Oh My, Oops!
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An occasional commentary (for Australia’s federal politicians) #5

2nd February, 2008

Bryan Kavanagh LVRG, AAPI

Early this morning Australian time, the BBC featured a well-credentialed panel in Davos discussing the world economic meltdown. As usual, none had workable solutions. None ‘saw the cat’, the real estate bubble, painted in camouflage within the global economic picture. Each of them nevertheless provided some useful insights: Nouriel Roubini merited a congratulatory pat on the back for having called the downturn; similarly, Laura Tyson, an advisor to Barack Obama, for suggesting that it’s pointless to seek scapegoats when there’s a systemic problem that needs to be urgently addressed. But there were no answers, because participants couldn’t get down to the root causes of the unfolding economic depression.

It was accepted that central banks failed us by not turning back the credit spigot before the real estate bubble began developing. And, golly, if only we had our time over again, this wouldn’t have happened! Nonsense! Easy credit may have exacerbated the real estate bubble, but it didn’t create it, and it would have occurred even under a tighter credit regime – because that’s where the capital gains and tax advantages were to be found, the cost of money notwithstanding.

The real problem is our double standard on real estate speculation. Although property bubbles precede and underpin each and every crash, politicians know that many of us get a warm inner glow when our property values increase, so they’re certainly not going to interfere by telling us there’s a line to be drawn on the increase in land price until it self-corrects in a recession. After all, a man’s house is his castle, isn’t it? So, it seems that real estate speculation and rampantly escalating land price increases are only ever to be condemned after the event by politicians and economists. But, even then, nothing must be put into place to ensure that these events can never happen again!

It is not only politicians and economists who can still praise land price escalation as one of the ‘benefits’ of the private ownership of land whilst condemning the lack of affordable housing out the other side of their mouths. Even at law, real estate has come to be regarded as ‘private property’, and charges thereon as something approaching some sort of aberrant nonsense – although this flies in the face of well-established dicta that even freehold land is distinguished from ‘private property’ and that ‘quit rents’ used to be payable on freehold titles. So, speculative accretion in land values are rarely questioned or condemned from within the law either.

These vagaries about the role and responsibility of holding land in modern society are supported by the theory of real estate valuation having been written out of the study of economics – so that we never become too condemnatory about excesses in real estate markets, nor the recurrent economic busts that inevitably flow from them. These cycles of boom bust are far from ‘the essence of capitalism’, as is often portrayed.

It is not generally understood that the value of a piece of real estate may be established by capitalizing its net rent at the yield (or rate), indicated by the market. Were valuation theory widely understood, it would be seen immediately that a ‘market’ yield of 3% and less (that is, greater than 33 years’ purchase!) on residential property is entirely speculative. It follows therefore that a bursting has to follow the bubble, so that yields can return to commercial levels.

In valuing real estate for 38 years it has often struck me that more than a few real estate agents and many valuers develop a feeling for impending economic recession well before economists do. And, no doubt, real estate agents and valuers, amongst others, will have had a derisory chuckle at last week’s announcements from Access Economics and the IMF that economic growth might tail off during the course of 2009. Some ‘forecast’!

The ludicrous state of affairs exists that economists can only ‘forecast’ after the event because, whereas property professionals do understand the theory of valuation, economists don’t – because it’s not part of their neo-classical economic training.

But so long as real estate professionals’ fees are based upon a property’s value, they’re not going ‘to blow the whistle’ on the damaging effects of real estate bubbles on the economy, either – even though it may surely be argued that an ongoing healthy and vibrant real estate market is preferable to one characterised by repetitive booms and busts. They defensively pose the question whether it’s the role of real estate agents and valuers to second-guess economic analysts, anyway? And “surely it’s not for real estate agents’ or valuers’ institutions to get ‘political’ [read ‘honest’] on the role of real estate within the economy?” Thus has the science of political economy been reduced to a standing joke by the contrived separation of real estate from the economy.

Until policy makers can assert that real estate speculation destroys economies, the chances of remedying the current economic depression are zero. On the other hand, we’ll know we’re back on track when framers of public policy do acknowledge the need to capture more publicly-generated land rent and less taxation to the public purse. It’s beyond time that they did so, because taxing thrift and industry and inflating land price bubbles have obviously proven antithetical to healthy economies for more than 200 years now.

To corroborate that we’re exceedingly slow learners, we’ve only got to listen to the many irrational and contradictory ‘solutions’ analysts are now promoting in response to the meltdown, Chaos rules, in the name of developing ‘a global solution’.

Even though the one thing necessary for a swift recovery from the financial collapse is a simple fiscal adjustment to our revenue systems, it seemed a remote possibility when I listened to the BBC this morning. So, we’d better batten down for the long haul, and trust that ‘The Powers That Be’ don’t prefer again to wage war rather than to make this simple adjustment, as they did 100 years ago.