws of supply and demand or whether, on the contrary, it doesn’t exhibit such unusual characteristics as to make it completely atypical.
The housing market is, after all, like no other. The asset that is traded provides an essential element of life and valuable utility – a place to live. It retains and often increases its value over generations, rather than – as with most commodities – being consumed or otherwise losing value with the passage of time.
Most importantly, it involves an asset for whose purchase many people are able to command resources far in excess of their purchasing power in respect of any other commodity. Today’s house prices could not have reached anything remotely like their current level if it were not for the fact that purchasers are able to raise large sums on mortgage, secured by the assurance that – when they come to sell (or the bank forecloses) – other purchasers will be able to do likewise.
The constant availability of mortgage finance at ever-increasing levels is, in other words, the central element in the structure of house prices. And we get closer to understanding the problem when we recall the hugely significant change that occurred three decades ago in the way mortgage finance was provided.
Up until that point, mortgage finance was largely provided by building societies – mutual societies which relied for the funds they lent for house purchase on the savings provided to them by their members. But in the 1980s, the building societies demutualised and became trading companies. Even more importantly, they were muscled aside by the banks which rapidly discovered that lending on mortgage was easy, secure and extremely profitable.
The new dominance of the banks in mortgage lending was given added significance by a power that the banks have and building societies did not. Whereas the building societies were limited by the resources made available to them by lenders, the banks suffered no such constraint. They were able to create mortgage finance out of nothing, by the stroke of a pen. There was virtually no limit as to how much they could lend, provided that there was adequate security for the loans they made. And that problem – adequate security – was easily taken care of because they could simply go on lending to new generations of borrowers and purchasers who could afford, with the banks’ help, to pay the ever-inflating prices.
The banks had discovered a huge machine for generating profits. They could charge interest on money they themselves created, and they could ensure that their lending was virtually risk-free by virtue of their willingness to go on lending so that prices (and the value of the assets that provided their security) kept on rising.
This change – the most important change in our monetary conditions for generations – is only dimly understood. The Reserve Bank, however, is becoming uncomfortably aware of the instability of the situation we find ourselves in. If the banks should suddenly encounter a downturn and incur significant bad debts, and house prices turned down rather than up, the whole ramshackle structure could come tumbling down. Others can see that huge bank profits – removed from our economy and transferred back to Australia – are a heavy burden for our balance of payments. Yet others understand that the asset inflation in the housing market is the major source of inflation and a huge driver of widening inequality, as those who can access mortgage finance prosper and others are left behind.
The Bank of England has recently conceded that 97% of all money in the UK is created out of nothing by bank lending and the greater part of that goes on house purchase. We are in exactly that same situation; there is no solution to housing unaffordability until the banks are made to behave more responsibly.
Bryan Gould
7 May 2015.
It’s The Economy, Stupid
As with most elections, the Clinton dictum that “it’s the economy, stupid,” has held good in the general election of 2015 – with special emphasis this time on “stupid”.
The debate about who has done or will do best in managing the economy has been even more confused and irrational than usual this time. It is often the case that “the economy” means something quite different to the voters than it does to those contesting for power. For the voters, it simply means whether they have jobs, or feel better off today than they did yesterday. Arguments over the interpretation of longer-term economic trends leave them largely unmoved. And the more bitter and divergent those arguments, and the more they depend on either side on disputed facts, the less willing and able the voters are to get involved.
Ten years from now, however, it is a safe bet that much of the confusion will have cleared. We will be sufficiently distant from the hurly-burly, less engaged in partisan dispute, and better able to agree on what recent history really tells us. A consensus of informed and objective opinion as to what really happened and why will have emerged.
We already know the shape of that consensus. We know because we have been here before. It took a Keynesian revolution and a Second World War before we could see clearly what had caused the Great Depression but that understanding did emerge. The ideological prejudices of those who had insisted on retrenchment as the cure for recession simply could not survive the clear light cast by unchallengeable facts.
By 2025, we will have reached a similar clarity of view and analysis as to what caused the Global Financial Crisis and the consequent recession. Those who were major players – and therefore major culprits and protagonists – will have departed the scene. We will know that the GFC was the inevitable outcome of mistaken and irresponsible excesses, and of an irrational belief that markets are infallible and self-correcting.
We will know that the response to the recession that inevitably followed – as the banking system teetered on the brink – made it the longest and deepest recession of modern times. We will know that British living standards fell more sharply and recovered more slowly than they need have done and were still in 2015 lower than they had been in 2007, and that austerity was a deliberate and bone-headed denial of all we had thought we had learned.
So, why do we have to wait till that point when it is already clear what has happened? How can the assertion of partisan positions, unsupported by the facts, nevertheless muddy the waters to the extent that the voters of 2015 are left confused and uncertain?
The answer is partly and importantly a consequence of Labour’s inexplicable failure to defend itself and its economic record and to develop a coherent argument as to what really happened and what can now be done. Labour surrendered any ability to argue an alternative economic case when it accepted that the reduction of the government’s deficit is the most important single goal of economic policy and one that it would carry into government if it were elected. That ensured that no real challenge could be offered to the Tory analysis and policy prescriptions, however mistaken and destructive they may be.
It is also, however, a reflection of the Tory ability to dominate the debate agenda and to flood the news media and information sources with misleading and sustained misinformation. How else to explain that it is Labour that has to defend itself against the charge of responsibility for the Global Financial Crisis and the consequent recession – surely the definitive judgment on the errors and excesses of “free-market” economics? How else to explain that continued austerity is accepted as the only game in town? Or that George Osborne can claim to have produced “success” and “recovery”?
It may be expected – even accepted – that politicians, with their reputation for cynicism, will bend the facts and tell it like it isn’t. But what to say of the role of the massed ranks of media and the establishment that urge them on in their deceptions? Are they so dedicated to their partisan interests that they are happy to see the country languish in a continued failure that looks increasingly unavoidable, as long as “their side” retains power?
It does no service to the voters or to the country they live in that they should cast their votes on Thursday in deliberately engineered ignorance of the true state of affairs. Those who seek to mislead them in this way are taking huge risks with democracy as a form of government and with our future as a country.
Bryan Gould
4 May 2015
Obstacles to Trade
A few eyebrows were no doubt raised when the Prime Minister said on television news last week that his four or five-day visit to the Gulf – unsuccessful though it proved to be – was a better use of his time than spending the same time in Wellington.
We should not perhaps have been surprised at the Prime Minister’s order of priorities. Third-term leaders across the globe often find that the opportunity to stride the global stage is a welcome boost to the ego and an equally welcome diversion from the tedious business of domestic politics.
And, as John Key pointed out, his goal – a free trade agreement with the Gulf States – was, although unattainable for the present, a prize worth seeking. When a prize of that kind is won, as was the case a few weeks ago in the case of South Korea, the dollar value of the deal is immediately talked up. The Korean deal was said to be worth $65 million in its first year, and much greater figures are of course attached to a possible “success” in the talks aimed at a Trans Pacific Partnership Agreement.
Let us put to one side arguments about the price that we might have to pay for such arrangements and acknowledge that no one could fail to welcome the boost to our trade as the result of the removing tariffs in our export markets. But this still leaves a major puzzle about the Prime Minister’s and the government’s attitude on such matters.
If reducing tariff barriers against our exports so that we can sell at more competitive prices in individual markets is so beneficial, and so easily quantifiable in terms of the boost to our economy, why are we so relaxed about the tariff we impose on ourselves – not just in respect of particular markets but in every market, including our own, and on everything we try to sell?
If, as is widely accepted, our dollar is over-valued, and has been for a very long time, that simply means that we are charging too much for our goods and service in export markets – and, for that matter in our own market when we are competing against foreign imports. We ask buyers, in other words, to pay 20% more than the goods are really worth. We are in effect demanding a premium, or imposing a tariff, on our own goods. And if a tariff of, say, 20% in an export market damages our trade, then that trade is equally damaged by an over-valuation of 20%. And over-valuation applies of course across the board, and not just – as a tariff does – to particular products in a particular market.
So, if we can so easily calculate the benefits of reducing tariffs, why cannot we apply the same calculation to the benefits of reducing the over-valuation? If the Prime Minister finds it worthwhile to travel the globe in search of the odd success in getting deals to reduce tariffs on particular goods, wouldn’t it be worthwhile him staying at home for a few days to work out ways that we can escape from the damaging over-valuation treadmill?
As it happens, we don’t need to be statistical whizzes to work out the cost of over-valuation. We can make an initial estimate by looking at our continuing failure to pay our way in the world. We have run a perennial trade deficit – that is, buying more from overseas than we sell or, in other words, consuming more than we produce. It is that deficit, and not the government’s, that really measures how well we are doing.
That trade deficit is now on the rise again, as happens every time we have a consumer-led boom, and as our over-valued products fail to keep pace with cheap imports. We are rapidly heading back to danger territory, when we could spend up to five cents in the dollar more than we earn; and when we need to cover the shortfall by increased borrowing and selling assets, that represents a typical rake’s progress that cannot be sustained.
The longer it goes on, the worse it gets. Every time we borrow more, at high interest rates, the cost of repayment increases. And every time we sell off assets to foreign buyers, the greater the size of the income stream we lose as profits are paid into foreign hands – and, of course, the less control we have over our own economy.
Yet the government, and most New Zealanders, seem completely unconcerned, and in most cases completely unaware, that this is our true situation. And it is not just the direct cost of the trade deficit that penalises us. The fear that the trade deficit will get completely out of hand and can no longer be financed by borrowing means that we are frightened to grow as fast as we could and we fail to diversify and invest in new capacity – as witness our increasingly dangerous dependence on the unreliable price of a single commodity.
Wouldn’t a few days’ attention to these issues, rather than knocking one’s head against Saudi intransigence, be a good use of time?
Bryan Gould
2 May 2015
Which Deficit?
So, the much-touted and long-awaited government surplus looks unlikely to arrive this year. Is that a surprise? No. Does it matter? Not much.
The only reason for sparing much time on the failure to eliminate the government deficit is that it relates to a target that the government itself identified as the crucial test of its ability to manage the economy. In doing so, it exploited the confusion in most people’s minds – and that includes the minds of many media commentators – as to what deficit we are really talking about.
Just a few days ago, in reporting the probability that the government would remain in deficit, Radio NZ news described it as “the country’s deficit” as though the two deficits were the same thing. Sadly, the government deficit, about which so much fuss is made, is only a minor factor in an economy which continues to remain in substantial deficit in its total operations.
Far from running the economy in a prudent fashion, the government presides over a New Zealand economy that continues to chalk up foreign payments deficits, year after year. We continue, in other words, to go on spending well beyond our means. We fill the gap by selling assets to foreigners and by borrowing at high interest rates to overseas lenders – a classic instance of a rake’s progress that makes a day of reckoning eventually inevitable.
That foreign payments deficit is about to get a lot worse, as the overvalued dollar (about which so much jingoistic celebration was enjoyed) makes it more and more difficult for us to pay our way. Those cheaper Aussie holidays today are bought at the cost of Kiwi jobs and living standards tomorrow.
So, let us be clear about the deficit we are talking about – the country’s deficit, the one that matters, the one that is getting worse all the time, or the government’s deficit, that simply defines how much the government takes in tax revenue from the rest of the economy by comparison with how much it spends.
Is there are any link between the two? Yes – the priority given by the government to its own deficit has almost certainly made the country’s deficit worse. This is because, in a recession, which by definition arises when people (that is, households and corporations) are earning and spending and investing less, the slow-down can only deepen if the other major sector – the government – also cuts its spending.
Our recession was longer and deeper than it should have been, in other words, because the government gave priority to balancing its own books, and ignored what was happening to the whole economy. An economy that went backwards for several years was even less able than usual to pay its way in the world when the world economy began to improve.
But surely, many will say, it must be a good thing for the government to tighten its belt when the economy slows down? That would be true if the government were a business, but running an economy is not the same as running a private business. The paradox is that the government’s preoccupation with its own finances has meant a more sluggish economy and reduced tax revenue so that it becomes more and more difficult for the government to balance its books.
This is the lesson taught by both history and recent experience. It is a lesson that has now been painfully learnt all over again by the world’s central banks, some of which – the European Central Bank, in particular – wasted six or seven year insisting on austerity as the proper response to recession. The people who paid the price for that mistake were Europe’s poor and unemployed; we were saved from worse only because our Australian-owned banks remained relatively stable and because our main export markets in Australia and China remained until recently reasonably buoyant.
If the government’s finances are only a small part of the picture, why have they attracted so much attention? It is worth noting in passing that, while the Labour government of 1999-2008 recorded a surplus in eight of its nine years, the current government has now chalked up six successive deficits. So why focus on this particular factor?
The answer is that focusing on the government deficit has been driven by political rather economic considerations. It has served the government very well as the justification for policies that come straight from the neo-liberal handbook. We can be sure that the next round of cuts in the level of public services will be misleadingly explained as “necessary to eliminate the deficit”.
In the end, in any case, facts cannot be denied. As any accountant will tell you, borrowings and lendings must, as a matter of accounting identities, match each other. Our perennial foreign payments deficit – what we need the rest of the world to lend to us – must be matched by the borrowings our economy makes in total. If the focus is entirely on achieving a government surplus, that makes it inevitable that the private sector (households and corporations) must borrow even more.
The truth is that, by looking only at the government deficit and ignoring the country’s deficit, we create an unbalanced and broken-backed economy that will survive only as long as overseas peddlers of “hot money” are willing to go on lending to us.
Bryan Gould
12 April 2015
Call To Action – A New Book
I am delighted to report that a new book, co-authored by my long-time colleague, John Mills, and myself was published in London last week by W H Allen. The book is called “Call To Action” and comprises a powerful argument for addressing the major problems that have now held back the British economy for decades. Those problems include a damaging loss of competitiveness, a policy blind spot on the importance of the exchange rate, a perennial and debilitating foreign payments deficit, the perilous decline of manufacturing, and the futile focus on the government deficit as the prime goal of policy. The book provides a carefully researched case for taking action now before it is too late and could offer the way to better outcomes following the May election.
Call to Action by John Mills and Bryan Gould
Published by WH Allen, part of Ebury Publishing
£10.00
Buy now
This book is also available as an ebook.