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December 3, 2009
David Warsh, Proprietor


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Was Henry George Right After All? (A shaggy dog story)

I am not, to put it mildly, an expert on the endgame leading to last year’s banking panic. For that we have authors Andrew Ross Sorkin, of The New York Times (Too Big to Fail); David Wessel, of The Wall Street Journal (In Fed We Trust); the beat reporters of the newspapers; several columnists; and blogger Yves Smith, who provides a stream of commentary. (For an insider’s view of the run-up to the crisis, there is Lawrence McDonald’s A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers.) But I like to think that, as a journalist, I know something about how public opinion is formed.

And for my money, the match that lit the fuse of the astonishing explosion in October was an article by Alan Sloan and Roddy Boyd three months earlier in Fortune. Sloan is, by common consent, the best financial journalist in the business. How Lehman Lost Its Way couldn’t have been timelier. It atoned for a puff piece the magazine had done a couple years before on Lehman CEO Richard Fuld.

The words in the article were bad enough – Lehman had made one desperate bad bet on real estate after another, and adopted plenty of shaky accounting – but the detonator, the feature of the article that convinced me that the thing could only end badly, was the photographic essay on McAllister Ranch, a multibillion dollar “recreational community” of 6,000 homes that Lehman had bankrolled in arid Bakersfield, Calif., 120 miles northeast of Los Angeles. It had become a ghost town: “three square miles of fenced-off, almost lunar landscape punctuated by a half-finished clubhouse and a golf course gone to weeds.” (You can see a few of the images here, indifferently displayed.)

McAllister Ranch was a classic illustration of the kind of gross overbuilding that has been part of every serious downturn of the twentieth century, most of the nineteenth too. Last week, it was little Dubai’s turn to announce that it would delay payment on its mortgage debts. Perhaps that goofy palm-tree island and the half-empty office towers of the Persian Gulf city-state will become symbols of the bust as well.

Could it be that Henry George was onto something after all?

George, you’ll remember, was a great nineteenth century social reformer, the author of Progress and Poverty, tireless advocate of a single tax on land that he insisted was the remedy to all that ailed the world, written off as a crank by economists in pursuit of their vision of a scientific economics devoid of moral overtones. He died in 1897, after two unsuccessful mayoral campaigns in New York City, but not before attracting an enormous following, including, in Great Britain, the playwright George Bernard Shaw. George’s granddaughter, the dancer Agnes de Mille, recalled that, as a visitor to London as a child, his disciples would shyly ask permission to touch her hair – she was a living relic. George was written up to good effect as part of the “Victorian underworld” of economics in Robert Heilbroner’s The Worldly Philosophers: The Lives, Times and Ideas of the Great Economic Thinkers; and, even better, as a “saint and social deliverer” in Men of Good Hope: A Story of American Progressives, by Daniel Aaron.

Today George himself is a fading memory. But because the use and abuse of land is as lively a topic as it was when he first wrote, a hardy band of followers remain committed to the Georgeist tradition. The Secret Life of Real estate and Banking, by Phillip Anderson, proprietor of Investment Advisory Services, which bills itself as “the world’s foremost expert in business, real estate and commodity cycles,” appeared last year. Mason Gaffney, of the University of California at Riverside, dean of American Georgeists, just brought out After the Crash: Designing a Depression-Free Economy

But Georgeist arguments are hard to connect to mainstream views, except by straightforward empiricism and main-strength awkwardness. Take the first paragraph of Gaffney’s book, for example:

“It’s widely recognized that the economic crisis of 2009 was caused by unsound lending in real estate. Largely ignored, however, is that this contraction was easily predicted on the basis of a well-established pattern of land speculation, premature subdivision, and excessive building on marginal land that recurs approximately once every 18 years.”

Two of those assertions seem inarguable. When the crash came, the crisis was indeed rooted in unsound real-estate lending practices. And in fact it has been about 18 years since the United States savings and loan crisis, and the brief (but very expensive) recession of 1990-91 associated with it. Another 17 years before that occurred the 1973-75 recession, in which bank lending and the REITs (real estate investment trusts) played a major part.

But caused? That’s another matter. So is “easily predicted.”

Nothing there about China’s entry into global markets, about financial innovation, deregulation, technological change, US political gyrations, or any of the other factors more commonly cited. No doubt that when the crisis came, it was rooted in bad real estate loans around the world. The open question is whether property is a mainly a capital sink, a periodically dangerous form of hoarding, as opposed to a fundamental source of fundamental instability.

Land as an investment does seem to have characteristics that distinguish it from other asset classes. People throw their money into it in the expectation that its value will only increase. When it turns out they are wrong, they often hang onto it far too long, slowing the pace of recovery. So in some deep sense, Henry George was right. But then so was John Maynard Keynes. So was Karl Marx.

Instead of indulging in a spate of ancestor worship, it makes sense to give the topic a good going over. There will be plenty of time to consider real estate lending when banking reform moves to the top of the agenda next year. That mechanics of the real estate cycle are worth thinking about. After all these years, the Georgeists deserve a seat at the table.

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The world’s trade ministers gather Monday in Geneva for their seventh semiannual World Trade Organization conference. Led by policy director Richard Baldwin, VoxEU, the research and commentary site of the Centre for Economic Policy Research, prepared a lucid e-book that makes interesting reading for anyone interested in global trade.

The bottom line: signs are that the recovery has begun, but the decline in global trade between the third quarter of 2008 and the second quarter of 2009 was truly huge — the deepest since the Great Depression and the steepest ever, fully deserving of the sobriquet “The Great Trade Collapse.” The suddenness of the collapse holds out hope for an equally sudden recovery. To prevent it from happening again? Address those trade imbalances.

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