Affordable Housing Institute : US

[Continued from yesterday’s Part 1.]

Yesterday’s post, taking as its text a provocative and compelling Financial Times article, Asia’s Revenge,  by Martin Wolf, described how overpriced oil was bartered (via the capital markets) into overpriced financial assets.

 

Mine’s overpriced?  So’s mine!

 

Unbalanced global capital flows show up directly in housing – because what else can you buy with dollars but US housing debt instruments? 

 

Yet the justification is less important than the consequences. Between January 2000 and April 2007, the stock of global foreign currency reserves rose by $5,200bn. Thus three-quarters of all the foreign currency reserves accumulated since the beginning of time have been piled up in this decade. Inevitably, a high proportion – probably close to two-thirds – of these sums were placed in dollars, thereby supporting the US currency and financing US external deficits.

 

As far as I know, housing is the world’s largest asset class – that is, more of the world’s collective wealth resides in housing than in any other class of assets.  Housing is also the world’s most broadly held asset class, the one touching more people than any other.  Under-investment in housing means under-investment in cities.  The logical intra-national end state is the ultimate wealth-extraction machine – the slum – but a logical inter-national end state is the resource-exploited colony.

 

Via AHI, I’ve been to a fair number of countries with large informal housing sectors.  In each place, I’ve been struck by the high quality of banking and financial structuring talent I’ve found there, and how little of it is being directed down the affordability pyramid to the lower-income households or lower-priced homes.  Bankers like scale – the more zeroes the better.  They thus divide the world less into domestic versus foreign investment, and more into big-and-numerical versus small-and-fuzzy.  It’s so much easier to buy the sparkly new Wall Street innovation – or to apply the same technology to our own domestic formal investments – than to muck about in the financial pasture trying to grow new seedling products and markets.  That’s especially true when your own offspring, and all your colleagues’ offspring, have taken their expensive US or UK MBA’s and done their stint on Wall Street or the City of London working on exactly these high-tech gewgaws.

 

Highest quality.  No really, highest quality

Like, for instance, dot-coms (remember them?):

 

Yeah, that’ll work!

 

The savings glut had another dimension, related to a second financial shock – the bursting of the dotcom bubble in 2000. One consequence was the move of the corporate sectors of most high-income countries into financial surplus. In other words, their retained earnings came to exceed their investments. Instead of borrowing from banks and other suppliers of capital, non-financial corporations became providers of finance.

With dot-com unavailable as a capital outlet, surplus-generating entities looked for the next big thing.  They found it in mortgages and credit derivatives.

A simple way of thinking about what has happened to the global economy in the 2000s is that high-income countries with elastic credit systems and households willing to take on rising debt levels offset the massive surplus savings in the rest of the world. The lax monetary policies facilitated this excess spending, while the housing bubble was the vehicle through which it worked.

The bubble, if we allow it to be so called, was the consequence, not the cause.

Which is effect, and which is cause?

The charts show what happened, as a result, to “financial balances” – the difference between expenditure and income – inside the US economy. If one looks at three sectors – foreign, government and private – it is evident that the first has had a huge surplus this decade – offset, as it has to be, by deficits in the other two.|

Inevitably, huge household financial deficits also mean huge accumulations of household debt. This was strikingly true in the US and UK. In the process, the financial sector accumulated an ever greater stock of claims not just on other sectors but on itself. This frightening complexity, which lies at the root of many of the current difficulties, was facilitated by the environment of easy borrowing and search for high returns in an environment of low real rates of interest.

Everybody had so much money they could make huge bets with each other, like the late stages of a hold ‘em tournament.

Too many chips chasing too few pots led to a cavalier attitude toward risk.

“Risk? I love risk!”

Fortunately, the US and the other afflicted high-income countries have one advantage over the emerging economies: they borrow in their own currencies and have creditworthy governments. Unlike emerging economies, they can therefore slash interest rates and increase fiscal deficits.

Which we’ve done, banking on value.

Yet the huge fiscal boosts and associated government recapitalisation of shattered financial systems are only a temporary solution. There can be no return to business as usual. It is, above all, neither desirable nor sustainable for global macroeconomic balance to be achieved by recycling huge savings surpluses into the excess consumption of the world’s richest consumers. The former point is self-evident, while the latter has been demonstrated by the recent financial collapse.

So among the most important tasks ahead is to create a system of global finance that allows a more balanced world economy, with excess savings being turned into either high-return investment or consumption by the world’s poor, including in capital- exporting countries such as China. 

What asset class offers high-return investment and increases consumption by the world’s poor?  Housing.

Plenty of capital investment opportunities here

Nations running large current-account surpluses have a geopolitical strategic reason to create a thicker and more robust housing finance ecosystem, to reinvest in expanding and improving their own national housing supply.

Housing is the asset class that can productively absorb all the capital you can throw at it.  Along the way, housing and housing finance generate all sorts of good-government ancillary benefits.  Housing moves more people toward full economic citizenship (as Ashoka calls it).  It promotes financial literacy and savings.  It strengthens the institutions of domestic government, especially regional and metropolitan.  It improves citizen participation and democracy. 
 

It is essential in any case for countries in a position to do so to expand domestic demand vigorously. Only in this way can the recessionary impulse coming from the corrections in the debt-laden countries be offset.

Housing creates demand for service providers (appraisers, originators, underwriters).  It cleans our bureaucratic cholesterol by creating stronger citizen-stakeholder demand for efficient public services.
 

Fixing civic engagement since granpa was a bigot
 

It is, in short, good for what ails developing countries.
 

Yet there is a still bigger challenge ahead. The crisis demonstrates that the world has been unable to combine liberalised capital markets with a reasonable degree of financial stability. A particular problem has been the tendency for large net capital flows and associated current account and domestic financial balances to generate huge crises. This is the biggest of them all.

Lessons must be learnt. But those should not just be about the regulation of the financial sector. Nor should they be only about monetary policy. They must be about how liberalised finance can be made to support the global economy rather than destabilise it.
 

Housing creates domestic demand.  Housing diversifies geographic risk and sectoral risk.
 

This is no little local difficulty. It raises the deepest questions about the way forward for our integrated world economy. The learning must start now.
 

Nations that do not have enough domestic demand for housing finance have to export their capital to other nations with more domestic demand.  If you want to keep your money at home, create home owners who want to borrow it to improve their homes, at home. 
 

If you don’t keep your money at home by profitably investing it in expanding markets like affordable housing, you wind up where we are now, where all those who hold sheaves of dollars are hoping and praying those dollars will still be valuable and will have US-based assets in which to invest.

Look again at the chart.

Who took revenge on whom?

Even more fun is when they overpay

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