(the crisis of democracy #2)
The January 18th 2020 issue of The Economist has a special report on housing. It is troubling in more ways than I can say, but it is also a perfect illustration of some points I was trying to make in my previous post about epistocracy. The Economist prides itself on being a leading publication on economic questions in the English language world. It has a prestigious history, but in the past decade it started to shift dangerously toward the left.
According to The Economist, the greatest problem of housing markets is the misguided policies of governments to encourage private ownership of real estate. Their policy recommendation is for governments to play a bigger role in the housing markets. If not directly, then through exercising more control. All for the betterment of all, of course. We would all be better off living as tenants in government built rental buildings.
I am simplifying it, but that is the overall message. The exploration of the causes is little more than a history lesson describing government interventions and their consequences. Real root causes are hardly addressed.
It did not pay much attention to rent control and its effects on housing. It made only passing arguments on the effects of zoning. No talk about disastrous city planning. No mention of the effects of inflation and lose monetary policy.
Let me give you an alternative scenario:
- Loose monetary policy creates inflation.
- Since housing is the largest item in a typical family’s budget, rent is where the effects of inflation can be felt the most.
- There is an outcry about ‘affordability’, landlords are condemned and vilified, the media demand action.
- To appease their voters, politicians introduce rent control.
Landlords get the message and get out of business or just seriously restrict new construction. They do this for two reasons: they don’t like to be vilified and they can easily find alternative investment opportunities for their money.
- Available supply of rental housing goes down, demand drives up prices, housing isn’t just more expensive, it is also far more difficult to find.
- People realize that the best way to control their housing costs is ownership. It is also the best protection against inflation, the best way to create and protect their savings.
- The increased demand for ownership increases prices.
- Builders respond by building wherever they can, causing ‘urban sprawl’
- Activists demand control over the runaway free market, politicians enact land use legislations, zoning laws and restrictive building codes.
- Limiting supply increases prices, creates bubbles.
- Popping bubbles create financial crises and lower demand.
- Central banks lower interest rates to ‘stimulate’ the economy.
- Lower interest rates increase prices and re-inflate the bubbles
The above is just a sketch. I could use several more points to illustrate the harm caused by constant government meddling with the economy. Government housing, building ghettos in prime locations; the incredible levels of corruption involved in government financed co-op housing; the jerking around of home owners to alternatively incentivize or restrict the conversion of their properties to include rental units, but again, I think the point is clear:
The market tends to act rationally within the confines created by politics.
The Economist sees this exactly the other way around. It posits the market as the problem and politics as the solution. It blames the victim for the problems and its suggested solution is to give more power to the abusers who created the problem in the first place.
And we didn’t even get to the root causes yet. The real culprits of the housing problems (crisis, bubbles, shortages, unaffordability) are:
- Fiat money – loose and unpredictable monetary policy
- Rent control
- Land use legislation (green-belts)
- Fractional reserve banking, allowing banks to create unlimited amount of credit money
- Policies allowing divorcing interest rates from rates of savings
- Restrictive zoning and building codes; ever more bureaucratic and lengthy building permit processes
- Excessive costs imposed on new constructions and high costs on resale
Let me expand on this last point. In Toronto’s red-hot market today, 30% of the cost of a new unit is government fees and taxes. The developers make 15% at best. An acquaintance, sort of a developer, told me that they are approached by various city governments all the time with the suggestion that they should build rental housing.
But, how can they? Let’s suppose that they can build a unit for $500,000. $150,000 goes straight to the government. If they sell it as a condo, they get their money in about 2 years. If they rent it, they have to amortize the cost of that $150,000, on top of paying 2.5 times the rate in property taxes compared to owners. This means that one third of the cost of rental in Toronto is some sort of tax.
So, the response of developers to the requests for more rental buildings is “give us a break on the development fees”. The answer is usually no.
Who is at fault here? Who is the greedy one? Being a landlord is a very risky business and not a particularly respectable one. After the profit hungry capitalists and the greedy bankers, landlords are third on the left’s vilification hierarchy. Who needs that? Being treated like dirt for providing an essential service? For making money on something that is declared to be an essential human right? Can we be surprised if not many people are willing to subject themselves to this?
The economist article argues for the socio-economic value of renting, which, supposedly, enables greater labour mobility. Property owners are far less likely to move for a new job then renters. The thing they do NOT mention is that it does not have to be so. What depresses mobility are the excessively high transaction costs. In Toronto, new constructions are liable for a 13% sales tax, an up to 2.5% land transfer tax and a similar amount of “city tax”. All this is on top of the ~5% real estate agent fee and legal fees. Between buying and selling dates, the value of the property must increase at least 11% just to break even. If it was bought new, the number is 24%.
Land use legislations also have side effects that seem to escape the attention of The Economist. Increased density and limits on expansion drive up prices. As a result:
- Tax revenues go up, as most municipalities levy taxes on property value, not on the value of services provided or to the degree those services are used.
- A capture effect is created making the reversal of the policy nearly impossible. Property owners within the city want to keep the prices high. If the land use policy is reversed, the value of the existing properties will decrease, or stop increasing. Municipalities can count on the complete support of the incumbent owners to maintain the artificially high property prices. New entrants onto the market be damned.
- Those who manage to get over the new threshold, will immediately become supporters of the status quo.
When The Economist promotes the idea of government built and managed housing, they conveniently overlook the sorry fact that governments can never compete with the free market on either price or quality. “Affordable housing” is a gross misnomer. It is welfare housing. Funded by taxpayers and run by bureaucrats. Government built housing has 20-30% higher construction and management costs. They are poorly maintained. Most residents could find much better-quality accommodation if the cost difference would be handed to them as a rent subsidy.
The Economist does identify one of the greatest risks of the housing market, the artificially low interest rates, without actually pointing a finger at the underlying cause: fractional reserve banking creating credit money as if there was no tomorrow. If it keeps on going like this, there won’t be one.
In a healthy banking system, interest rates are defined by the amount of savings looking for productive use. That is not the system we have.
As usual, I could go on, but our real subject is not housing or real estate but the experts. In this case, the ‘experts’ of The Economist.
Just consider everything they missed, misrepresented or turned a blind eye on concerning this subject.
Just think how predictably tendentious their position is.
Just think: are these the experts we want to run our lives?
My strongest objection to the epistocracy idea is the fuzziness of the definition. The lack of the practical details. The concept is very similar in this fuzziness to its grand daddy, communism.
In any social organization, we need decision makers. Those are, by definition, politicians. The ‘experts’ will always be subservient to the actual wielders of power and we can certainly count on them to never bite the hand that feeds them.
I believe,……. I’m afraid, that the Fabian Socialists infiltrated and took over The Economist.
They are the wolves in sheep clothing, hammering the world stoutly to “remould it nearer to the heart’s desire”. With stealth, subterfuge and lies. Because they know better what’s good for us than we do ourselves.