SA5. Crunch and Slump by Geoffrey Lee

By Geoffrey Lee – The credit crunch and the housing slump of 2008-09 are so intimately related that one cannot be solved without treating the other.

Banks and credit.

Banks are in the enviable position of being able to create money out of thin air. This

is done by a confidence trick. When they lend me £200,000 to buy a property, they do not go round to their other customers and say, “Please don’t take your money out, because we have lent it all to Geoffrey Lee”. No, they gamble on the hope that their depositors will always keep enough in their accounts to cover the bank’s lending, If all their customers attempted to drawn their money out, they would find, as Northern Rock’s customers found, that the money wasn’t there.

Because money lent becomes a new deposit, the sum total of all deposits is always growing. This multiplying effect means that if banks keep 12.5% of their deposits (a traditional percentage) in cash, they can safely.lend the rest, which can eventually turn an £8 deposit into £100 of lending. Once upon a time, the amount banks could lend was tightly regulated, but since 1971 successive governments of different political complexions have progressively dismantled these controls, leading to a disastrous free-for-all. If we want to avert a recurrence of this present crunch, we also need to understand why banks and other lenders acted so unwisely in their own interests as well as the interests of everybody else.

Housinq prices.

Both in this country and in the United States, the first clear sign that things were going wrong with the economy was a collapse in house prices. In one sense, house prices have not collapsed at all. The price of a house is what it costs to build it, and this has not greatly changed. What has changed is the price of the land it sits on. The price of a piece of land, whether used for housing or anything else, derives from two sources: its natural attributes, like its fertility or its underlying minerals, and the work of the community. In the case of housing land, the second source is usually much the more important. This includes the provision of roads, sewerage, drainage, water supplies, police forces, fire brigades, schools, hospitals, transport and so on. Without these services, land would have little value in a developed society. With them, land commands a sale price or a rent which goes to the freeholder.

In times of boom, the price of the land underneath housing went up and up. Eventually people could not afford it. House prices wobbled, and then plummeted. Building societies, banks and others who had advanced money on the expectation that boom conditions would continue indefinitely suddenly found themselves in deep trouble.

Housing land is only one kind of land which was affected. The price of agricultural land, industrial land, land under shops and so on all behaved in a similar way. In those cases too, banks had advanced money without adequate security in anticipation of an indefinite boom. As with housing, both the borrowers and the lenders have suffered from this fundamental miscalculation.

Others, too, who might have been expected to anticipate these events failed to do so. Neither the Government nor the Opposition appear to have seen trouble coming. Few professional economists gave any warning. Large firms as well as small ones have already been ruined, and others seem likely to go the same way. Ordinary people have suffered terribly. Many have lost their jobs, and many more are likely to do so.

Towards a solution.

All kinds of short-term solutions have been proposed. Many people probably agree that there should be further controls on banking. Some people have suggested requiring the Bank of England to lend whatever is necessary to get us out of the present mess with an interest-free overdraft, which would cut the cost of issuing interest-bearing bonds, stocks and other financial instruments. It has also been suggested that the government could lend to local authorities for them to lend to potential house purchasers at a low rate of interest. Such solutions have big disadvantages as well as advantages, and it is not the business of LANDISFREE to defend them. Whatever is done, we are all in a mess and will continue to be in a mess for a long time to come. There is no quick fix.

What we can do, however, is to ensure that nothing like the present crunch ever occurs again. This requires an understanding of the fundamental differences between land and the things which have been created by human effort. The “law of supply and demand” applies to most things. If there is a demand for more buildings or computers or cabbages, resources are deflected to produce them. But land does not behave like that. The quantity is fixed, and the effect of growing demand is merely to raise the price. When the price becomes too high for the market to bear, there is a slump.

This points to a fundamental restructuring of our taxation system. In an ideal world, that which has been privately created should be enjoyed by its creator without any arbitrary confiscation by the state under the name of taxation. What has not been created privately is either a gift of nature or the result of work by the community as a whole and should be returned to the community. The place where this public revenue manifests is the rent of land, or “situation rent” as the economist Alfred Marshall put it. If we agree that most of this “situation rent”, or site value, has been created by public investment, then, logically, we must agree that the revenue from it should be returned to the community.

The practicality of collecting this community-created revenue (which, of course, includes the costs incurred by the government itself in providing a stable environment for economic activity) is simple. The first requirement is to value all land; the second is to impose a tax based on that valuation. The valuation would refer to sites alone, and would exclude any “improvements” resulting from human activity. This is called Land Value Taxation, or LVI. There were two attempts to do this, in 1909-10 and in 1931, and in both cases (though for different reasons) the valuation was never completed.

In the view of professional valuers, the valuation should be easy and cheap and, once it is in existence, taxation could begin. This could be done either for local purposes, in replacement of Business Rates and Council Tax, or for central government purposes in replacement of part of existing taxes like income tax and VAT, or for both kinds of purposes.

As with other taxes, LVT would require periodic revision. When there was a movement towards boom conditions, more L VT would be collected and therefore the economy would be less “overheated”. When there was a movement in the other direction, less revenue would be collected and more money would therefore be available for spending and investment. Violent booms and slumps would cease, and the general economy would be stabilized.