We are on a Real Estate Monetary Standard

I’ve been thinking a lot about this over last few weeks when I have the chance to think. It seems like we are on a real estate monetary standard. Much like how we can use assets like gold to create a commodity money system, it seems like we operate our current monetary system as a real estate standard.

Banks create money against real estate assets. We use this money in our day-to-day transactions, without much thought about what stands behind this money, but most loans are for residential and commercial real estate.

If we did operate under a real estate standard, we would expect to see the larger economic business cycle greatly impacted by the real estate cycle, far more than the declines in real estate activity would predict.

As Cullen pointed out over at Pragmatic Capitalism, this is exactly what we see. We see housing as a huge controlling factor for our overall economic growth. Here is a key paragraph from the paper Cullen quoted from Ed Lerner:

“For long-run growth, residential investment is pretty inconsequential, but for the wiggles we call recessions and recoveries, residential investment is very very important. To make this visually clear, I have created a series of figures that illustrate what was happening to each of the contributions to growth before and during the recessions.

Here’s more:

“Eight of the ten recessions were preceded by sustained and substantial problems in housing, and there was a more minor problem in housing prior to the 2001 recession. The one clear exception was the 1953 recession, which commenced without problems from housing.”

The contribution to recessions is extremely clear – you can take a look at the paper and see just how huge of an impact housing has on our economy, despite its size.

The larger point I’ve been thinking about is that we’re close to running out of real estate to create money against, despite the urge for our economy to grow. Ed Lerner is talking about real estate creating conditions for a recession, I am also thinking about real estate coming up to create the conditions for a depression.

Real estate is valued 2 objective ways. One is against cash flows, the other is against replacement cost. We can’t leverage cash flows much more with the low rates we have, and even worse, we can  rebuild the structure for less then the housing price. So banks are naturally reluctant to lend much more value against real estate.

This is commonly thought of as a balance sheet recession, but it seems as though thinking about our system as a “real estate monetary standard” would help us give us more insight.

I’ll have more on this at some point, but wanted to throw this out there.

(Update: What are the odds?  Here is Mark Thoma on Robert Schiller: ‘Wealth Effects Revisited: 1975-2012′)

 

 

Comments
  • Lord January 21, 2013 at 12:24 pm

    There is a lot of truth to this, but as far as building for less do you mean less than owed as much is underwater or less than is being sold for which is not true of markets I am familiar with? One could also compare payments to incomes but even with the drop in incomes payments have fallen further making housing more affordable, though how much one should use current rates as proxy for the long term is a concern.

    • Michael Sankowski January 21, 2013 at 1:23 pm

      Hi Lord,

      Great questions. The longer posts I’ll have will help to address some of those points. What I mean specifically about building for less is the replacement value of the labor and materials required to build a house.

      There are three widely used ways to value real estate: cash flows, replacement cost, and comparables. The wider public knows about comparables because this was the method which was used over the last decade as the way to determine the value of real estate.

      But cash flows (think rent and the net present value of rent) and replacement costs (think rebuilding the entire structure) are more objective ways to value real estate.

      We are running into problems with both of these valuation methods for real estate. The cash flows from renting the properties do not justify a higher value, and the replacement cost of the materials and labor does not justify a higher value.

      It’s a problem for our private money system if the underlying asset on which we create money – in our case, real estate (and some capital improvements) – have reached valuations where creating more money is difficult.

  • beowulf January 21, 2013 at 1:49 pm

    Dean Baker explains all (rather plausibly, I think).
    “The economy is acting exactly as those who warned of the bubble predicted. We saw a sharp falloff of residential construction as we went from a near record boom, with construction exceeding more than 6.0 percent of GDP at the 2005 peak, to a bust where it fell below 2.0 percent of GDP. This meant a loss in annual demand of more than $600 billion a year.

    We also saw a large falloff in consumption due to the loss of $8 trillion in housing wealth. The housing wealth effect is one of the oldest and most widely accepted concepts in economics. It is generally estimated people spend between 5 and 7 cents each year per dollar of housing wealth. This means that the collapse of the bubble would be expected to cost the economy between $400 billion and $560 billion in annual demand.

    There is no mechanism that would allow the economy to easily replace the combined loss of between $1 trillion and 1.2 trillion in demand that would be predicted from the collapse of the housing bubble.”
    http://www.cepr.net/index.php/blogs/beat-the-press/underwater-homeowners-cannot-explain-the-weak-recovery

    Note that Baker is talking $1T to $1.2T a year, which makes Obama’s $800B in stimulus spending over 2 years less than even half-assed, on an annualized basis.

  • PeterP January 21, 2013 at 2:32 pm

    We could successfully target NGDP by having the Fed target housing prices. In recessions we would live in Bernankevilles ;)

    • Michael Sankowski January 21, 2013 at 8:09 pm

      This is literally Scott Sumner’s stance. He wants to use the fed to buy up real world assets and not just U.S. Treasuries, until the economy is humming. This means to buy up real estate loans – therefore buy real estate – in a variety of forms.

      The owner of the real estate is the person holding the note. If the fed buys up a bunch of securitized loans on real estate, this means the fed owns real estate.

      So what Sumner is proposing is to have the fed buy real estate, in truly vast amounts, in order to stimulate the economy. If it were gold instead of real estate, we would be under a gold standard.

      • beowulf January 21, 2013 at 10:29 pm

        What he’s talking about is nationalizing the mortgage market. The damned thing is the govt is headed that way anyway, its already guaranteeing 9 out 10 new mortgages. There was a ProPublica story about this last month.
        http://www.propublica.org/article/weve-nationalized-the-home-mortgage-market-now-what

        We can have a free market system where real estate loans are made and held without govt guarantees (to say nothing of real estate’s tax advantages, I’m sure stock market traders would love to be able to deduct up to $500k of capital gains every two years). Or we could socialize the mortgage industry with the govt loaning directly (paying bank or mortgage broker an origination fee) with the interest income and principal flowing to Tsy, or rather to its third-party mortgage servicer to make it look less like a tax payment— which in terms of draining both reserves and Aggregate Demand is exactly what it is. This is basically what was done to the student loan industry in 2010. Its now a single payer system where the Dept of Education loans directly and receives repayment directly,

        Anyway, so now we have a foot in two boats. Everyone says they want a free market, but what they really want is a free market with govt guarantees.. If I had a time machine, I’d bribe Congressman (from my sports betting fortune) to keep out mortgage and tax advantages for real estate ownership– affordable housing is important but subsidizing it just inflates prices. Even today that’s a good idea except…. deflating real estate prices is not anyone’s idea of a solution here. Either (1) we go to a student-loan like socialized system OR…. (2) We set current prices as benchmark , then privatize the mortgage market and strip out RE tax advantages from IRC. RE prices will plummet…. for underwater owners its all the same, the govt will just forgive the mortgage amount above new price. For homeowners who lose equity, the govt can reimburse them with a T-bond (a consol, ideally) equal to the difference between new price and benchmark price.

        • Michael Sankowski January 21, 2013 at 11:25 pm

          The government is an “insurance company with an army” .

          I had mentioned this before but the government is there to insure uninsurable risks to the best extent it can. it’s slowly moving up Maslow’s hierarchy of needs.

          What you are mentioning about the mortgage market and the student loan market are huge. These are huge issues. I don’t even know how to wrap my arms around them.

          All of this is monetary and fiscal policy, and we’re debating with a world that doesn’t even bother to connect the simplest dots. We’re going to stagger into our next 1/2 century.

          That’s one solution, but let’s face it – totally impossible. Ed Harrison has the best blog title ever – those credit writedowns will happen.

          • beowulf January 22, 2013 at 11:32 am

            “What you are mentioning about the mortgage market and the student loan market are huge. These are huge issues. I don’t even know how to wrap my arms around them. ”

        • Tom Hickey January 21, 2013 at 11:27 pm

          In my view, the guarantees are now hardwired into the system, and we are not going back. The only way to eliminate the moral hazard is for the govt to take over “retail” banking including residential mortgages (primary residence only) and leave the rest of commercial banking to the private sector, no guarantees expressed or implied.

          Of course, in a large enough crash, govt will still feel compelled to step in to present disaster from going viral. As Bill Black argues, we already have laws for bank resolution. We just need to follow them, as we did in the S&L crisis, wiping out equity, cramming down debt holders, and replacing management, and, very importantly, investigating and prosecuting wrong-doing.

          • Michael Sankowski January 22, 2013 at 9:25 am

            I don’t know about this step, Tom.

            We’ve essentially nationalized the real estate market because we use real estate as the backing for our currency. This is similar to how the U.S. government confiscated gold when we had a real gold standard. This time, they just used market outcomes to do this.

            But do we want a real estate standard?

            I’ll have more on this over the next few weeks. It’s not that I am totally against government action – not at all. Market forces aren’t perfect, but they are useful. And the private sector is the bigger and more important part of everyones life.

            Putting real estate lending entirely to the government sounds terrifying to me, and would for most people. If we nationalize the mortgage market, we are in effect nationalizing the banking system, whatever the ending institutional arrangements which implement this outcome.

            • Tom Hickey January 22, 2013 at 10:02 am

              Warren has been saying for a long time that the way to regulate banks is on the asset side. He claims that the ultimate factor in the crisis was the driving up of housing prices not only due to imprudent, predatory, and fraudulent lending, as shown by Black and Wray, for instance, but also the failure of bank regulators to put a leash on collateral. They allowed banks to lend on collateral that was way overvalued, even after the FBI had warned of rampant mortgage fraud.

              I think that that there is any sure step, Mike. Everything can be corrupted. That’s why I like a balance of public and private. But I don’t think that the balance can be achieved through public-private partnership, in that it results in moral hazard. Better to keep the two separate and let govt take care of what politically must in guaranteed and let the private sector manage risk where that is paramount, fully responsible for the consequences.

              There is no reason that govt can’t easily run a savings and payment system, which is what most retail banking is. Some of that is already set up through the postal system and E/EE bonds. Govt already ends up with most of the mortgage debt anyway. Why not just extend low interest long-term mortgages to primary homeowners against the collateral of the property assessed by the govt. The govt already does this for tax assessment. To me it’s a no brainer.

              Give the rest of banking to the private sector and let them take their profits and their lumps. I would get rid of the limited liability corporate model, however, and go back to the partnership model on which traditional banking operated. Then self-regulation would mean something.

              • Tom Hickey January 22, 2013 at 10:04 am

                Should be “I don’t think that that there is any sure step, Mike.” Meaning any arrangement can be corrupted. But at least when it is govt that is chiefly responsible in voters’ minds, there is recourse at the voting booth.

              • Michael Sankowski January 22, 2013 at 10:13 am

                The renewed focus on the benefits of mercantilism is going to bring this entire debate to the mainstream.

                Think about the sector balances – where can you get the demand to put your economy to full capacity?

                You can leverage private sector assets
                You can have the government deficit spend
                You can “steal” demand from other countries

                That’s it. Those are the options.

                I’m saying that Warren isn’t wrong, but rather he paints an incomplete picture. The leveraging was necessary to run a real estate backed currency system. 100% necessary. We needed to leverage in order to finance our growth.

                Of course this brings other problems, but the real benefits are there. We’re richer today than we were in 1980, much richer.

                • Tom Hickey January 22, 2013 at 10:26 am

                  Mike, are you saying that we needed a criminal enterprise such as Bill Black has documented in detail to do this? Otherwise, asset values could not have risen as high and as fast as they did, simultaneously serving as ATMs through HELOCs.

                  The one banker who stayed out of this game of what Chuck Prince called “musical chairs” was Jamie Dimon among the TBTF’s and, of course, many of the more prudent regionals and local banks. No issues here in Iowa, although now we are getting a bubble in farm land again.

                  If this is the way we are going to run the country, the US is deep doo-doo. Most experts that I consider experts see a bigger and more danger crisis developing on top of this one due to inability to achieve basic reforms, let alone hold bad actors accountable.

                  • Oilfield Trash January 22, 2013 at 12:16 pm

                    Tom

                    You cannot hand a child candy every day and be upset about the cost of the fillings to repair the cavities.

                    We can blame the banks for their behavior, but the banks did not create the GSEs, which used the G-fee the credit enhance collateral, and the banks behavior did not force the FED to lower interest rates, which IMO increased negative real rates of interest.

                    In this type of lending environment for intelligent people to not expect some amount of fraud (underwriting nonconforming loans etc.) is beyond me.

                    The government’s negligence was trusting the banks, who are motivated by individual interest, to operate in this environment as a benevolent oligarchy promoting the public good. TBTF could not have happened otherwise, and expecting the banks to unwind their prior behavior when it is against their interest is not going to happen either.

                    The goverment and FED policies allowed the GSEs to distort a free market and it backfired on them and now they either pay a price to continue to support it or they walk away and let market forces sort it out. Both have a price tag which we as citizens are going to pay.

                    • Tom Hickey January 22, 2013 at 12:56 pm

                      I don’t disagree with this, but “the government” didn’t just come up with this from out of the blue, nor for “big govt” liberal reasons. It was based on the revolving door, cronyism, and corruption that resulted in regulatory, intellectual, and eventually, state capture.

                • Tom Hickey January 22, 2013 at 10:29 am

                  “We’re richer today than we were in 1980, much richer.”

                  Maybe from the window you are looking out, but not from what I see. I see a country teetering on the edge due to excessive inequality that is still rampant. Look where all the “riches” went since 1980. Mostly to the top of the town.

                  • Michael Sankowski January 22, 2013 at 11:23 am

                    Nah. Stuff is much better today. The real world gains to auto quality, housing quality, and food quality are huge and hit every social class.

                    Not saying life is easier for the U.S. middle class and lower class, but nearly everyone has access to better stuff for the same cost. Even a middle class lifestyle has better things in it.

                    Additionally, we funded China. We helped to raise 1 billion people out of bone crushing poverty into something like or close to a middle class existence. This is one of the biggest events in human history, and U.S. demand was a large part of that event. It could not have happened without the U.S. providing a massive amount of…everything to China.

                    The world is much, much richer. It’s an objective fact.

                    • Michael Sankowski January 22, 2013 at 11:32 am

                      really, google world gdp. We’re richer, on a per capita basis, on every basis, by huge amount.

                      Also, Tom, come on with the needing a criminal enterprise stuff. Really. We’re trying to have a discussion, not a shouting match. Give me the benefit of assuming I am part of the loyal opposition at the very least.

                    • Tom Hickey January 22, 2013 at 12:36 pm

                      Per capita, average,mean, etc. mean nothing. It’s the distribution that counts. The wealthier are wealthier, and those that are “enjoying a higher standard of living” are living on the tab, and for many, this means beyond their means. This is unsustainable. The world economy is a largely rent-generating machine for the privileged class and its cronies and minions, and a greater of global GDP is rent-based.

                    • Tom Hickey January 22, 2013 at 1:01 pm

                      Global Inequality Skyrockets: Report Says Top 1% Have Increased Wealth By 60% Over Last Two Decades

                      A new report released by the anti-poverty group Oxfam is filled with staggering statistics that make clear the depth of the inequality problem.

                      http://www.alternet.org/news-amp-politics/global-inequality-skyrockets-report-says-top-1-have-increased-wealth-60-over-last

                    • Michael Sankowski January 22, 2013 at 3:57 pm

                      Tom, the median person in China and India is much, much richer than they were in 1980. Many times richer. The distribution of wealth in China can’t disguise a massive increase in the standard of living for the median person.

                  • Oilfield Trash January 22, 2013 at 3:32 pm

                    Tom

                    “I don’t disagree with this, but “the government” didn’t just come up with this from out of the blue, nor for “big govt” liberal reasons. It was based on the revolving door, cronyism, and corruption that resulted in regulatory, intellectual, and eventually, state capture.”

                    So what, if I walked into a building full of whores, then the only reasonable conclusion is I walked into a whore house.

                    If revolving door, cronyism, and corruption that resulted in regulatory, intellectual, and eventually, state capture is to blame for our problems, which to some extent I agee, we need to make the necessary changes to goverment and stop running a whore house.

                    • Tom Hickey January 22, 2013 at 6:41 pm

                      I am proposing that the way to do that is end moral hazard by separating govt and the private sector. Public-private partnerships are an invitation to capture. Let govt take over retail which it is already doing, and let the private sector take on the actual risk management of investment and speculation with no govt backstop, ever. If companies go under and this threatens the economy, then nationalize them for as long as it takes to fix them, which is really what bank resolution is. Usually, it’s sprung on Friday closing an over in a weekend. What we have now is socialism for the rich and capitalism for everyone else.

                  • Tom Hickey January 22, 2013 at 6:47 pm

                    Again, Mike, we are talking about countries of upwards of a billion people. The top 1% in both countries is fabulously wealthy, admittedly there is a growing “middle class,” but well over 600 million in both countries are living at the same standard or are worse off than previously. Both India and China are experiencing social unrest as a consequence.

                • jt26 January 22, 2013 at 11:05 am

                  I’m surprised it fell out of the mainstream. Reagan was very successful with it in the 80s; remember the days of voluntary Japanese car import quotas and the Plaza Accord. (Europe was also very successful with the car import quotas.)?

                • Tom Hickey January 22, 2013 at 11:17 am

                  “The renewed focus on the benefits of mercantilism”

                  Did you catch Evans-Pritchard, “A new Gold Standard is being born”
                  http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100022332/a-new-gold-standard-is-being-born/

            • Oilfield Trash January 22, 2013 at 11:21 am

              Michael

              “Putting real estate lending entirely to the government sounds terrifying to me, and would for most people. If we nationalize the mortgage market, we are in effect nationalizing the banking system, whatever the ending institutional arrangements which implement this outcome.”

              As they say in Texas “the horses are already out of the barn”. The goverment has nationalized the majority of real estate lending. The major investor is the Treasury, the FED is the market maker, who the heck is buying more MBS that the FED, and provides finacing for liquidity. When the FED buys MBS on the open market, IMO, it is using monetary policy as a subsititue from fiscal policy.

              http://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Mac

              “The September 7 conservatorship was termed by The Economist as the “second” bailout of the GSEs.[24] Prior to the enactment of the Housing and Economic Recovery Act of 2008, on July 13, 2008, Treasury Secretary Henry Paulson announced an effort to backstop the GSEs based on prior statutory authority, in coordination with the Federal Reserve Bank. That announcement occurred after a week in which the market values of shares of Fannie Mae and Freddie Mac fell almost by half (from a previously diminished value of approximately half of year-earlier market highs).[25] That plan contained three measures: an increase in the line of credit available to the GSEs from the Treasury, so as to provide liquidity; the right for the Treasury to purchase equity in the GSEs, so as to provide capital; and a consultative role for the Federal Reserve in a reformed GSE regulatory system.[26] On the same day, the Federal Reserve announced that the Federal Reserve Bank of New York would have the right to lend to the GSEs as necessary.[27]

              Capital infusion by the Treasury

              The agreement the Treasury made with both GSEs specifies that in exchange for future support and capital investments of up to US$ 100 billion in each GSE, at the inception of the conservatorship, each GSE shall issue to the Treasury US$ 1 billion of senior preferred stock, with a 10% coupon, without cost to the Treasury.[6][28] Also each GSE contracted to issue common stock warrants representing an ownership stake of 79.9%, at an exercise price of one-thousandth of a U.S. cent ($ 0.00001) per share, and with a warrant duration of twenty years.[29]

              The conservator, FHFA signed the agreements on behalf of the GSEs.[29] The 100 billion amount for each GSE was chosen to indicate the level of commitment that the U.S. Treasury is willing to make to keep the financial operations and financial conditions solvent and sustainable for both GSEs. The agreements were designed to protect the senior and subordinated debt and the mortgage backed securities of the GSEs. The GSEs’ common stock and existing preferred shareholders will bear any losses ahead of the government. Among other conditions of the agreement, each GSE’s retained mortgage and mortgage backed securities portfolio shall not exceed $850 billion as of December 31, 2009, and shall decline by 10% per year until it reaches $250 billion.[30]“

  • Greg January 21, 2013 at 6:06 pm

    Excellent piece Mike. I think you are on to something, an alternate way to understand our system. I’ve thought similarly but I also am torn between this and those who insist we are on an oil standard of sorts.

    I dont necessarily buy the oil standard lock stock and barrel because too much of it, at least how Ive seen it argued, uses the “oil is priced in dollars” as an argument. I see that as a complete non starter of an argument because whatever numeraire is used to price something is somewhat irrelevant in a world market. To qualify as being on a standard of sorts, it seems to me that one must find that thing which is never consumed, can be used as a general store of value by most people and that you keep a buffer stock of.

    I remember a comment in a thread one time (and Im gonna attribute it to Beowulf but I could be wrong) that said our govt has an unwritten energy policy which is essentially “Use ours up last”. Now this being the case I think what we might have is essentially a dual system, with two standards. Our govt money standard and our private banking standard. Our govt moneys buffer is “Oil in the ground on US soil” and our banks buffer stock IS US soil.

    • Michael Sankowski January 21, 2013 at 8:13 pm

      It doesn’t seem like oil has the same properties as real estate. We don’t find much money being created against oil or other commodities – Izabella Kiminska and the commodity financing plays aside.

      Most of the bank loans in the United States are for residential real estate. Banks create money out of thin air, which is backed by the value of the real estate.

      The oil think makes a bit of sense and Chris Cook has proposed moving to an energy backed monetary system. Bucky Fuller proposed the same thing. Those are proposals and not what’s happening now. I was just putting this out there as a way to help us understand our current monetary system.

      Under a gold standard, we had problems during times of low gold discovery because the economy wanted to grow faster than the monetary system would allow. I think we are running into the same issues with real estate and capital improvements.

    • Tom Hickey January 22, 2013 at 12:40 pm

      Greg, we are any “standard” that one chooses to use. That’s how a fiat currency where there is no specified anchor. Go over to Zero Hedge and everything is valued against gold, which is why they claim we are nearing hyperinflation. Go to the energy blogs and everything is valued against energy, where they claim that the global economy is running up against its limit.

      • Greg January 22, 2013 at 1:12 pm

        Tom’

        Agreed. A point I was trying to make is that, to me, it looks like the govt tends to base its spending on areas where they can leverage oil resources and protect the home energy front. Hence getting involved in every middle east conflict and not worrying about the level of spending it takes (Seems to me we could make the argument that Bush acted like he deposited a 2 trillion dollar coin before going into Iraq/Afghanistan, it was not counted towards our national debt and had its own separate accounting as I recall…… it was not borrowed from our banking system like all our other govt spending we do). Our banks simply leverage real estate. Two different goals

  • jt26 January 21, 2013 at 6:19 pm

    I was thinking something similar when QE3 was announced in Sept, commenting on pragcap: …in 1 year MBS will be 40% of the Fed’s BS, 55% in 2 years, 70% in 3. It’s pretty clear BB is using housing as a nominal anchor (rather than gold), and by pumping it up he is effectively doing a devaluation:
    - reduces effective nominal net debt (at least if you’re a home owner)
    - doesn’t affect headline CPI until it trickles through to the real economy (i.e. real (new) housing demand actually comes back or through speculators or blowback through rents as hon-owners can’t buy into the rally)
    - relative devaluation of wages (solves the sticky wage problem)

    • Michael Sankowski January 21, 2013 at 8:14 pm

      Are the numbers really that high? wow. Huge numbers.

      I don’t have all the information on this – email it to me if you have a minute.

      • jt26 January 22, 2013 at 7:46 am

        I checked the numbers again …
        http://www.clevelandfed.org/research/trends/2012/1012/01monpol.cfm
        As at Sept2012, current total Fed BS is 2.8T, 0.84T in MBS.
        And assuming a commitment to buy 0.48T/year and keeping the rest of the BS constant.
        40% in 1 year
        48% in 2 year
        54% in 3 year
        Sorry, I must have screwed up the calculation back then …

        • Michael Sankowski January 22, 2013 at 9:17 am

          Those are still huge numbers. And jeeze, it’s a comment on a blog about an obscure number off the top of your head, which ended up being pretty dang close!

          50% of the fed balance sheet is going to owning residential real estate. That’s a big deal.

  • wh10 January 22, 2013 at 8:24 am

    Mike, I think the latest from Raghuram Rajan is related to this discussion. I think he makes some valid points for consideration.

    http://www.project-syndicate.org/commentary/boosting-demand-impedes-recovery-by-raghuram-rajan

    • wh10 January 22, 2013 at 8:29 am

      This isn’t far from Pavlina R. Tcherneva’s point about needing to target stimulus more effectively. Obviously her solution is on the other end of the scale from Rajan’s, but they’re making similar points. (And it’s all related to your point about the importance of high-value collateral in sustaining demand in a private debt-based system.)

    • Michael Sankowski January 22, 2013 at 9:15 am

      “But if we believe that debt-driven demand is different, demand stimulus will at best be a palliative. Writing down former borrowers’ debt may be slightly more effective in producing the old pattern of demand, but it will probably not restore it to the pre-crisis level. In any case, do we really want the former borrowers to borrow themselves into trouble again?

      I swear I’ve written this nearly word for word in some MR post. Cullen and Richard Koo agree on this too. Even if we could stimulate more lending, do we want to do this? Probably not.

      • wh10 January 22, 2013 at 9:30 am

        Right.

        Is there a way to do it through more-targeted, equity-driven demand – i.e. fiscal policy? Is that more stable, and is it more desirable? In other words, is there something wrong with sustaining what we had before the crisis w/fiscal? I think I’ve read Mosler say something along these lines. Maybe it’s not good if you think America can do better, and the govt would be incentivizing the wrong things. But why not implement policies that address both the demand (fiscal) and supply side (e.g., education!) issues? The latter seems much more long-term, and just hoping for things to change seems like it will be a painfully long wait. In other words, throwing fiscal out, as Rajan seems to suggest, seems like throwing the baby out with the bath water. I think it’s a point that needs serious consideration, but I’m not ready to abandon hope on fiscal, and I don’t think Rajan has fully disproven (just highlighted the relative lack of teeth of some policy options).

  • Oilfield Trash January 22, 2013 at 9:01 am

    Exactly, Ashwin correctly describes this.

    Successive stabilisation leaves the economy in a condition where all economic actors have moved away from the idiosyncratic, illiquid economic risks that are the essence of an innovative, entrepreneurial economy towards the homogeneous liquid risks of a stagnant economy.

    THe G fee in Freddie and Fanny and the FED driving Real Interest rates negative allowed for the explosion of growth of RE loans.

    • Michael Sankowski January 22, 2013 at 9:08 am

      I really like Ashwin’s thinking and writing.

      This is a Minsky thinking about how the economy forces its actors to move to take on more risk or be left behind as unprofitable.

      But not many people address the fact that a very large amount of credit is real estate lending.

    • jt26 January 22, 2013 at 3:36 pm

      In some sense the government’s “successive stabilization” is due to the government ‘s lack of imagination. It thinks all problems can be solved by building more houses. 1930′s Europe was the same way. Their view was Europe was a zero sum game, if France gains X, Germany loses X. If Europeans could have dared to imagine what would happen in the 40 years following 1945, they wouldn’t have bothered with all the petty animosity. Many people claim that WWII shows what “fiscal stimulus” can do; that is so dead wrong; it was the sparking of imagination … “you can deliver unlimited energy from a handful of rock? we’ll have phones with no cords that display color movies that I can carry in my shirt pocket?; I’d rather do that than invade Poland!”

  • jt26 January 23, 2013 at 11:41 am

    Adding to my comment (jt26 January 21, 2013 at 6:19 pm) and Mike’s thoughts on the money-like properties of real estate and valuation, I wonder if the other Fed motivation is to unemcumber real-estate so there is enough owner equity to make the collateral money-like again. This may be an alternative valuation method, sort of like stocks … it could be the best or worst stock in the world but the margin is the same (excluding small caps, low $ etc.).

  • Carola Conces Binder January 23, 2013 at 3:36 pm

    This has really interesting historical parallels with the free banking era, which effectively entailed a state bonds standard. I wrote a post about the similarities: http://carolabinder.blogspot.com/2013/01/real-estate-monetary-standard-new.html

    • Michael Sankowski January 23, 2013 at 4:38 pm

      Excellent post Carola.

      I used the gold standard era as a good way to convey the idea quickly. We’re closer to the free banking era standards than to the gold standard era because banks are allowed to create money as they see fit, against a wide array of assets. The gold standard is a easy way for people to picture what’s happening with real estate, because gold standards are easy to understand and talked about all the time.

      • Dan Kervick January 24, 2013 at 10:11 am

        Mike, it seems to me we are much closer to a gold standard system than a free-banking system. Commercial bank liabilities are claims against their reserves. Market exchange of these liabilities routinely results in bank-to-bank transfers of reserves. In the gold standard days, banks were required to have reserves of gold. In the present day, banks are required to have reserves of USG-issued dollars. Otherwise, its the same system.

  • Dan Kervick January 24, 2013 at 7:13 am

    Michael,

    The connection between the real estate cycle and the broader business cycle seems intriguing. But I’m not sure this leads to the conclusion that we are on a real estate monetary standard. The dollars I possess in the form of bank deposit balances are not redeemable for real estate, either on demand or at term. And if a bank fails, the depositors don’t receive any real estate, do they? They receive money from the government. Commercial bank dollars are backed by government dollars. And I don’t think a case can be made that the government’s dollars are backed by land.

    Think of precious metal based system in which each bank is required to hold a certain quantity of precious metals in reserve, and required by law to redeem its notes for metal on demand. Banks in such a system will certainly own a number of other valuable assets. And in some sense they clearly “loan against” those assets when they expand their lending, because they are confident that, if need arises, they can convert those additional assets into metals, and redeem the notes they create with the desired metal. But whatever those additional might be, they are not the standard of the bank’s notes. We have such a system now, but metals have been replaced by government-issued dollars.

    The idea of land-backed currency is one that has been popular from time, and was first proposed – as far as I know – in John Law’s Essay on a Land Bank. It was later defended by Ben Franklin. The problem with the concept has always been the volatility of land values. If we were literally on a real estate standard, wouldn’t we expect to see the purchasing power of bank deposit dollars vary more or less in line with the prices of real estate?

    • Michael Sankowski January 24, 2013 at 11:16 am

      Hi Dan,

      Everything you say is correct. I am just pointing out our current system has a strong whiff of being a real estate monetary standard. I used a bold title to make you read the first paragraph!

      As Carola points out, it’s actually pretty close to the free banking era in terms of how the system operates. But not many people even know about the free banking era and even fewer ( including me) understand the free banking era.

      Now, the value of the money issued against the real estate can have directly different values from the value of the real estate. Money valuation is pretty complex, and I don’t pretend to understand it entirely, despite many years plumbing the secrets of the currency markets. And anyone who claims to understand the value of money is frackin’ nuts, in my book.

      So I thought it would be a good way to help people further understand our system. We create money against real estate. The money isn’t directly redeemable against the real estate, but the implied put in mortgage contracts makes it semi-redeemable against real estate.

      We are finding out, the banks act as though the money is redeemable against real estate.

      • Tom Hickey January 24, 2013 at 12:14 pm

        Right. And the financial sector knows that the collateral is implicitly or explicitly guaranteed by the govt. Which is why Warren says to regulate the asset side rather than the liability side.

    • jt26 January 24, 2013 at 12:03 pm

      Bank reserves are not the (first) backstop for bank money, it’s the collateral (i.e. owner’s equity). I think that is Mike’s point. Reserves are like the ultra-ultra safe AAA tranche of CLOs :-}

      • Dan Kervick January 24, 2013 at 3:42 pm

        I think the issue is not just about backstops, jt26. Bank money is a kind of IOU. And they are not just a pro forma IOUs that are never actually redeemed. They are functional IOUs that are redeemed routinely as part of everyday business. I issue payment orders against my bank deposit balance (bank money) all the time, and as a frequent result, the bank makes a payment from its own reserve balance (USG money) to another bank. If my bank had insufficient reserves of USG dollars to make these payments, it would have to borrow them from another bank, or directly from the government at a penalty rate.

        It’s just like as the bills of exchange and banker’s notes issued by the goldsmiths and early bankers, except now the representation of the deposit liability is usually a verifiable electronic bank statement rather than signed pieces of paper, and the reserve asset that is either withdrawn, or allocated to another depositors’ account, or moved from one bank to another, is a sum of USG dollars in some form, rather than a quantity of gold.

        Government-issued dollars are not just sitting there in the background to backstop the bank dollars “just in case”. They are the actual currency of everyday bank-to-bank payment transactions. The bank depositors’ money I possess consists in claims on this currency, claims that are routinely redeemed either by direct withdrawals of USG dollars in physical currency form, or by depositor commands to their bank to transfer some USG dollars to the bank of someone the depositor has paid.

        • jt26 January 24, 2013 at 6:29 pm

          Understood. I was thinking specifically about Mike’s thesis, i.e.
          - bank loan created against (real estate) owner’s equity and future cash flow
          - money moves out through the economy; settles against reserves
          - interbank settlement is not an issue, if bank losses are small (i.e. on average the owner equity is the first stop loss)
          Perhaps, the different viewpoints can be reconciled by whether one views the economy as a credit economy (Keen) or a monetary exchange economy. I tend to like the credit economy description better because it fits my everyday experience and experience with investments. (i.e. usually you only see TED spread start to rise as large bank losses are perceived by the markets).

          • jt26 January 24, 2013 at 6:37 pm

            BTW my description isn’t really accurate, as technically, my cash flows are the first stop loss, but in practice, new credit creation is related to the owner’s equity, that’s why leverage varies so much across the business cycle (at the top of the cycle the worst office building project can get done for 1:5; at the bottom of the cycle only great projects get done and only at 1:1).

  • elanrealestatesale January 24, 2013 at 10:06 am

    good one and even we are into real estate business and its nice to read the information about the monetary standards.

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