The Housing-Finance Feedback Cycle…Exposed


Over the weekend, Agora Financial Australia’s publisher threw open the forum. He asked you what your biggest problems are when it comes to investing.

Thank you if you wrote in. We’re still working through the responses.

But already one theme is pretty familiar. I’ve heard it many times before.

You’re confused.

There is so much information out there. How to make sense of it all? And which asset classes should you allocate your money to?

I can’t answer these exact questions. But I can give you some pointers when it comes to understanding the economy.

I’ve got a good book in my hand that can help with this. Because the economy does have a structure and a very clear bias.

The book is called Why Can’t You Afford a Home? by Josh Ryan-Collins.

I’ll admit it — this is a pretty unfortunate title. It doesn’t really convey the wealth of information inside.

The title makes it sounds like a book for a 20 year old who doesn’t have a house deposit.

It’s much more than that. Even if you own a home — or more than one — you should consider reading it. Today’s boom-bust economy is all laid out for you inside of it.

Today’s Profit Watch explains why…

The two great blind spots in the market

The book highlights the two ‘blind spots’ of modern economics.

The first of those is economic rent. The second is the credit creation of the modern banking system.

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It also shows why it’s the ‘asset rich’ who get ahead in today’s economy, while wage earners are left to pick up the crumbs.

Not only that, the boom-bust cycle begins here, too.

I should say that Josh Ryan-Collins comes with excellent credentials. I’ve read two of his previous books. Both are great.

He’s also a former student of banking expert Richard Werner, whose work is another set of books you need to read.

But back to Why Can’t You Afford a Home? and the reasons you should read it…

1. It’s about the land

You’ve read about the high household debts across the West. You know about the sky-high property valuations. You know about the acute affordability issues.

Apparently, the UK, Canada, Australia and the US all have a problem with building a reasonable ‘supply’ of homes to keep prices down.

It’s nothing of the sort. It’s entirely because housing has become ‘financialised’. It’s become very profitable for investors to chase gains in property markets rather than engage in genuinely productive behaviour. This generates what’s called a rentier economy.

The game is to chase what are known as ‘land rents’ — the windfall gains that naturally accrue to landowners as the economy expands.

However, neoclassical economists at the beginning of the last century basically wrote land out of the study of economics. Some say it was deliberate.

That means many of the men and women who advise governments and central banks are missing a key variable in the economy. Is it any wonder they didn’t see the subprime crisis of 2007 coming? No.

Mr Ryan-Collins will wisen you up fast when it comes to the implication of this.

The main point is that real estate has become the major asset in almost every major economy.

It’s also the collateral for each banking system.

That brings into being what Josh Ryan-Collins calls…

2. The Housing-Finance Feedback Cycle

This is where the banks come into play. For years, modern economists taught that a bank collects deposits and lends that money on to borrowers.

This is not how commercial banks work. Bank lending creates deposits. That means when a bank makes a loan, it injects new money into the economy.

The Bank of England confirmed this in a quarterly update in 2014. However, various writers and academics have written about this for OVER A CENTURY.

It seems hard to believe that something so important could be so misunderstood.

Here’s the deal: The more credit the banks create for property transactions, the higher property values will go. The opposite is true. We can see this clearly in Australia right now.

The regulators hit the brakes on investor and interest-only loans. That’s slowed the market down.

It’s also how housing markets keep rising even though real incomes are stagnant.

We then get calls for social housing, share equity schemes, first home buyer grants and a myriad of other short-term fixes, except dealing with the two big issues I mentioned at the top of this article (that’s the rent and credit creation).

The name of the economic game is to capture those rising land values with borrowed money (actually created out of nothing) while it’s going on.

Unfortunately, this is a game of musical chairs over a long period of time. Lending against real estate is mostly unproductive and therefore doesn’t create an income stream to pay off the debts.

Property downturns turn into the most vicious downturns because they usually leave the banks with bad debts and consumers in negative equity.

The central banks — including the RBA — have the power to stop this. They could direct the banks to lend to small- and medium-sized businesses or for socially useful infrastructure projects.

This is how China uses its state-owned banks. It’s also the secret of how the Japanese and Germans rose from the ashes of 1945 to dominate the next 50 years of economic growth.

Regardless, there are no signs of this happening anytime soon.

So two key variables we have to watch in the economy are whether real estate values are rising and falling, and whether bank credit is expanding or contracting.

For example, the Financial Times reports that commercial retail rents in the US have exceeded their post-crisis highs. That suggests the US consumer is in a healthy place right now.

Timing this overall property cycle is the key to growing your wealth during the good times, and avoiding the busts when they come.

Pick up Josh Ryan-Collins’ book when you can. You’ll start to see this housing-finance cycle in action. And you’ll sleep better knowing you understand how the economy basically works.

More soon…


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Callum Newman,
Editor, Profit Watch

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