söndag 13 juli 2008

How wrong can anyone be?

This is taken from the website of Freddie Mac, one of the two big government-backed companies involved in US mortages.

"Freddie Mac operates in a single, safe business: residential mortgages backed by the equity of millions of American homes across the nation. Freddie Mac is subject to rigorous governmental oversight and substantial capital requirements, and our financial disclosures surpass those of other large institutions. These practices ensure that our business is financially transparent and accountable to our shareholders, regulators and the American public."

The trouble is that, as I was taught when I studied economics, land is not wealth, and house prices include a substantial chunk of land value in the total. So this equity in land, concealed as "American homes", was never quite as sound as most people, including the recognised experts, imagined. Worse till, the value was pumped up to a bubble value by financial organisation's willingness to lend.

When the sub-prime crisis broke last August, the commentators said that Freddie Mac and Fannie Mae were safe. Now it seems they are unravelling too. What happens next is going to be interesting, if painful.

The general view is that this was due to poor regulation of the banks. Wrong. It is due to banks lending money for land purchase. And there is no way of preventing them from doing so apart from the introduction of a tax on the rental value of land, which would need to be quickly ramped up to a high level, a change that would have to be accompanied by the progressive reduction of taxes on labour, goods and services. Unfortunately, land value taxation is not in the economists' repertoire of policies so pencil in the next crash for 2028 or thereabouts.

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